By: Mark Edwards – Senior Credit Officer & Bank Economist
Each year, Northrim Bank publishes the Alaska Economic Update. It is an opportunity to review the past year as well as look forward to the current year in regards to oil prices, jobs and housing. We will break the report into three sections for the blog. Once all have been posted, we will post the full report in our ‘Resources’ section for your convenience.
The Alaska economy has faced two difficult years of recessionary forces. It appears that 2018 will be a year of improvement, and the worst of the economic challenges are behind us or at least trending positive. There has been a short-term drag on the economy from the Alaska Legislature moving slowly towards a more sustainable budget by making difficult decisions on reduced spending levels and lower Permanent Fund dividends. However, a balanced budget solution will have long-run positive impacts through a return of business confidence and a stabilized climate for private capital investment.
Oil prices and production levels have trended upwards in the past year, which have helped close a portion of the state budget deficit and stimulated more exploration activity in the private sector. The federal government has also been encouraging the energy sector with regulatory improvements, leasing activity and the approval of ANWR legislation in the recent tax overhaul bill. Federal military and infrastructure spending is also expected to help stimulate economic activity.
A surging U.S. economy has helped the tourism industry reach record levels of visitors and helped the state government and many residents earn higher than expected returns in their investment portfolios and retirement accounts. U.S. economic strength has put pressure on the Federal Reserve to raise short term interest rates, with more hikes expected in the coming year.
Higher borrowing costs could put downward pressure on home prices, which have held steady in all our major markets despite the recession in Alaska. Building permit activity has increased and Alaska’s foreclosure and delinquency rates are still much lower than the national averages. Inflation has remained low in Alaska, averaging only 0.5% per year for the last three years. Alaska’s gross state product and total income began trending upward in the third quarter of 2017 after seven quarters of decline.
A 1% job loss in 2017 of approximately 3,300 positions in Alaska was driven by layoffs in the oil & gas industry, which most impacted business and professional services, construction and state government. As a result, the population decreased by 2,600, for only the fourth year of decline since 1945. The health care industry continues to expand and has been the leading source of job growth in Alaska over the last decade.
Inflation – U.S. inflation expectations are rising after years of limited change in overall prices. However, the rate of change in “Urban Alaska” has almost been non-existent for the last three years. The Federal Bureau of Labor Statistics (BLS) reported that the consumer price index (CPI-U) for Alaska rose 0.5% in 2017, roughly equal to the 0.5% and 0.4% rate of change in 2015 and 2016. Inflation for the last decade in Alaska averaged an increase of 1.9% per year. Energy prices increased 12.1% over the year. Without the rising cost of energy, inflation in Alaska would have decreased -0.6% in 2017. There were small decreases in housing, food, education, communication and other services.
Stable prices have helped maintain consumer purchasing power during this period of slower personal income growth. The national rates for the CPI-U began rising faster across the U.S. in 2016 at 1.3%, followed by 2.1% in 2017. This is important for the Federal Reserve because 2% inflation is its target rate for the overall economy. Stable inflation is one of the two pillars of the Fed’s “dual mandate,” along with full employment, guiding how they manage the nation’s monetary policy. Over the last decade Alaska’s inflation rate only deviated from the U.S. rate when the country was in recession and national housing prices were falling, while Alaska’s home values held stable. Now the reverse is occurring. Housing prices are flat in Alaska and increasing rapidly throughout the country.
Interest rates - The Federal Reserve raised the overnight target rate to a range of 1.5% to 1.75% on March 22, 2018. This follows quarter point rate hikes in June, March, and December of 2017. This was the sixth 0.25% rate increase in two years after nearly a decade of no movement. Although dependent upon a variety of economic indicators and forecasts, gradual increases are anticipated in the coming year. Current market expectations are for two additional short-term rate increases of 0.25% each in 2018, but that is dependent on the continued strength of the economy. While rates are volatile, current levels are below historical levels and are expected to trend upward as the national economy continues to improve. Rising interest rates will impact a variety of industries. Sectors that require more fixed asset investments and higher levels of financial leverage will see borrowing costs rise. Conversely, interest rates paid on short-term CDs and savings accounts should also climb up slowly during 2018.
U.S Treasury rates have increased roughly 1% for all durations between one month and two year maturities. However, you can see in the graph the longer durations in the yield curve have flattened with smaller spreads. The Fed has begun tapering off its investments in long-term Treasuries and mortgage backed securities that it made during the multi-trillion dollar policy known as quantitative easing. As the Fed
slows its activity in the markets, the longer term rates should rise in response to lower demand.
In the next post, we will have an update on housing issues.
