Inflation surges

Inflation is rising, with CPI climbing steeply above the Fed’s 2% target. But core CPI excluding energy and food remains stable.

Consumer Price Index

Job gains were the lowest since May 2016.

Job Gains

But the unemployment rate fell to a low 4.5%.

Unemployment

Hourly wage rate growth has eased below 2.5%, suggesting that underlying inflationary pressures are contained.

Average Hourly Earnings Growth

The Fed is unlikely to accelerate its normalization of interest rates unless we see a surge in core inflation and/or hourly earnings growth.

Gold testing $1100/ounce

Solid job numbers have boosted the prospects for an interest rate hike before the end of the year. Employment is growing steadily, having exceeded its 2008 high by more than 4.2 million new jobs.

Employment and Unemployment

Unemployment is falling as job growth holds above 2.0 percent a year.

Interest Rates and the Dollar

Long-term interest rates are rising, with 10-year Treasury yields headed for a test of resistance at 2.50 percent after breaking through 2.25 percent. Recovery of 13-week Twiggs Momentum above zero indicates an up-trend. Breakout above 2.50 percent would confirm.

10-Year Treasury Yields

The Dollar strengthened in response to rising yields, the Dollar Index breaking resistance at 98. Respect of zero by 13-week Twiggs Momentum indicates long-term buying pressure. Breakout above 100 would confirm another advance, with a target of 107*.

Dollar Index

* Target calculation: 100 + ( 100 – 93 ) = 107

Gold

Gold fell as the Dollar strengthened, testing primary support at $1100/ounce. 13-Week Twiggs Momentum peaks below zero indicate a strong (primary) down-trend. Follow-through below $1080 would signal another decline, with a target of $1000/ounce*.

Spot Gold

* Target calculation: 1100 – ( 1200 – 1100 ) = 1000

US October payrolls justifies December move

From Elliot Clarke at Westpac:

Recent softer gains for nonfarm payrolls cast doubt over labour market momentum, giving cause for some to question whether the FOMC would be able to deliver a first hike before the year is out.

The October report changed that view, with the 271k gain for payrolls taking the month-average pace back up to 206k as the unemployment rate declined to 5.0%.

There is certainly more room for improvement in the US labour market. But subsequent gains need to come at a more measured pace.

We continue to anticipate that a first rate hike will be delivered at the December FOMC meeting.

Read more at Northern Exposure: October payrolls justifies December move

Effect of long-term unemployment on the labor participation rate

Alan B. Krueger is Bendheim Professor of Economics and Public Affairs at Princeton University and an NBER research associate. Here he discusses the effect of long-term unemployment on the declining labor participation rate:

….The SIPP [Survey of Income and Program Participation] data indicate that, irrespective of the business cycle, the probability that an unemployed worker will be “steadily” employed in a full-time job for at least four consecutive months a year later is strikingly low and declines further as the duration of joblessness rises. Even in the strong job market of the late 1990s, the chance of a long-term unemployed worker finding steady, full-time employment after a year was only around 20 percent. This likelihood did not change very much during the 2001 recession, and it didn’t change substantially during the Great Recession. Conversely, the likelihood that an unemployed worker will leave the labor force a year later increases substantially as the duration of joblessness rises. According to the SIPP, 35 percent of workers who became long-term unemployed during the Great Recession were out of the labor force by 2013.

Why does long-term unemployment have such an adverse effect on workers? There has been a long, unresolved debate in the economics profession about whether the job finding rate is lower for the long-term unemployed because of either unobserved heterogeneity in the characteristics of such workers or something about the nature of unemployment that adversely changes people. Although this is an inherently difficult question to answer, the literature suggests that duration dependence plays a larger role than unobserved heterogeneity in explaining this phenomenon….. Much research suggests that long-term unemployment has a negative impact on both the supply side and the demand side.

On the supply side, an individual’s mental health and self-esteem can be affected by the experience of long-term unemployment. Till von Wachter has done good work showing that one’s physical health and mortality are adversely impacted by joblessness. Andy Mueller and I did a longitudinal study where we asked workers who were receiving unemployment insurance about the intensity of their job searches. We found that job search activity tends to decline the longer people are unemployed. We also found that the long-term unemployed tend to be socially isolated…… Furthermore, long-term unemployment tends to be associated with repeated job loss and lower re-employment earnings. All of these findings point to a decline in human capital and disengagement from the labor market as a result of long-term unemployment.

On the demand side, studies have shown that employers discriminate – at least statistically – against the long-term unemployed. Kory Kroft, Fabian Lange, and Matt Notowidigdo conducted a study in which they sent out resumes with varying gaps of joblessness, and they found that the likelihood of receiving an interview depended upon the duration of unemployment. Rand Ghayad also found similar results.

My take on the evidence is that the experience of being unemployed makes it harder for people to get back on their feet, and that even a strong economy doesn’t solve this problem. In addition, once a person leaves the labor force, he or she is extremely unlikely to return. The labor force flows data from the CPS bear this out (Figure 6). According to CPS data, the monthly rate for transitioning from out of the labor force to back in the labor force is unrelated to the business cycle. We didn’t see a wave of people returning to the labor force either in the late 1990s or earlier in the 2000s, and we’re not seeing one now……

Conclusion
To conclude, I will briefly comment on policies to address the problem of long-term unemployment. One of the overriding lessons that I take away from this body of research is that, if left untreated, long-term unemployment can have hysteresis-type effects on the labor market. A cyclical recovery does not cure the problems created by long-term unemployment. Going forward, I think one of the lasting legacies of the Great Recession is that the labor force participation rate will be about one percentage point lower than it otherwise would have been. This analysis argues in favor of using “overwhelming force” in a deep recession to prevent those who lose their jobs from becoming long-term unemployed in the first place.

Since long-term unemployment has been so widespread throughout sectors of the economy, “industry-specific” policies are insufficient to solve the problem. In 2012, for example, only 10 percent of long-term unemployed workers were from the construction sector, and only 11 percent were from manufacturing, despite the fact that these industries were hit particularly hard by the Great Recession.

Instead, I would prefer more targeted measures geared specifically toward helping the long-term unemployed stay in the labor force and find employment, such as a tax credit for employers who hire the long-term unemployed or direct employment. There also has been some research to support the notion that volunteering can help jobless workers make new connections, learn new skills, and stay engaged in the labor force. In the United States, job search assistance has typically been found to be effective in helping workers regain employment. I also think wage loss insurance might be worth considering, especially for older long-term unemployed workers.

Lastly, given that many of the long-term unemployed have already left the labor force, we should consider policies that address the structural decline in labor force participation. For example, more family-friendly policies might help greater numbers of women either enter or remain in the labor force. Likewise, reforms to the disability insurance system could possibly prevent some workers from permanently exiting the labor force.

Source: NBER Reporter Online

Why Fixed Investment is Critical to the US Recovery

The financial sector normally acts as a conduit, channeling savings from private investors to the corporate sector. When the conduit works effectively, the injection of demand from corporate Investment is sufficient to offset the ‘leakage’ from demand caused by Savings. Savings patterns alter during a financial crisis, however, with concerned households cutting back on expenditure and using any surplus to pay down debt, rather than depositing with the bank or buying stocks. Household Savings rise but corporate Investment contracts. The resulting ‘leakage’ from demand causes GDP to spiral downward.

When Investment contracts, unemployment rises. The relationship is evident on the graph below, but it could also be said that Investment rises when employment grows — businesses invest in anticipation of rising demand. Either way, it is safe to conclude that rising investment and job growth go hand-in-hand.

Employment Growth and Private Nonresidential Fixed Investment

Fixed Investment and Corporate Profits

Rising corporate profits also lead to increased investment. The lag on the graph below — investment growth follows profit growth — clearly illustrates the causative relationship.

Employment Growth and Private Nonresidential Fixed Investment

This is an encouraging sign, as the current surge in corporate profits is likely to be followed by rising investment — and further job growth.

Weekly Earnings and GDP

Rising weekly earnings already point to improving aggregate demand and consequent investment growth.

Weekly Earnings Growth

All that is missing is for the federal government to increase investment in productive* infrastructure to further boost job growth.

*Infrastructure investment needs to generate a sufficient return to repay debt incurred to fund the spending. Something many politicians seem to forget when preoccupied with buying votes for the next election.

More….

The Long War [podcast]

The Impunity Trap by Jeffrey D. Sachs | Project Syndicate

RIP ZIRP | PIMCO

How much longer can the global trading system last? | Michael Pettis

Crude retraces

Gold breaks $1180 support

Itzhak Perlman: Schindler’s List (video)

There are two kinds of discontented in this world, the discontented that works and the discontented that wrings its hands. The first gets what it wants and the second loses what it has. There is no cure for the first but success and there is no cure at all for the second.

~ Og Mandino

Why Fixed Investment is Critical to the US Recovery

The financial sector normally acts as a conduit, channeling savings from private investors to the corporate sector. When the conduit works effectively, the injection of demand from corporate Investment is sufficient to offset the ‘leakage’ from demand caused by Savings. Savings patterns alter during a financial crisis, however, with concerned households cutting back on expenditure and using any surplus to pay down debt, rather than depositing with the bank or buying stocks. Household Savings rise but corporate Investment contracts. The resulting ‘leakage’ from demand causes GDP to spiral downward.

When Investment contracts, unemployment rises. The relationship is evident on the graph below, but it could also be said that Investment rises when employment grows — businesses invest in anticipation of rising demand. Either way, it is safe to conclude that rising investment and job growth go hand-in-hand.

Employment Growth and Private Nonresidential Fixed Investment

Fixed Investment and Corporate Profits

Rising corporate profits also lead to increased investment. The lag on the graph below — investment growth follows profit growth — clearly illustrates the causative relationship.

Employment Growth and Private Nonresidential Fixed Investment

This is an encouraging sign, as the current surge in corporate profits is likely to be followed by rising investment — and further job growth.

Weekly Earnings and GDP

Rising weekly earnings already point to improving aggregate demand and consequent investment growth.

Weekly Earnings Growth

All that is missing is for the federal government to increase investment in productive* infrastructure to further boost job growth.

*Infrastructure investment needs to generate a sufficient return to repay debt incurred to fund the spending. Something many politicians seem to forget when preoccupied with buying votes for the next election.

When good news is bad news

“The U.S. economy added 295,000 jobs in February, a strong gain that beat expectations by a mile. Unemployment fell to 5.5%.” You would expect stocks to surge on the strong employment numbers. Instead the S&P 500 fell 1.4% on Friday. Penetration of support at 2080 warns of a correction.

S&P 500 Index

I can only ascribe this to fear of a rate rise. The stronger the employment data, the closer the prospect of the Fed raising interest rates. But Janet Yellen is likely to err on the side of caution, only raising rates when she is sure that the economy is on a sound footing and inflationary pressures are rising. That is far from the case at present, despite the good job numbers.

There is plenty of short-term money in the market, however, that seems to think otherwise.

Surprising lack of inflation as unemployment falls | Bank of England

Sir Jon Cunliffe, Deputy Governor for Financial Stability at the Bank of England:

“The big surprise, therefore, for the [Monetary Policy Committee] … has been the extent to which employment has been able to grow without generating more inflationary pressure through higher pay increases. Understanding why that has happened and how long it will persist is, in my view, now key to deciding policy.”

One possible explanation may be a longer-than-usual lag between falls in unemployment and pay pressure emerging, which could mean that inflationary pressure is building in the pipeline that will be more difficult to curtail if the Bank does not act now. However, another is that a combination of factors has caused labour supply – the amount of hours of labour available to the economy – to be much stronger than in previous recoveries, for example due to the increase in women’s state pension age and changes to the incapacity benefits regime. And the fall in unemployment has included a high number of long-term unemployed, who probably act as less of a drag on pay.

Yet despite the biggest squeeze on real incomes for nearly a century, there appears to be little evidence that workers are demanding a catch-up in pay, Jon observes, possibly due to a shift in the psychology of UK workers resulting from the sharpness of the recession and the years of austerity that have followed it.

Read more at Bank of England | Publications | News Releases | News Release – Monetary policy one year on – speech by Sir Jon Cunliffe.

Is unemployment really falling?

US unemployment has fallen close to the Fed’s “natural unemployment rate” of close to 5.5%. Does that mean that all is well?

Not if we consider the participation rate, plotted below as the ratio of non-farm employment to total population.

Employment Participation Rate

Participation peaked in 2000 at close to 0.47 (or 47%) after climbing for several decades with increased involvement of women in the workforce. But the ratio fell to 0.42 post-GFC and has only recovered to 0.435. We are still 3.5% below the high from 14 years ago.

When we focus on male employment, ages 25 to 54, we exclude several obscuring factors:

  • the rising participation rate of women;
  • an increasing baby-boomer retiree population; and
  • changes in the student population under 25.

Employment Rate Men 25 to 54

The chart still displays a dramatic long-term fall.

Work for the Dole doesn’t work – but here is what does

From Jeff Borland, Professor of Economics at University of Melbourne:

…95% of the time a government spends thinking about unemployment should be spent thinking about ways to promote economic growth.

Read more at Work for the Dole doesn't work – but here is what does.

Full Employment and the Path to Shared Prosperity | Dissent

Great summary of the current political gridlock by Dean Baker and Jared Bernstein:

There are many policies that can reduce inequality, but there is none as straightforward conceptually and as difficult politically as full employment. The basic point is simple: at low rates of unemployment, the demand for labor allows workers at the middle and bottom of the wage distribution to achieve gains in hourly wages, annual hours of work, and thus income.

Levels of unemployment are not the gift or curse of the gods; they are the result of conscious economic policy. The decision to tolerate high rates of unemployment is a choice. It is one that has enormous implications not just for the millions of people who are needlessly unemployed or underemployed but also for tens of millions of workers in the bottom half of the wage distribution whose bargaining power is undermined by high unemployment.

It is pretty obvious that low unemployment would enhance wage growth amongst middle- and low-income workers. But the policies to create low unemployment are not as clear:

Full Employment and the Path to Shared Prosperity | Dissent

Great summary of the current political gridlock by Dean Baker and Jared Bernstein:

There are many policies that can reduce inequality, but there is none as straightforward conceptually and as difficult politically as full employment. The basic point is simple: at low rates of unemployment, the demand for labor allows workers at the middle and bottom of the wage distribution to achieve gains in hourly wages, annual hours of work, and thus income.

Levels of unemployment are not the gift or curse of the gods; they are the result of conscious economic policy. The decision to tolerate high rates of unemployment is a choice. It is one that has enormous implications not just for the millions of people who are needlessly unemployed or underemployed but also for tens of millions of workers in the bottom half of the wage distribution whose bargaining power is undermined by high unemployment.

It is pretty obvious that low unemployment would enhance wage growth amongst middle- and low-income workers. But the policies to create low unemployment are not as clear:

How Hitler’s roads won German hearts and minds | VOX

Interesting conclusion from Hans-Joachim Voth and Nico Voigtländer, writing at VOX.

Long before the Nazi regime committed its singular crimes, it had become remarkably popular in Germany (Evans 2006). Voting records from 1933 and 1934 reveal the effect of one factor that, according to many historians, boosted support for the regime – the building of the Autobahn. Using detailed information on the geography of road-building, we isolate the effect of construction on voting behaviour by analysing the ‘swing’ in favour of the regime over a nine-month period (November 1933 to August 1934). We find that opposition declined much faster where the new ‘roads of the Führer’ ran.

Direct economic benefits for residents in Autobahn districts may have played a role, but they were probably small. More importantly, the new roads provided concrete proof of the regime’s actions, delivering on its promise to get ‘Germany moving again’. Within a couple of months of taking power, a highly ambitious highway construction project was under way at 17 different locations all over the country, affecting more than 100 electoral districts. In other words, the visible progress of road construction made the regime’s ability to follow through on its promises salient for many Germans.

Combined with effective propaganda trumpeting the regime’s successes, the roads succeeded in winning the hearts and minds of many Germans. Nor were they the only ones to be impressed. When the US Army rolled into Germany at the end of World War II, one of the officers taken with the ease of transport on motorways was Dwight D. Eisenhower. When he became President of the United States, he lead the initiative to built the country’s interstate highway system.

Read more at Nazi pork and popularity: How Hitler’s roads won German hearts and minds | vox.

A Mis-Leading Labor Market Indicator | Liberty Street Economics

From a paper by Samuel Kapon and Joseph Tracy at the Federal Reserve Bank of New York:

As the economy recovered and growth resumed, the unemployment rate has fallen to 6.7 percent. …..The employment-population (E/P) ratio frequently is used as an additional labor market measure. The E/P ratio is defined as the number of employed divided by the size of the working-age, noninstitutionalized population. An advantage of the E/P ratio over the unemployment rate is that it is not impacted by discouraged workers who stop looking for employment.

Employment-population (E/P) ratio

Since the end of the recession, the E/P ratio has largely remained constant—that is, virtually none of the decline in the E/P ratio from the Great Recession has been recovered to date. An implication is that the 7.6 million jobs added since the trough of employment in February 2010 has essentially just kept pace with growth in the working-age population. In its failure to recover, the E/P ratio would seem to depict a much weaker labor market than indicated by the unemployment rate. An important question is whether this is a correct or a misleading characterization of the degree of the labor market recovery…….

Read more at A Mis-Leading Labor Market Indicator – Liberty Street Economics.


Hat tip to Barry Ritholz.

Are US corporate profits sustainable?

Fierce debate has been raging as to whether rising US corporate profits are sustainable or likely to shrink, leaving the market overvalued. Consideration of some of the key contributing factors will enable us to assess if and when this is likely to occur.

Interest Rates

Low interest rates are clearly boosting corporate profits. The inverse relationship is evident from the strong profits recorded in the 1950s, when corporate bond rates were lower than at present, and also the big hole in profits in the 1980s, when interest rates spiked dramatically during Paul Volcker’s reign at the Fed.

Corporate Profits and AAA Bond Yields

The outlook for inflation is muted and the rise in interest rates is likely to be gradual and over several years, rather than a sharp spike, if the Fed has its way.

Employee compensation

Employee Compensation as a percentage of Net Value Added (by Corporate Business) has fallen sharply since the GFC, boosting corporate profits. Again we can observe an inverse relationship, with corporate profits spiking when compensation rates fall, and vice versa.

Employee Compensation compared to Net Value Added

A sharp fall in unemployment would send wage rates soaring, as employers bid for scarce labor. But that is not yet on the horizon and we are likely to experience soft wage rates in the medium-term (one to two years).

Corporate Tax Rates

The third element is the effective corporate tax rate which has fallen to an historic low, post GFC. Part of this can be attributed to tax losses incurred during the GFC, used to shield current income. The effect is likely to be short-lived, causing effective tax rates to drift upwards, towards pre-GFC rates around 24%.

Effective Corporate Tax Rate

Conclusion

The sharp rise in corporate profits is unsustainable in the long-term, but adjustments in the medium-term are likely to be modest. Higher wages and interest rates will have a more significant impact in the long-term, but are only likely to occur when sound economic growth is restored — which in turn would have a compensatory effect on corporate profits.

The quality of a person’s life is in direct proportion to their commitment to excellence, regardless of their chosen field of endeavor.
~ Vince Lombardi

What Happens When Unemployment Benefits Are Cut? North Carolina Offers a Clue | WSJ

Cutting out benefits can reduce the jobless rate in two ways, says Mr. Feroli [Michael Feroli, chief U.S. economist at J.P. Morgan], pointing to past economic literature. Under the employment effect, people will take jobs even if the work pays less than the job seekers want. In the participation effect, people will drop out of the measured workforce since actively seeking a job (a criterion for being labeled officially unemployed) no longer carries an advantage of receiving jobless benefits.

Read more at What Happens When Unemployment Benefits Are Cut? North Carolina Offers a Clue – Real Time Economics – WSJ.

Australian government hiding unemployment

The ABC examines whether Australia’s unemployment rate has been manipulated by the Government. Hat tip to Leith van Onselen at Macrobusiness.com.au. He also highlights the disparity between the official unemployment rate of 5.7%, published by the ABS, and the 9.5% unofficial rate as measured by Roy Morgan Research.

The monetary policy revolution

James Alexander, head of Equity Research at UK-based M&G Equities, sums up the evolution of central bank thinking. He describes the traditional problem of inadequate response by central banks to market shocks like the collapse of Lehman Brothers:

Although wages hold steady when nominal income falls, unemployment tends to rise as companies scramble to cut costs. In the wake of the crash, rising joblessness created a vicious circle of declining consumption and investment that proved very difficult to reverse, particularly as central banks remained preoccupied with inflation.

Failure of both austerity and quantitative easing has left central bankers looking for new alternatives:

…..Economist Michael Woodford presented a paper [at Jackson Hole last August] suggesting that the US Federal Reserve (Fed) should give markets and businesses a bigger steer about where the economy was headed by adopting a nominal economic growth target. In September, the Fed announced its third round of QE, which it has indicated will continue until unemployment falls below 6.5% – the first time US monetary policy has been explicitly tied to an unemployment rate. US stocks have since soared, shrugging off continued inaction surrounding the country’s ongoing debt crisis.

While targeting unemployment is preferable to targeting inflation, it is still a subjective measure that can be influenced by rises or falls in labor participation rates and exclusion of casual workers seeking full-time employment. Market Monetarists such as Scott Sumner and Lars Christensen advocate targeting nominal GDP growth instead — a hard, objective number that can be forecast with greater accuracy. Mark Carney, due to take over as governor of the BOE in July, seems to be on a similar path:

Echoing Michael Woodford’s comments at Jackson Hole, he advocated dropping inflation targets if economies were struggling to grow. He has since proposed easing UK monetary policy, adopting a nominal growth target and boosting recovery by convincing households and businesses that rates will remain low until growth resumes.

While NGDP targeting has been criticized as a “recipe for runaway inflation”, experiences so far have not borne this out. In fact NGDP targeting would have the opposite effect when growth has resumed, curbing inflation and credit growth and preventing a repeat of recent housing and stock bubbles.

Read more at Outlook-for-UK-equities-2013-05_tcm1434-73579.pdf.