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RAPID RESPONSE Comments (Normally available by subscription)...
HERE ARE A FEW ECONOMIC NEWS ITEMS ABOUT WHICH I RECENTLY COMMENTED.
Ah, There’s the Rub
PEPPER PIKE, OH—January 4, 2008. Nonfarm payrolls increased a skimpy 18k workers for December. The month saw sizable declines in jobs in the construction (-49k) and manufacturing (-31k) industries. But at the same time, wages went up 0.4%, on the heels of a 0.4% rise the prior month. The year-over-year rate of growth of average hourly earnings is +3.75%. Strong wage growth in the context of a weakening labor market could be a sign that cost pressures from energy and other items are becoming imbedded in the economic system.
This was one month when the Household Survey of employment yielded the same general indication as the nonfarm establishment headcount. The jobless rate for December jumped to 5.0%, up from 4.7% for 4 of the 5 previous months. The tallies of employment and unemployment revealed a 436k drop in the former and a 474k increase in the latter. These monthly surveys, however, display considerable volatility. In the prior month of November, employment registered a gain of 696k and unemployment dipped by 78k workers. A few months of smoothing is needed to detect the underlying trend. For the month of December, substantially larger increases in unemployment were suffered by teenagers (+0.7%), blacks (+0.6%), and Hispanics (+0.6%).
· Victory? “Amidst the increased talk of recession, it may be something of a moral victory that job growth was north of zero instead of south. But it is little more than that. The economy is absorbing body blows from a contracting housing market, from the credit squeeze, and from $100/barrel oil prices. Until we get resolution on whether business remains standing or the economy takes the fall, employers have hung out the ‘not hiring’ shingle.”
· Technical point. “Zero job growth does not mean zero economic growth. With productivity gains from the existing labor force, the economy can expand at a 1-2% rate without any increase in employment. But it is not much fun.”
· Irony. “What was the change in the battered real estate world? Answer: +2.0k. In the banking and insurance world, jobs receded just 5.9k. These categories of jobs would seem to have some downside risks.”
· Anything positive? “The total private workweek went unchanged in December, at 33.8 hours. And economically sensitive ‘temporary help services’ employment increased 100 workers in December.”
· TWO factors. “Retail trade employment fell 24k in December, in part reflecting the diminished state of consumer spending. But it also reflects the fact that retail trade is the ‘new manufacturing,’ in the sense that rapid productivity gains in retailing are working towards paring traditional retail employment. Note that jobs at ‘nonstore retailers’ saw a 3.3k pick-up.”
· By popular demand. “The Fed will probably end up ignoring the inflation warnings and cut rates at the close of it next policy meeting (1/29-30). Maybe that is why the 2-year Treasury note has fallen more than the 10-year Treasury (steepening the yield curve to 113 bp) and the dollar continues to grind lower.”
· FLASH! ISM nonmanufacturing business activity = 53.9 (-0.2). “The service side of the economy continues to extend its expansion, but even here, there is a clear indication of decelerating growth.”
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Here’s my quick take re the ISM survey for December 2007 and construction spending for November (1/2/08):
1. The numbers, part 1. The composite Purchasing Managers Index (PMI) of the Institute for Supply Management (ISM) plunged 3.1 points, to 47.7. A figure below 50 is thought to be associated with a decline in manufacturing.
2. The breakdown. Relative to the total change, new orders subtracted 2.1 points, production subtracted 1.2 points, and inventories subtracted 0.1 points. Employment’s contribution was approximately 0, while supplier deliveries added 0.2 points to the total. (With rounding errors.)
3. Was it an early holiday vacation or cold weather? Whatever the excuse, manufacturing declined big-time in December. Now let’s put things in perspective. This was the first indicated drop of factory activity since January 2007 (when the PMI fell below 50, to 49.3, for a single month). The PMI dipped below 48 both in 1998 and 2003 with no recession. Before the actual recession of 2001, the PMI receded all the way to 41. According to the ISM, the overall economy is not in a contraction mode until the PMI falls below 41.9.
4. The REAL bad news. The Prices component rose to 68.0 (+0.5) in December and the supplier deliveries component (which sometimes reflects bottlenecks) also advanced 1.6 points, to 53.3. This puts the Fed into a quandary: which master to serve? The economic growth master or the stable prices master? It is important that the Fed makes the right decision! (One hopeful sign in the ISM report: no commodities were said to be in “short supply.”)
5. Foreign flows. The recent tendency for improvement in the net foreign trade flows seems to have been sustained. The purchasing managers reported increasing exports (52.5) but declining imports (48.0).
6. The numbers, part 2. Total construction spending for November inched 0.1% higher, and this was a bit better than expected.
7. The good, the bad, and the ugly. The ugly? That’s easy; it’s private residential construction, which dropped 2.5% (somewhat faster than the y/y rate implied by its 17.8% decline). The bad? Public construction increased 2.5% (somewhat faster than the y/y rate implied by its 16.2% increase). Why is this bad? The economy might be deriving a short-term growth “fix,” but with public revenue growth decelerating, federal, state, and local budget deficits will likely be expanding. The good? Private nonresidential construction spending, which increased 1.7% (somewhat faster than the y/y rate implied by its 19.5% rise).
8. The problem with averages. TOTAL construction spending is just about flat with its year-earlier figure (-0.1%). But there really are two different construction environments out there. Total residential spending (including public) is down 17.5% while total nonresidential spending is up 18.1%.
9. Q4 GDP accounting. It looks like residential investment could decline at a slightly faster rate than it did in Q3 (-20.5%). But with some strong positive revisions, nonresidential investment looks like it might expand faster than it did in Q3 (+16.4%).
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Here’s my quick take re the PI and PCE for November 2007 (12/21/07):
1. The numbers. Personal income for November increased 0.4% (up from 0.2% in October). But the hot news is that consumer spending ran hot for November; it rose 1.1% for the month. Unfortunately, price increases ate into that total, paring back the real (volume) gain to 0.5%.
2. On second thought... Consumer spending estimates for September and October were lifted +0.2% each month (but inflation absorbed half of each month’s revisions).
3. Amateur hour. Today someone said the economy is “already in recession.” Ha! Consumer spending just recorded it biggest increase in more than two years. Even if spending goes unchanged in December (in real terms), Q4 spending will be up about 2.5% (AR). These numbers will require forecasters to raise their Q4 GDP estimates.
4. Leading indicator: watch what I do, not what I say. The personal saving rate fell in November (from 0.3% to -0.5%), but ironically, this is a positive indicator for the economy, as people will reduce their saving rate only if they truly have confidence in the economy. Inflation-adjusted consumer spending grew in October and November despite inflation-adjusted disposable income falling each of those months. Consumers are behaving as if the spike of energy prices is transitory, not permanent. (Disposable income was about flat based on core inflation.)
5. Myth buster. Wages and salaries increased $40.1B in November (y/y = +$319.7B). Personal interest payments rose $0.6B (y/y = +$28.7B). Consumers are not, in the aggregate, overburdened with consumer debt. [Note: personal interest payments do not include mortgage interest.]
6. Down home on the farm. Farm income has grown like weeds; it’s up 75% over the past 12 months. Visions of tractors and combines are dancing in farmers’ heads.
7. Now for the bad news. The broad based PCE price deflator for November soared 0.6% in total and 0.2% ex food and energy. (Just think how good the economy would be looking without all this inflation!) The core inflation rate y/y is now up to +2.2%, versus +1.9% in September and +2.0% for October. Inflation is outside the Fed’s comfort zone and the trend is going in the wrong direction. Those forecasters that are expecting lots of interest rate cuts in 2008 are very likely going to be disappointed.
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Here’s my quick take re housing starts for November 2007 (12/18/07):
1. The numbers. Housing starts for November fell 3.7%, to a 1.19 million unit pace. Building permits edged down 1.5%, to a 1.15 million unit rate.
2. Arithmetic. On a 12-month change basis, housing starts are down 24.2% (building permits = -24.6%). These figures are below the maximum rate of declines seen; for instance, in September, housing starts were down 31% y/y. For the early months of 2008, these rates of decline will surely fall further (speaking of arithmetic, the second derivative is positive). What this arithmetic means in practical terms is that while housing will for a number of months still constitute a drag on the economy, that drag will be diminishing.
3. Geography lesson. Starts and permits are down the most over the past year in the West (-28.3% and -26.2%) and South (-27.4% and -28.0%). Where are the two worst overpriced markets in the country? California and Florida. What states have some of the highest foreclosures? California and Florida. Which regions of the country are California and Florida located?
4. Inventory control. Units completed in November = 1.344 million (AR); units under construction, end of period, November = 1.091 million. These figures indicate that on the production side of the inventory equation (there is a demand side, too) that the builders are proactively working to get the unsold inventory of new homes under control.
5. Where is the bottom? This could be the question of the year for 2008. Housing cycle bottoms in 1975, 1982, and 1991 came in around 900k units. That’s less than 25% below the current level, and the current level is about 46% below the peak. The majority of the decline is behind us! But will this be a higher or lower bottom? The scale of the economy is much bigger today; by itself, this should argue for a higher low. But we are not seeing the coming of age of the baby boomer generation as was seen in the 1970s and 1980s--a lower low. But we are seeing an echo of the baby boomers, and on top of that, the economic maturing of a huge class of immigrants, who after 10 years, tend to have almost the same degree of homeownership as citizens--a higher low. But there is a humongous inventory of unsold new and existing homes-- a lower low. And there has been a major tightening of mortgage underwriting standards--a lower low. But mortgage rates are low--a higher low. And the unemployment rate is low and there is $10.6 trillion of home equity (home value at market prices less all mortgages--very nearly the highest figure ever) available to tap for down payments--a higher low. And a very cheap dollar makes U.S. homes in places like Manhattan and Naples great bargains for Europeans and Canadians--a higher low. These are all the arguments. Where do I come out? A higher bottom.
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Here’s my quick take re the CPI and industrial production for November 2007 (12/14/07):
1. The numbers, part 1. Consumer prices soared 0.8% higher for November. Energy prices (+5.7%) were the main culprit, but the closely followed core (ex food and energy) prices advanced a higher than expected 0.3%. The 12-month changes: total CPI = 4.3% (vs. 3.5% for October) and core CPI = 2.3% (vs. 2.1% for October).
2. Painted into corner. The Fed is engineering a policy-making crisis. The Fed has stated that total inflation will assume increased significance in its policy deliberations. Total inflation has markedly deteriorated (and even core inflation has risen). A goal of the current leadership is to emphasize greater transparency. If the Fed does not act proactively to stem a worsening inflation picture, then it will become transparent that the Fed’s is losing credibility to deal with its primary policy goal. Hence, the Fed will need to make a very difficult choice in upcoming months, and the indication is that the window provided by low inflation readings for dealing with economic weakness is closing.
3. Colder weather signals fewer winter clearance sales. Apparel prices in November increased 0.8%.
4. Do you want to pay higher gasoline prices or higher food prices? Corn-based ethanol has been a policy bomb. It has caused prices for much of the food complex--grains, meats, and dairy—to soar. Amidst big harvests, food costs are rising at the fastest rates seen in years.
5. Round up usual suspects. Medical care costs continue to march higher; November = +0.4% and the y/y = 5.0%. Tuition is another chronic inflation irritant; November = +0.6% and the y/y = 5.4%. Helping to restrain overall inflation, new/used car prices = 0% and the y/y = -0.4% while personal computer/peripheral equipment prices for November = -4.1% and the y/y = -13.1%.
6. The numbers, part 2. Industrial production rebounded 0.3% for November, but October’s previously stated drop-off was deepened (from -0.5% to -0.7%). The numbers for manufacturing showed a similar pattern: November = +0.4% but October was revised from -.04% to -0.6%. Capacity utilization for November inched one-tenth a percentage point higher, to 81.5%; manufacturing = 79.9%.
7. The mystery deepens. Why was October such a bad month? Declines of that breadth and magnitude are usually associated with shocks (such as weather events or strikes). Was it the credit squeeze? Did factories take a “time out” to determine the fall-out of the credit squeeze?
8. A good bet. Utility output declined (-1.3%) on a seasonally adjusted basis for the third straight month. But never fear: winter WILL come.
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Here’s my quick take re the December FOMC meeting (12/11/07):
1. What they did. The FOMC decided to lower the federal funds rate target by 25 bp. (The vote on the policy action was not unanimous; Eric Rosengren/FRB-Boston favored a 50 bp cut.) The FOMC also lowered the discount rate by 25 bp (unanimously).
2. Caving in to fears. It was pretty obvious that after the 10/31 meeting that the Fed wanted to move to the sidelines, as headline inflation started to re-accelerate. (CPI y/y was +3.5% for October and could rise above 4% for November.) But fears arose over a significant slippage of stock prices. Fears arose that economic growth would come to a halt. And fear arose that the credit markets would seize up. Whether hyped or real, the Fed gave in to fears.
3. Biting the hand that feeds you. Some in the Market were hoping for bigger cuts in the fed funds and discount rates. They only got -25 bp. “How disappointing!” The DJIA went from +35 to -175 points. Getting into the habit of appeasing Market players is a bad practice. Fed funds futures and the level of the Treasury yield curve are anticipating several more cuts. I think they will be disappointed.
4. THEY KNOW NOTHING! Many hoped for a bigger cut in the discount rate, to bring it closer in line to the fed funds rate. But the discount rate is a penalty rate. Under normal circumstances, banks should NOT be borrowing from the discount window—it is a sign of weakness (that you can’t get regular funding elsewhere). If you need that funding, then its availability is more important than its price. But you certainly don’t want to encourage dependency—and that’s why sustaining a penalty premium is appropriate.
5. Key phrases. “...[E]conomic growth is slowing...” “...some softening in business and consumer spending.” “...strains in financial markets have increased in recent weeks.” “...but elevated energy and commodity prices, among other factors, may put upward pressure on inflation.” The following phrase suggests that the Fed’s assessment of the economic and inflation risks are roughly equal (or neutral): “Recent developments ... have increased the uncertainty surrounding the outlook for economic growth and inflation.”
6. Now we are all Fed watchers... All manner of persons have commented on this FOMC meeting, not just economists, but CEOs, commodity pit traders, portfolio managers, business reporters, news readers, almost right down to the shoe shine boy. This was one of the more anticipated meetings in modern times, and the babel has nearly been deafening.
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