Friday, October 2, 2015

The Fed is powerless to boost jobs growth

September jobs growth was disappointingly slow, but there's a decent chance that all we're seeing is the typical month-to-month volatility that this series has displayed for many years. This is most likely a temporary statistical slump that will reverse in coming months. 

As the chart above shows, ADP's estimates of private sector jobs growth have been much less volatile than the BLS's establishment survey. Since the recovery began in mid-2009 through last month, the two surveys have registered almost identical total jobs growth: BLS 11.974 million, ADP 11.989 million. That's a difference of only 15K jobs, or a mere 12-13 bps. BLS numbers typically overshoot or undershoot the ADP numbers. If this pattern repeats, we should see stronger jobs numbers next month.

In any event, the chart above shows how the monthly swings in jobs growth have at times been significant. The September number was no outlier. 

But what we can't ignore is the significant shortfall in the labor force participation rate and the growth of the labor force. If past trends were still in place, we would have at least 10 million more people in the labor force today and many millions more jobs. For a variety of reasons, there are huge numbers of people who have simply "dropped out." Some reasons come quickly to mind: high marginal tax rates, huge regulatory burdens, ongoing growth in transfer payments, and generous welfare benefits. The retirement of the baby boomers is also a factor, but I have trouble believing that it was a coincidence that this kicked in right around the time that federal spending surged in early 2009. 

On a year over year basis, jobs growth today is about the same as it has been for the past five years. Earlier this year I thought that there was a chance things might be improving, but I've given up on that hope. We've been stuck in a disappointingly slow-growth economy for the past five years or so, and nothing much has changed of late.

Nevertheless, the fact that the equity market ended up on a positive note today suggests that the market has been priced to rather pessimistic growth assumptions, as I've long argued. Fears, doubts, and uncertainties have weighed heavily on investor sentiment. This is not a bubble market that is vulnerable to popping, this is a market characterized by caution. PE ratios, for example, are only about average, despite the fact that corporate profits are very close to all-time highs relative to GDP. What that tells me is that the market is priced to the expectation that economic growth and corporate profits will be very disappointing. From that perspective, today's jobs report was not a negative surprise.

I don't think it makes any difference whether the Fed postpones liftoff as a result of these numbers or not. (But I would love to see them adopt a more positive attitude and raise rates 25 bps, as that might make the rest of the country a little more optimistic as well.) Whether they launch another round of Quantitative Easing or not wouldn't make much difference either. It should be obvious by now that monetary policy is powerless to stimulate growth. How would another injection of, say, $500 billion in bank reserves (in an exchange for an equal amount of notes and bonds) make a difference to the private sector's willingness to take risk, start up a new company, hire more people, or invest in new productivity-enhancing plant and equipment, when banks are already loaded with $2.5 trillion of excess reserves? The Fed can't print money, only the banks can. And even if the Fed could print money, extra money doesn't necessarily translate into more jobs. More likely, it would just translate into higher prices.

No, the focus needs to shift away from the Fed. They've done all they needed to and all they can do. If we want a healthier economy and more jobs growth, the solution has to come from Washington. We need more growth-friendly polices that make it easier for people to create new businesses and hire more workers. We need lower marginal tax rates (especially on businesses) in order to enhance the after-tax rewards to taking risk and working harder. And we need to slash regulatory burdens to reduce the cost of doing business.

It's my hope that this will be the focus of next year's elections, and that the electorate will respond to the sensible solution—not the populist solution—to our economic woes.

UPDATE: Here's today's version of the "Wall of Worry" chart:

Thursday, October 1, 2015

Reasons to avoid panic

Markets are still very worried that the U.S. economy is going to succumb to all the nasty things going on in the world: a pronounced slowdown in the Chinese economy, the struggles of commodity-dependent economies (e.g., Brazil, Australia, Canada), the sudden reversal of fortune of the world's oil producers, and the recent heightened U.S.-Russian conflict in the Middle East. Is the world spinning out of control? Can the U.S. remain a bastion of strength in a weakened world? These are the questions that investors are struggling with as they decide whether to de-risk and seek out the safety of cash, even if that means giving up significant yield.

As the chart above suggests, fleeing corporate debt, emerging market debt, and equities implies giving up yields of 5-8% at a time when cash is yielding almost nothing.

The decision is not obvious, nor is it easy. Although it is unusual for the global economic tail to wag the huge U.S. economy dog, it's not impossible. What would be the consequences for the world if Russia effectively controls the better part of the Middle East? There's lots of uncharted water out there. Would a tiny hike in U.S. interest rates push too many fragile economies over the edge?

While pondering these uncertainties, it's important to remember that the vital signs of the U.S. economy are still reasonably healthy.

Weekly unemployment claims are within an inch of a multi-decade low. If the U.S. economy were fraying on the margin, claims would be rising, not falling.

Announced corporate layoffs have ticked up a bit in recent months, but the big rise was due to one-time troop reductions. On balance, layoff activity remains relatively muted, confirming the message of weekly claims. It's worth noting as well that only 1.87 million people in the U.S. currently are receiving jobless claims. That's a huge drop from the 2010 high of 11.65 million, and it is the lowest in almost 15 years.

This morning's ISM announcement was about as expected, but as the chart above shows, activity in the manufacturing sector has been slowing down of late. Nevertheless, the index is still well above levels that would signal an emerging recession in the overall economy.

Not surprisingly, weakness in the rest of the world has shown up in a softening of export orders to U.S. manufacturers.

As the charts above show, manufacturing activity in the Eurozone continues to expand, albeit slowly. The low level of Eurozone swap spreads reflects generally healthy financial conditions and thus points to continued growth.

Manufacturing activity may be on the soft side, but construction spending is rising at strong, double-digit growth rates. Residential construction activity is still far below the levels of a decade ago, and thus has lots of upside potential left.

Credit spreads are clearly elevated, but their message—that a weakened economy is increasing default risk—is still not yet at crisis levels. Importantly, swap spreads are quite low, which suggests that the economy still sits on strong financial bedrock. Fears are high, but systemic risks are low. Markets are very liquid, and that is a necessary if not sufficient condition for surviving the current turmoil.


Car sales have doubled in the past six years, and September sales exceeded expectations. On a 3-mo. moving average basis (to filter out the monthly noise), sales are up over 6% in the past year. As the chart above shows, sales have rarely been this strong. But that's not surprising, since sales fell so much for so long that there has to be some catch-up. The U.S. auto fleet has aged meaningfully over the past six years, and it will most likely take several years of above-average growth to get back to what we previously considered "normal." So there's every reason to expect sales to continue to increase for at least the next year or so.

Monday, September 28, 2015

Walls of worry update

The inverse correlation between the market's level of fear, doubt and uncertainty as proxied by the ratio of the Vix index to the 10-yr Treasury yield) remains strong, as the chart above shows.

The list of worries is long: China, commodities, oil prices, energy sector debt, emerging markets (especially Brazil), regulatory burdens, high marginal tax rates, and more recently, healthcare stocks that face the threat of politicians who want to control the prices of certain drugs.

And it is still the case that, despite all these concerns and the rising level of corporate credit spreads, 2-yr swap spreads are unusually low. Swap spreads stand out in a field of nerves, because at current level they signal that systemic risk is virtually nonexistent, financial market liquidity conditions are very healthy, and the banking sector is strong (as well it should be, with trillions of dollars of excess reserves).

It's worth repeating that every recession in the past 60 years has been preceded by a severe tightening of monetary policy, which can be seen in a strong and rising dollar, high real yields, a flat to inverted yield curve, and rising credit spreads. Moreover, the past three recessions have been preceded by high and rising swap spreads (the swap market wasn't very active prior to that). Of all those preconditions, only  rising credit spreads can be found today, but as the chart above shows, they are not critically high. Without the confirmation of rising swap spreads, it looks like the problems of the HY debt sector—although serious, especially for the energy and commodity sectors—are not highly contagious.