Please enjoy this Blomberg column published this morning.
FEDERAL RESERVE: Rebuild the Fed From the Bottom Up
Please enjoy this Blomberg column published this morning.
“Government is a just execution of the laws, which were instituted by the people for their people’s preservation: but if the people’s implements, to whom they have trusted the execution of those laws, or any power for their preservation, should convert such execution to their destruction, have they not the right to resume the power they once delegated, and to punish their servants who have abused it?”
—John Wilkes, The North Briton, October 19, 1762
No truer words have ever been penned to the betterment of a people struggling to break free of tyranny. Indeed, John Wilkes is considered by some historians to be the primary source of inspiration for revolutionary colonial Americans given his staunch defense of religious liberty, prisoners’ rights and freedom of the press, rights we hold dear to this day.
So idolized was Wilkes, our forefathers named countless towns and babies in his name, quite the honor all things considered. You see, Wilkes was also an infamous pornographer and relished his notoriety, raising self-promotion to an art form. Even Benjamin Franklin was disturbed by the raunchy rake, which is saying something considering Franklin’s own proclivity for dalliances.
But what if the colonials, the “We the People” to be, assigned added value to Wilkes’ brand of self-cultivated ill-repute? What if he rose to such fascinating infamy precisely because he launched vicious attacks on the privileged? What better way to become a champion of the powerless? Ring any bells?
On November 8, 2016, a stunned TV audience bore witness to Wilkes’ legacy playing out across this great land. Millions of voters joined forces to punish their elected servants who had so egregiously abused their power. The establishment was disenfranchised overnight.
Since the election, a not entirely unexpected pivot has taken place. President-elect Donald J. Trump is sure to have recruited cabinet members whose rich resumes no doubt raise the hair on the backs of some of his most radical supporters. We can only hope the promised, the demanded, reforms are not sacrificed on the altar of deal-making. It will come as no surprise to regulars of these missives what the deepest betrayal would be for yours truly. Trump must hold firm on his commitment to return the Federal Reserve to its right place as an apolitical institution. The very future of the American dream depends upon our new president being true to his word.
Reams upon reams have been written on the downfall of the American Dream. Social mobility stunted. Generations of stagnant incomes. The decline in new business formation. Income inequality the likes of which hasn’t persisted since the days preceding the Great Depression. Money in the bank is a theory for most Americans, even those fast approaching retirement. If you do have savings, by the way, you are punished with insulting levels of interest rates.
And just so we’re clear here and inside the trust tree, let’s be honest and acknowledge how and especially where the anger this trap incites will manifest itself — that is, shout-out-loud, hostile and open conflict and on our streets. An exaggeration? If only that were the case.
Two weeks ago, Real Vision aired an interview conducted with me right after the elections were held. Many subjects were covered over the hour. But the one that struck the loudest chord with viewers was the issue of underfunded public pensions, which stands to reason given the headlines of late.
But the reaction from viewers was anything but expected. The bile, the contempt, the malicious back and forth in the comments between public and private sector workers stunned me speechless.
It was the teachers, firefighters and policemen vs. you name the line of work among those in the private sector. No side won in the event you’re holding your breath. And both made great points. Promises made should not be broken. Teaching our children, protecting our citizens from harm – noble, often thankless professions without question. By the same token, why should someone who has worked their entire life swallow a spike in their property taxes to foot the bill? It’s not as if the investments in their 401ks are not on the same vulnerable footing as those in pensions.
The outrage prompted a private conversation with a great friend who also happens to be the most insightful municipal bond strategist out there (a subtle way to say the following comments must remain anonymous).
The first order of business was a correction to my concern that Uncle Sam would be forced to bail out weak pensions in the end: “The federal government is most definitely NOT going to write checks to state and local government! If anything, the current lineup on the Hill wants to move more responsibility to the states (and they have no money anyhow).”
There’s no arguing with the no money part. But indulge the rest of the conversation as here’s where we get down to causality, to culpability.
“I would lay more blame on your friend, the Fed. Remember that public pensions were funded in 2000 and prior to that, earning a seven-to-eight percent return on assets was no sweat. For the last 15 years though, we’ve had nothing but volatility and low interest on fixed income, the place where conservative investors are supposed to go to deal with retirement investment. This has clobbered long-term investors of all shapes and the feedback to the economy is not fully being taken into account (in my opinion). If you are approaching retirement (read: baby boomers) and know you don’t have enough money in your 401k, you are not likely to run out and buy stuff.”
Few would dispute that Keynes’ Paradox of Thrift is alive and well. The ravages of the Fed’s low interest rate policy have forced an increasing number of Americans to save more to offset what they are not earning on their savings. The resulting decline in aggregate demand goes a long way to explaining the current economic recovery’s refusal to accelerate – even factoring in the third quarter’s 3.2-percent pace, current forecasts calling for 2.3-percent growth in the fourth quarter leave 2016 full year growth just shy of the two-percent mark.
But that’s the point of the Paradox. The millions of baby boomers retiring are going to cash, as they should to provide for this little thing called security. Still, the forced frugality sets an anything but virtuous cycle in motion, glaringly reflected in the economic health of the generations behind the boomers, an alarming number of whom still live with their parents. Bunking up remains altogether too common, which of course reflects mobility, or better said, the lack thereof.
The tie that binds the generations comes down to one word: debt. That’s where the Federal Reserve has inflicted the greatest damage. Set aside for a minute U.S. sovereign and corporate debt. While they’re mammoth challenges for tomorrow’s policymakers, it is household debt that has torn at the fabric of our culture and fueled the fury.
The latest figures from NerdWallet, produced by aggregating Fed and Census Bureau data reveal that the average household carries $132,529 in debt, including mortgages. That’s up from $88,063 in 2002. The cost of living, which the Fed lectures us is running too cold, has risen by 30 percent over the past 13 years, surpassing income growth of 28 percent over the same period.
What makes up the deficit? We read nonstop about student loans helping to bridge the gap. But it’s credit cards that have taken up the slack of late. The average indebted household is sitting on $16,061 in credit card debt, a hair shy of 2008’s high. As for those low interest rates, the average credit-card interest rate is 18.76 percent which translates into $1,292 in annual interest payments.
Add it all up and total household debt is $12.35 trillion. Estimates call for the prior housing boom peak to be surpassed by the end of this year.
Putting a face on these nameless numbers, these ‘indebted households,’ provides much-needed perspective. Imagine you’ve grinded out a living as a building engineer in Western Pennsylvania for over 35 years. Your pension was long ago converted into a fee-laden 401k that’s taken plenty of hits over the years. Meanwhile, the guy who works on the top floor of your building makes multiples of your income, a reality you don’t even resent. Your pride runs too deep to throw a pity party. But that’s not to say you don’t have your limits.
How exactly do you take the latest headlines in the Post-Gazette that at over $60 billion, the shortfall in Pennsylvania’s pension fund makes it the ninth-worst in the country? That state Democrats are battling to raise your already high taxes to cover the funding gap? Do you fall in line with the lemmings, taking your lumps? Do you apply for yet another credit card to cover your own newfound budgetary shortfall? Do you slip further behind, accepting your station and the demise of the American Dream?
Or do you switch sides and vote for the party that’s vowed to tackle pension reform come hell or high water? The outcome of Pennsylvania’s state legislative elections speaks for itself. Democrats lost seats in Harrisburg, Johnston and Erie. Outside Pittsburgh, there are no Democrats west of the Susquehanna leaving Republicans with a 34-16 majority, enough to override the governor’s veto. An override in the House is not in the cards — Republicans hold only 122 of the 203 seats. Still, it’s the largest GOP majority since the 1950s.
Now, back out to the rest of the country. Take a moment to study “The Two Maps of America.” A gracious reader suspecting I might miss the dueling visual wonders was kind enough to forward me the article published in the New York Times on November 16th, days after the election. In the spirit of paying forward good deeds at this time of giving, a link to the article can be found below.
What do these maps convey? Rather than a geographically divided nation, the first map reveals Donald Trump won most of the land mass. A stunning 80 percent of the counties voted Republican, many in traditionally blue states like Michigan, Minnesota and Wisconsin, and yes, Pennsylvania.
Meanwhile, so illustrative is the NYT’s Tim Wallace’s description of the second map, it would be criminal to paraphrase: “Hillary Clinton overwhelmingly won the cities, like Los Angeles, Chicago and New York City, but Mr. Trump won many of the suburbs, isolating the cities in a sea of Republican voters. Mrs. Clinton’s island nation has large atolls and small island chains with liberal cores, like college towns, Native American reservations and areas with black and Hispanic majorities.”
A separate publication recently highlighted the irony of Clinton’s staunch support in the ‘liberal core college towns.” According to the Economist, a college education in America equates to more in lifetime earnings than is the case in every other developed country save Ireland. As for the why: “the use of maths in the workplace is 10 percent greater than the OECD average. The supply is limited, since Americans are not particularly numerate.”
In the event you bristled at the pretense, at the elitist tone, you’re not alone. Our being “innumerate” means we’re incapable of conceptualizing and working with numbers. It means we don’t educate our children, that we’ve given up on the American Dream as evidenced by our de facto indentured servitude. To think, some still wonder how the media and the establishment drove our electorate to revolt.
President-elect Trump, consider this to be an open letter. The time has come to quit placating the masses with subprime this and that to still their spirits. Please fulfill your promises to represent them and their children with integrity, knowing the road ahead will be anything but easy, and that the temptation to allow business as usual to continue at the Fed will be enormous.
Millions upon millions of your supporters voted to do just as John Wilkes urged the oppressed colonials to do on October 19, 1762. They punished the servants who so abused their power by voting them out of office. Serve your country by refusing to squander their hard-fought liberty.
Over the past week, as the Trump rally has marched on, I’ve been on the receiving end of an entirely different sort of unexpected acclaim. It started with an hour-long interview I did with Real Vision’s Grant Williams that is going ‘viral’ (I’m still new to these terms given I was inside the Federal Reserve for so long where social media was banned, and with good reason.)
The subjects covered in the extensive interview, filmed just after the election, include prospects for the Fed under the new administration, what had the Italians so piping mad and most of all, public pensions. It was this last subject that most captured the media’s attention, catching me off guard.
Some subjects such as global debt and public pension shortfalls are so massive that most choose to pretend they don’t exist. An entire cottage industry has sprung up to debunk any concerns about that little $200 trillion global debt issue, even as Libor skips upwards. It’s as if Reinhart & Rogoff’s work on record debt inducing stagnation never existed.
As for public pensions, earlier this week, I observed that Meredith Whitney’s bearish call, as aired on 60 Minutes, marked the beginning of the end of the public’s concerns. So coordinated was the campaign to disprove Whitney’s timeline that her entire body of work ended up vanishing into thin air.
And so we have learned to live with elephants in our rooms. The alternative doomsday scenarios are simply too big to get our heads around. That’s all good and well unless our mothers were right, you remember, that thing about ignoring problems not making them go away.
In the event you don’t follow me on Twitter and LinkedIn, a) congratulations as you live a much less frenzied, information-overloaded, cluttered life, and b) please enjoy the links to a five-minute slice of the Real Vision interview as well as the three articles in which I was featured this week.
Wishing you a joyous and warm holiday weekend.
A Pensions Time Bomb Spells Disaster for the US Economy — Business Insider
Danielle DiMartino Booth on the Trump Federal Reserve — Investopedia
Of all the recognized generational cohorts dating from the American Revolution, it is the 13th or the Generation X cohort which demographers find hardest to define. Did the stork deliver the first Gen X-ers as early as 1960 or as late as 1965? Was the end date for their births 1976 or 1984? And what of their collective character? At one time they were considered to be disdainful apathetic slackers, but since have become known as confident, hardworking and extremely entrepreneurial.
What is not in question is their unforgettable movie characters whose reasons for being were to make us laugh, not cry. Think Sixteen Candles’ hysterical foreign exchange student, Long Duck Dong and the impossible, too cute to rebuke truant, Ferris Bueller. And who didn’t harbor a soft spot for Pretty in Pink’s Ducky or Chet in Weird Science? It was the 80s, and even outcasts could be transformed into loveable friends on the big screen. You just can’t deny the affection we all felt for every last recipient of Saturday detention as The Breakfast Club credits rolled along to our anthem, “Don’t You Forget About Me?”
But then there was Less than Zero, which more than made up for the rest of the light-hearted lot. The 1987 hit stands as the Eighties’ testament to Film Noir replete with shoulder-pad wardrobed femme fatales, darkly doomed heroes and even nastier anti-heroes. Can anyone argue James Spader as a debt-collecting drug dealer was his least likeable character? Of course, the movie made an icon out of Robert Downey, Jr., whose stoned character gave new meaning to, ‘Don’t Leave Home Without It,’ when he tried to swipe his American Express card to gain entry to the family mansion’s (open) sliding glass door.
The film’s byline, “It Only Looks Like the Good Life,” summed up the Yuppie era to a tee, a time when U.S. households woke to the idea of aspiration, as in aspirational lifestyles. Longing to break free from their parents’ frugal ways, many Baby Boomers embraced the relatively novel world of easily accessible debt with relentless relish.
Of course, it was a different place from which to take a leap of fiscal faith. Both the saving rate and 5-year jumbo CD rate were 7.9 percent when Less than Zero was released in November 1987. Inflation, meanwhile, had finally been tamed and was running at about half the rate people were setting aside in rainy day funds.
You might be thinking, hmmm, wasn’t something else going on about then? Well, yes, of course. It would be daft to ignore the other thing that had just taken place in the weeks before the afore mentioned less than joyful downer of a movie was released, known to market historians simply as Black Monday.
Unlike the movie though, the markets didn’t end in a funeral scene. In fact, October, November and December 1987 proved to be a splendid time to jump into the markets, which investors were in fact encouraged to do by the new sheriff in town, a soft spoken Federal Reserve Chairman the world would come to revere as The Maestro.
In early May, 2000, the Wall Street Journal took the occasion of the Nasdaq finally capitulating to gravity to publish, “How Alan Greenspan Finally Came to Terms with the Market.”
“He became Fed chairman two months before the 1987 crash, and his first major task was to pick up the pieces. He sought a way to predict at the beginning of each day how U.S. stocks would open, a precursor to the futures markets that have since evolved to perform that task. During volatile periods in the late 1980s, a Fed staffer would arrive at the office at 5 a.m., call Europe to find out trading activity and have that day’s forecast on the chairman’s desk by 7:30.”
Bear in mind, the Fed’s mandate was then and remains to maximize employment while minimizing inflation. Becoming an expert on stock market trading patterns isn’t buried anywhere in the fine print of its 1913 charter.
Did it take investors long to catch on to Greenspan’s new and improved mandate? Not hardly. Interest rate moves were not announced back then. Still, investors could plainly see the dramatic decline in yields as the Fed pushed the fed funds rate down by a half a percentage point, to just below seven percent the Tuesday after that fateful Monday in 1987.
As Reuters columnist James Saft wrote on the 25th anniversary of the crash, “The response, like a kid given its first sugary soda, was electric, with a strong rally winning back a small portion of the earlier losses. The Fed kept at it in the coming months, operating quite publicly, and often giving trading desks advance notice, and repeatedly taking overnight interest rates lower.”
With that, the rules of the game changed. Traders began gaming the Fed and profiting from the increased confidence that stock prices were front and center for policymakers.
Of course, households had nothing to complain about as many rode this stock market wave to paper riches. Pray tell, how did they respond to this wealth accumulation? For millions of Yuppies, the answer came down to shopping till they dropped.
Households had piled on upwards of $160 billion in credit card debt as the New Year rang in on 1988. But that was nothing compared to what was to come with the advent of securitization one year later. Care of deregulation, another gift Greenspan bestowed upon the financial markets, lenders began to sell off slices of credit card-backed debt to an investor class that grew hungrier for cash equivalent income as interest rates embarked upon the decline of a lifetime.
The more yields slumped, the stronger the demand for all manner of asset-backed debt. Of course, we all know how this story ends. What began with car loans and credit card balances eventually led to bonds backed by home mortgages and ultimately the subprime crisis.
Households’ response would surely have been a curiosity to those who lived through the Great Depression. But that culture of prudence had long since been written into the history books as a curiosity of its own. What replaced the frugality was in a word, perverse. The more households were worth, the less actual money they had in the bank.
Before all was said and done, credit card debt was pushing $1 trillion and the saving rate had plumbed new lows, as in into negative territory, as home equity was cashed out hand over fist. Americans were spending more than they were taking in at the greatest clip since the Great Depression.
Of course, all of this bad behavior came to a crashing halt with the advent of the other event that merited a ‘Great’ label — the Great Recession of 2009. After peaking north of $1 trillion in December 2008, credit card debt eventually troughed just below $800 billion in April 2012. Until very recently, the growth rate of credit card debt was unremarkable; the total outstanding continuously bumped up against a $900 billion ceiling.
Last year, though, the cycle finally turned and for the better if you ask most economists. According to Standard & Poor’s, at $969 billion, revolving credit is at the highest level since April 2009, before the bottom completely fell out of the economy. This figure, which is once again flirting with a ‘trillion’ handle, is up $54 billion over the last 12 months. This ‘improves’ upon the $12 billion, $34 billion and $46 billion gains over the same 12-month periods ending in 2013, 2014 and 2015 respectively. We are told that increased usage of credit is a sign of confidence, a sure signal that households view the job market’s prospects as healthy looking ahead.
Indeed, consumers’ median household income growth expectations rose to 2.9 percent in August from 2.8 percent in July and 2.75 percent in June according to a report the New York Fed released September 13th. Why then do their expectations for missing a debt payment remain near the highest level in two years? Moreover, why did consumers’ spending growth expectations decline to 3.3 percent in August from 3.8 percent in July and 3.6 percent in June?
According to the NY Fed, the downshift in expectations reflects consumers over the age of 40 and lower income households. That’s intuitive enough if you consider these two cohorts get hit hardest by healthcare and rent inflation, both of which are running at twice the pace of income growth. Perhaps a separate part of the story is rising minimum wages in many parts of the country. Do rising prices for necessities thus connect the dots between rising income and falling spending expectations?
It’s hard to say for sure without conducting a comprehensive survey of every working American. On a more philosophical level, one must stop and ask whether it’s a good thing that car, student and soon-to-be credit card borrowing all surpass $1 trillion?
Surely living within one’s means was once the American way for good reason before low interest rates and lax lending standards encouraged that standard to be stood on its head. Presumably the debate will rage on until the stock market pulls back and/or interest rates rise, or even worse, both.
High income earners dominate consumer spending but can also bring the economy quickly to its knees. A falling stock market could thus trigger a recession given consumption is the only pillar of strength remaining in the current recovery. As for rising interest rates, households, corporations and especially Uncle Sam can hardly afford that prospect to become a reality, especially in the uncontrolled manner they’ve risen since rates bottomed in July with nary a Fed rate hike to catalyze the move.
Falling stock prices and rising interest rates occurring concurrently is thus a central banker’s worst nightmare. Such an impossible scenario unfolding would be a dark ending to a 30-year feature film all about a party that never seems to end, until it does erasing so many facades and leaving the simple reality that it only looked like the good life. Nothing in life is free. And sometimes the payback can be less than zero.
In the blink of an eye. In a heartbeat. In a New York minute. Life can and does change in these thinnest slices of time. And yet for Don Henley’s anthem to the swiftness of change, and just how quickly those sharing our lives’ most precious moments can be lost, he ran against the norm for 6.22 minutes of endless pain and sorrow.
New York Minute, recorded in 1989 for Henley’s best-selling solo album, The End of Innocence, proved to not only have staying power, but to also be “the album’s most unique and interesting track.” The iconic title already in mind, he turned to songwriter Danny Kortchman for help with the lyrics. His stated aim: capture the atmosphere of a late 1980’s New York City, a gritty scene of come-hither lights, drugs and overt excess all fueled and well-greased by the golden glitter of greed.
That the song opens with an obviously lost, maybe even suicidal, Wall Street refugee is telling. Tom Wolfe’s Bonfire of the Vanities, his bestselling novel, was sweeping the globe on its way to becoming what the Guardian dubbed, “the quintessential novel of the 80s.” Chronicling the downfall of a Wall Street “Master of the Universe,” Wolfe’s main character painfully parallels Henley’s lost soul.
Then, even in real life, Masters fell. Nearly 30 years on, in the endless wake of the financial crisis, it’s deeply dissatisfying that the country’s gone to emergency, but nobody’s going to jail. Such is the reality of a Wall Street that’s become too complex to regulate and police.
While cause and effect elude, complexity does help explain why central banking policy struggles to keep up. With the toolbox of nominal interest rates barren, Fed officials have been forced to deploy nuance in its stead. Veiled threats delivered via FedSpeak have nearly exhausted their utility given their schizophrenic nature. The same cannot be said of the Federal Open Market Committee meeting minutes, which, in the markets’ estimation, have risen to command equal stature to that of the FOMC statement.
Perhaps less appreciated is that years ago in the heat of the financial crisis, Janet Yellen herself had already written the lyrics of the tune to which markets today dance. As she said at the December 16, 2008 FOMC meeting, one in the same at which interest rates were banished to the zero bound, “We could also consider using the FOMC minutes to provide quantitative information on our expectations.”
Score one for success on that count. Now, when they’re scheduled for release, media outlets place the minutes at the top of the week’s roster. This is from Reuters in its look ahead to this week’s trading: “Minutes to the Fed’s July policy meeting due on Wednesday may come under more scrutiny than normal given the central bank really only has one opportunity left, at its meeting next month, to raise rates before the November presidential election.”
As for the aforementioned FedSpeak on the week’s docket, which includes in alphabetical order, Bullard, Dudley, Kaplan, Lockhart and Williams, Reuters nails it: “Fed officials have given differing and often conflicting signals throughout much of this year on when the next move will come, leaving few with any clear sense of how much of a risk there is of a September rate rise.”
In the markets’ eyes, the minutes clarify, the words confuse. Why is that?
Look no further than Yellen’s original vision – that the minutes provide ‘quantitative information.’ Given the choice, markets will trade off quantitative over qualitative (FedSpeak words) any day.
But wait! They’re both word constructs. Right? Well yes, but one of the inputs is controlled, the other a complete unknown given what some maverick Fed district president might short-circuit and say in a speech. High frequency traders can build algorithms around instances of key words in the minutes. But it’s anyone’s guess when it comes to FedSpeak, no hot money profit potential, no sex appeal.
The Associated Press’ Martin Crutsinger recently had the gumption to call out the Chair. The venue was the press conference that followed this June’s FOMC meeting and refers back to this past April’s minutes’ release. His question was too priceless to paraphrase, you’ll soon concur:
“When the April minutes were released, they caught markets by surprise. In there, they showed – they seemed to show that there was an active discussion of a possible June rate increase, something we hadn’t gotten from the policy statement that was issued right after the meeting. Was that a conscious decision to hold back and tell us in – when the minutes came out, about the June discussion? And if so, could you tell us what surprises we could see in the June minutes?”
Do the words, ‘you could have heard a pin drop,’ come to mind?
Yellen’s answers has to have gone down as one of the most uncomfortable of all time. To watch, that is. She starts out by contradicting her position on the power of the minutes to shape market perceptions with the following:
“So the minutes are always – have to be an accurate discussion of what happened at the meeting. So they’re not changed after the fact in order to correct possible misconceptions. There was a good deal of discussion at that meeting of the possibility of moving in June, and that appeared in the minutes.”
And then began the tap dance to top all tap dances. Apologies in advance for sharing the pain, but you simply have to close your eyes as if you were in the room, or watching on TV, to get from beginning to end, to feel the embarrassing burn.
“I suppose in the April statement, we gave no obvious hint or kind of calendar-based signal that June was a possibility. But I think if you look at the statement, we pointed to slower growth but pointed out that the fundamentals—there was no obvious fundamental reason for growth to have slowed. And we pointed to fundamentals underlying household spending decisions that remained on solid ground, suggesting that maybe this was something transitory that would disappear. We noted that labor market conditions continued to improve in line with our expectations, and we did downgrade somewhat our expressions of concern about the global risk environment. So I do think that there were hints in the April statement that the Committee was changing its views of what it was seeing in a direction. We continue to say that we think, if economic developments evolve in line with our expectations, the gradual and cautious further increases we expect to be appropriate. And I suppose I was somewhat surprised with the market interpretation of it. But the June meeting minutes—the minutes of the April meeting were an accurate summary of what had happened.”
Of course, that’s a bunch of hooey. Aside from the temerity of Esther George, the April statement read like a chorus of doves cooing in perfect harmony, moving mountains to “remain accommodative” until improvement was seen on both the inflation and job market fronts. And no, there was nary a ‘hint’ that “most” participants felt conditions warranted a June rate hike. The minutes clearly rewrote the history of what took place in the room and were designed to shock and awe, which they did in spades.
As is often the case before moving on, context is key. Recall that there are four FOMC meetings and statement releases that are followed by press conferences and that there are four that are followed by the sound of silence. Though you may be tempted to jump to the conclusion that the four quiet meetings should be ignored, stop for a second and ponder the great opportunities they present to crank up the minutes as a powerful monetary policy tool.
Bank of America Merrill Lynch economist Michael Hanson is a true believer in the minutes’ mojo after being sideswiped by the April meeting minutes. He had this to say in previewing the ‘silent’ July FOMC meeting.
“Perhaps the biggest risk to market pricing will come not from this week’s statement, but from the minutes in three weeks’ time,” wrote Hanson of the August 17th release date. “Recall the sharp market reaction when the April minutes revealed significant support on the FOMC for a possible June rate hike. We see an elevated risk of a repeat with the July minutes.”
It wasn’t so long ago that the minutes were used for the opposite reason, to calm markets, that is. At the conclusion of its September 2014 meeting, the FOMC statement contained the dreaded word, “when,” as in, “When the Committee decides to begin to remove policy accommodation…”
Of course the markets gagged. A rate hike? The suggestion of follow through??
But then, as post-crisis fate always has it (and always will), a mitigating factor presented itself. In this case it was Europe not emerging from its crisis. European Central Bank President Mario Draghi was negotiating to buy bundles of junk-rated Greek and Cypriot bank loans, exacerbating tensions between tight-fisted Germans and the ECB.
And so, the Fed reacted by penning the mother of dovish minutes text, reneging on the September statement’s hawkish tone.
This breathless recap from the Wall Street Journal followed:
“U.S. stocks soared Wednesday to their biggest single-day gain this year, after meeting minutes from the Federal Reserve suggested the central bank would move cautiously on raising rates. The rally was a sharp reversal from a steep Tuesday drop on worries about international economic growth. U.S. benchmarks spent much of the day hovering around the flat line, after another session of European stock declines. But they surged after minutes from the Fed’s latest meeting unexpectedly showed more focus on slowing growth overseas and lessening inflation pressures.”
At a minimum, investors should be wise to Yellen’s silent-meeting victory. The deployment of the minutes as a monetary policymaking weapon represents a classic Mission Accomplished for the Chair. In a Fed meeting minute, everything can change. But does that make it right? Or should we question the tacit manipulation of Fed policy that’s advertised as being transparent but is anything but clear by design. As the “I’ll get mine first” greed of the ‘80’s again rears its ugly head, who do you think is greasing its wheels?
Some wedding gifts just keep on giving, even after the celebrated union upon which they were bestowed has failed. That would certainly be true in the case of Carly Simon and James Taylor, whose notoriously rocky marriage ended in 1983. The timing of her November 1972 wedding marked more than a vow to Taylor, it coincided with Simon’s gift to pop music and the release of “You’re So Vain,” which ripped to the No. 1 spot on the charts and still retains the ranking of 82nd highest on Billboard’s Greatest Songs of All-Time. What a generous gift!
But, was it for the duo? Might it just be possible this lasting gift bred some not so blissful turbulence in the marriage? At the time, speculation swirled around the obviously vainglorious but mystery male subject. Was it Warren Beatty, David Geffen, Mick Jagger, Kris Kristofferson, Cat Stephens or James Taylor himself? The list went on and on. As of November 2015, Simon has only divulged that Beatty was one of three the lyrics reference. Taylor is not among the remaining two mystery men.
It’s a safe bet that a Taylor of a completely different stripe is far from being a mystery man in Janet Yellen’s appreciably less torrid past. In fact, the roles might even be reversed in Yellen’s world, with a slew of economists lamenting her vanity in rejecting them. The eminent John Taylor would be first in line, given that no less than his namesake rule used for devising monetary policy has been so explicitly and publically snubbed by the Chair.
The Taylor rule debuted in 1993 and continues to grow in its appeal thanks to the simplicity with which it can be executed. Though Taylor engaged the mandatory calculus to build his model, the inputs are elegant in their straightforward real world ease of application. At the risk of being overly simplistic, the Fed should set interest rates based on targeted vs actual employment and inflation levels; an ideal interest rate is consistent with full employment which is theoretically in sync with potential economic output.
If inflation is above target or if the economy is running too hot, as in above potential, the Fed should raise rates. If inflation is too low or economic growth too slow, well then the Fed should lower rates to encourage growth. In a perfect world, inflation and economic output are neither too hot nor too cold. That just right Goldilocks place in the ether calls for a ‘neutral’ interest rate of two percent, where the fed funds rate has historically hovered.
Here, the situation becomes perplexing in that it is the very simplicity of the rule which renders it an abomination to the reigning elite. Their preference since the crisis broke has been to embrace overly complicated models and deploy obfuscation to drive interest rates to the zero bound and beyond with blind abandon.
To add insult to injury, Yellen herself has conceded that the Taylor rule has long since signaled rates were too low. This is what she had to say in a March 2015 speech:
“Even with core inflation running below the Committee’s 2 percent objective, Taylor’s rule now calls for the federal funds rate to be well above zero if the unemployment rate is currently judged to be close to its normal longer-run level and the “normal” level of the real federal funds rate is currently close to its historical average.”
How do you fix that if you’re a labor economist who just knows, knows in her bones, that zero interest rates will ultimately lure back permanently displaced workers? Why you change the assumptions, of course! And that’s just what she did.
In that same speech, Yellen went on to explain that if you substituted in her new and improved assumptions, the rule miraculously produced different results. She began with the supposition that despite how low the unemployment rate was, ‘significant slack still remained in the labor market.” She furthermore posited that it would be more reasonable to assume the historic equilibrium rate of two percent be replaced by zero based on the suggestion of “some statistical models.”
Shortly after the speech, Taylor criticized Yellen’s modifications, writing that “little or no rationale” was given to explain cutting the equilibrium rate to zero. “This is a huge controversial issue deserving a lot of explanation and research,” Taylor warned.
Taylor summed up Yellen’s approach of massaging the model as such: “This gives the appearance that one is changing the rule or the inputs to the rule to get an answer. I do not think that reason would go over well in Congressional testimony.”
And yet, so many of Taylor’s peers in the economic community continue to feed policymakers’ penchant for contorting the world into a fantastical one that only exists in those leaders’ dreams. Is it any wonder so many of today’s leaders in central banking sport God complexes?
Sadly, as has been the case so many times since the financial crisis broke, an opportunity has been squandered. A more aggressive path to normalization would have been appropriate as per Taylor’s rule and even Yellen’s own rule for gauging the fortitude of the labor market…then. Today it appears as if the current cycle has set sail for the history books. With interest rates grounded close to zero, the real question is what miracle can the Fed contrive for the attack on what’s to come?
Given anxieties are ratcheting up fast, it will be hard to comply with this next request. But try. Try to set aside those worries for a moment and look as far out into the future as you can see. Picture the following: the economy has weathered the next recession and hopefully lived to fight another day. Now ask yourself this: What lessons might we apply from today to the post-recession world of tomorrow?
As yours truly marks the one-year anniversary of her departure from the Fed this week, a new kind of rule comes to mind. Call it the Common Sense Rule. Its input is experiential in nature drawn from economies across the globe. Its deployment is simple to the extreme:
Raise the floor on interest rates to two percent and vow to never again breach that raised floor.
Will such a radical commitment ever come to pass? It’s impossible to say. But it would be a refreshing change from the norm that’s prevailed for near on 30 years. And wouldn’t it be a relief to return to a rules-based discipline instead of the smoke and mirrors of today’s undisciplined approach where contrived language, convoluted math and the always popular throwing spaghetti against the wall to see what sticks are employed with disastrous results?
Acknowledge that there is no single certainty in this world other than that of uncertainty. Or as Taylor himself wisely observed, “Uncertainty exists in the real world; you can’t ignore it whether you use rules or discretion.”
Waiting for the Godot of central banking has caused this nation undue harm by anesthetizing U.S. politicians and households to the inherent dangers of over-indebtedness. Period. End.
That said, with all deference to Ron Paul and his acolytes, the Fed does not need to be ended. We are not, nor ever shall be, a third world banana republic. Therefore, a central bank in some form is a given.
That is not to deny that the Fed is sorely in need of reform. In fact, a total re-engineering would seem to be in order, applying the same methods many of us learned in business school. Who said that in order to exact meaningful change, one must first create chaos? Let’s do just that.
Vanity has no place in central banking, nor should it. But that very weak and vainglorious predilection seems to have nevertheless crept into a group of leaders tasked with staying above the fray. We can hope that public outrage tempers the hubris driving our current monetary policymakers to such extremes. We can hold out for Common Sense ruling the day. Let there not be those among us “So Vain” that they believe it is all about them and not “We The People.”
The art of brevity was not lost on Abraham Lincoln. It is that brevity in all its glory that shines through in what endures as one of the most beautiful testaments to the art of oration: The Gettysburg Address rounds out at 272 resounding words. The nation’s 16th President humbly predicted that the world would quickly forget his words of that November day in 1863. Rather, he said, history would solely evoke the valiant acts of men such as those whose blood still soaked the consecrated battleground on which they stood. Of course, Lincoln was both right and wrong. Neither the men who sacrificed their lives nor his words would be forgotten. We remember and know that a terrible and ever mounting price would ultimately be paid, some 623,026 American lives, the steepest in man’s bloody history.
In what can only be described as the pinnacle of prescience, a 28-year old Lincoln foretold of the coming Civil War, which he presaged would come to pass if the scourge of slavery remained unchecked. In an address to the Young Men’s Lyceum of Springfield, Illinois in January 1838, Lincoln spoke these haunting words: “If destruction be our lot, we must ourselves be its author and finisher.” The enemy within.
Since that devastating brother against brother Civil War, so prophetically foreseen by Lincoln, more than 626,000 American soldiers have lost their lives defending the ideals and freedom of our Union. Today that Union stands, but it must now face the threat of an enemy rising within its borders to wage a different kind of war against our hard fought freedom.
To be precise, today’s dangers emanate from our nation’s boardrooms, where officers and executives have authorized an era of reckless abandon in the form of share buybacks. In the event the word ‘hyperbolic’ just came to mind, the ramifications of a lost generation of investment in Corporate America should not be lightly dismissed. This trend, above all others, has weakened the foundation of U.S. long term economic growth.
The real question is whether those who have facilitated the malfeasance will be held accountable. Before the launch of the second iteration of quantitative easing (QE2) that the Fed voted to implement on November 3, 2010, Richard Fisher, to whom yours truly once answered, raised serious concerns. An October 7, 2010 speech before the Economic Club of Minneapolis was the venue.
The contextual backdrop is key: Just weeks before at Jackson Hole, Ben Bernanke had unleashed the mother of all stock market rallies by hinting that QE2 was indeed coming down the FOMC pipeline. The hawks were understandably hopping mad as the debate on the inside was anything but settled. Fisher indicated as much, albeit with notoriously diplomatic panache:
“In my darkest moments I have begun to wonder if the monetary accommodation we have already engineered might even be working in the wrong places. Far too many of the large corporations I survey that are committing to fixed investment report that the most effective way to deploy cheap money raised in the current bond markets or in the form of loans from banks, beyond buying in stock or expanding dividends, is to invest it abroad where taxes are lower and governments are more eager to please.”
Six years on, corporate leverage is hovering near a 12-year high and domestic capital expenditures have plunged. In the interim, reams of commentary have been devoted to share buybacks and with good reason. Companies reducing their share count have, at least in recent years, been where the hottest action is, courtyard-seat level action.
But now, it looks as if the trend is finally cresting. A fresh report by TrimTabs Investment Research found that companies have announced 35 percent less in buybacks through May 19th compared with the same period last year. And while $261.5 billion is still respectable (for the purpose of placating shareholders), it is nevertheless a steep decline from 2015’s $399.4 billion. Even this tempered number is deceiving – only half the number of firms have announced buybacks vs last year.
Have U.S. executives and their Boards of Directors finally found religion?
We can only hope. The devastation wrought by the multi-trillion-dollar buyback frenzy is what many of us learned in Econ 101 as the ‘opportunity cost,’ or the value of what’s been foregone. As yet, the value of lost investment opportunities remains a huge unknown.
In the event doing right by future generations does not suffice, executives might be motivated to renounce their errant ways because shareholders appear to have stopped rewarding buybacks. According to Marketwatch, an exchange traded fund that affords investors access to the most aggressive companies in the buyback arena is off 0.8 percent for the year and down 9.8 percent over the last 12 months.
The hope is that Corporate America is at the precipice of an investment binge that sparks economic activity that richly rewards those with patience over those with the burning need for instant gratification. The risk? That central bankers whisper sweet nothings the likes of which no Board or CFO can resist. Mario Draghi may already have done so.
In announcing its latest iteration of QE, the European Central Bank (ECB) added investment grade corporate bonds to the list of eligible securities that can satisfy its purchase commitment. Critically, U.S. multinationals with European operations are included among qualifying issuers. As Evergreen Gavekal’s David Hay recently pointed out, McDonald’s has jumped right into the pool, issuing five-year Euro-denominated paper at an interest rate of a barely discernible 0.45 percent.
Hay ventures further that the ECB’s program will have the welcome effect of mitigating the widening of the yield differential, or spread, between Treasurys and similar maturity U.S. corporate bonds the next time markets seize up. The firm’s chief investment officer takes one last step over the intellectual Rubicon with the following hypothesis, “The Fed might want to imitate the ECB but may be restricted from doing so by its charter,” Hay posits, adding that, “We wouldn’t discount the possibility it will try to amend, or get around, any prohibitions, however.”
Talk about sweet nothings on steroids. But could it really happen in a theoretical launch of (God forbid) QE4?
For the record, Hay is right. There is no explicit permission in the Federal Reserve Act that authorizes open market corporate bond purchases. Hay is also correct, however, that there could be legal wiggle room. This possibility was corroborated by Cumberland Advisors’ in-house central banking guru Bob Eisenbeis, who noted that the Fed’s emergency powers provision, when invoked, allows for purchases of almost any security, especially those that are not expressly disallowed in the Act’s language.
As for the prospect that politicians would put their foot down and insist that the Fed stand pat and not cross the line? What are the odds of that happening if the economic backdrop is dire enough for the subject of QE4 and open market corporate bond purchases to be matters of public debate?
Given markets’ maniacal machinations of late, the degree to which the economic data remain mixed, and the growing vocal consensus among Fed officials that June is a ‘go’ for a rate hike, it’s a safe bet that the details of QE4 will not be a focal point of the upcoming FOMC meeting.
When the time does come, and it’s sure to come before rates are normalized, Corporate America will hopefully be capable of resisting the temptation to play along. To bolster their resolve: Required reading on all CEO, CFO and Board officer bedside tables should be last November’s missive by Bank of America Merrill Lynch’s Michael Hartnett.
In it, the firm’s Chief Investment Strategist paraphrases Winston Churchill and how the great statesman would have described the risk of what Hartnett cleverly warns could be, ‘Quantitative Failure,’:
“Never in the field of monetary policy was so much gained by so few at the expense of so many.”
May those words be ones Janet Yellen lives by.
Hartnett then goes on to encapsulate the one statistic that should haunt the current generation of central bankers more than any other: For every one job created in the United States in the last decade, $296,000 has been spent on share buybacks.
Recall that the fair Chair is a labor market economist above any other field. Surely she will be able to see the damage past QE has wrought and forgo the facilitation of further bad behavior. Should she ignore the potential for further QE-financed share buybacks to exact more untold economic damage, it would be akin to intentionally corrupting Corporate America.
In the words that have mistakenly been attributed to Abraham Lincoln, arguably with sound reasoning: “Nearly all men can stand adversity, but if you want to test a man’s character, give him power.”
Since the turn of this century, debt-financed share buybacks have severely tested the character of those charged with growing publically-traded U.S. firms. The time, though, has come for these wayward companies’ banker and enabler, the Fed, to hold the line, no matter how difficult the next inevitable test of their character may prove to be. It’s time for the Fed to defend the entire Union and end a civil war that pits a chosen few against the economic freedom of the many.
Volcker, Greenspan, Bernanke and Yellen. Which one does not belong? Logic dictates that Volcker should have been odd man out. After all, there is no legendary “Volcker Put.”
The towering monetarist made no bones about never being bound by the financial markets. The same can certainly not be said of his three successors. And yet, history contrarily suggests it is to Volcker above all others that the financial markets will forever be beholden.
Many of you will be familiar with Michael Lewis’ memoir, Liar’s Poker. Yours truly first read the book in a Wall Street training program much like the one Lewis survived to describe in his autobiographical work. The take-away then, in late 1996, was that Gordon Gekko was right — greed was good.
Recently, a second reading of Liar’s Poker, following nearly a decade inside the Federal Reserve, delivered a much different message than did that first youthful reading and was nothing short of an epiphany: Paul Volcker, albeit certainly inadvertently, created the bond market.
On Saturday, October 6, 1979. Volcker held a press conference and announced that interest rates would no longer be fixed and that further the Fed would begin to target the money supply in order to curb inflation and “speculative excesses in financial, foreign exchange and commodity markets.”
Alas, this new regime was not meant to be. In trying to introduce an alternative to interest rate targeting, the Fed replaced one guessing game with another. Predicting the demand for reserves and then buying or selling securities based on that demand proved to be just as dicey as a similar exercise to target a given level of interest rates had been.
Volcker’s experiment ended in 1982. But by then, the genie had escaped the proverbial bottle.
Michael Lewis explains: “Had Volcker never pushed through his radical change in policy, the world would be many bond traders and one memoir the poorer. For in practice, the shift in the focus of monetary policy meant that interest rates would swing wildly. Bond prices move inversely, lockstep, to rates of interest. Allowing interest rates to swing wildly meant allowing bond prices to swing wildly.
Before Volcker’s speech, bonds had been conservative investments, into which investors put their savings when they didn’t fancy a gamble in the stock market. After Volcker’s speech, bonds became objects of speculation, a means of creating wealth rather than merely storing it. Overnight the bond market was transformed from a backwater into a casino.”
What a casino. As Lewis points out in his book: In 1977, the total indebtedness of U.S. government, corporate and household borrowers was $323 billion. By 1985, that figure had grown to $7 trillion.
Volcker left the Fed in August of 1987 after handing the reins over to Alan Greenspan. Two short months later, there would be a celebrated birth, that of the Greenspan Put, a watershed that truly got the party started. At last check, that party’s still going strong though stress fractures have begun to show on the festive facade. Of course, you wouldn’t have noticed them with the celebration of credit continuing to party on.
By year’s end 2015, U.S. indebtedness had swelled to $45.2 trillion. Tack on financials, which few do, and it’s $64.5 trillion and unabashedly growing. We are a nation transformed.
There are many temptations that tantalize when it comes to delving into debt. Uncle Sam now owes a cool trillion more than the nation produces. In our history, only once before has the divide between debt and production been so wide. That time was right after World War II. The difference between now and then — the cost was great but the purchase of our freedom was priceless.
What has today’s vast store of debt purchased? Certainly not freedom.
American nonfinancial businesses are today in hock as never before, to the tune of $14 trillion. Sadly, most of their debt accrued since the crisis has been funneled into nonproductive endeavors that involve balance sheet tiddlywinks to pad earnings. Don’t believe a single economist who dares quantify the consequences of a foregone generation of capital expenditures.
(At the risk of digressing, there was a bittersweet irony to Greenspan’s lamenting a lack of productivity growth when record share buybacks occurred on his watch. Consider his tenure to have provided the training ground for today’s C-suite occupants.)
At the most fundamental level, it’s the household sector that has undergone the most tragic transformation. We of that sector are, after all, what this country is and what it will be tomorrow. And it was individual citizens who had the good sense and vision to found a democracy built on the tenet of government’s role being protector of our inalienable rights to life, liberty and property. We earned these rights through relentless hard work and proudly claimed them as our own. It was the American way.
But what happens when the incentive system that encourages the honest attainment of that very American Dream breaks down? What happens when people in positions of power add the forbidden fruit of debt to our nation’s recommended daily allowance of consumables cloaked as a bonafide food group?
Whether it’s margin debt, mortgages or car loans, Americans have been brainwashed into believing that living beyond their means will somehow get them ahead. Consider the data, which simply do not lie.
In 1984, disposable income, what we take home in the aggregate after we pay our taxes, was $2.9 trillion. That same year, total household debt was $1.9 trillion. Back then, we covered our debts and had a fair bit left over with which to fund savings and possibly pay for a trip to Disney or for our kids’ college educations.
Then along came ‘measured.’ The first era of ‘lower for longer’ interest rates arrived in the aftermath of the dotcom implosion. Baby boomers, while still years away from retirement, had nevertheless been shocked to see their retirement savings take such a huge hit. But rather than batten down the hatches, they whipped out their credit cards marking a turning point in our nation’s history.
The Gregorian calendar dictates that the first year of this young century was 2001. That also happens to be the first year Americans spent more than they cleared in disposable income by way of accumulating debt: they took in $7.74 trillion and racked up debts that totaled $7.82 trillion by year’s end.
Feeding the shift from those who once had rainy day funds to those who had been had were six words constituting a commitment from Alan Greenspan stating that interest rates would rise at a, “pace that is likely to be measured.” Stand and deliver the famous obfuscator among orators did. The good times lasted for so long that households began to get unsolicited offers for new credit cards and mortgages in the mail…for their children.
Was the Maestro warned of the disaster building? The answer to that is well documented in the terrible tale of Edward Gramlich, who pled with his boss to put a stop to the subprime madness before it claimed countless victims, the largest of which would be the entire U.S. economy.
And yet the borrowing binge continued, even in the darkest days of the foreclosure crisis as mortgage balances collapsed. Of course, by then, Greenspan had exited stage left, off to sign book covers and leave the cleaning up of the disastrous detritus to his successor.
What was the harsh medicine Ben Bernanke prescribed to wean the country off over-indebtedness? Why gasoline. Bernanke poured fuel on the fire in the form of seven years of zero interest rates making debt more accessible than it had been in 5,000 years of recordkeeping (as per Merrill Lynch’s math).
The result was that households never saw even one year in which they made more than they owed. Not one, even though the period of ‘beautiful deleveraging’ was supposedly underway.
From this and that dotcom IPO, bought on margin, no less…to liar mortgages…to super subprime car loans, the elixir of aspiration has simply been too strong to resist. Lost along the way is a culture that once valued waiting for the better things in life. In the wake of this wholesale surrender of a culture, households have slowly succumbed to a subpar existence. That’s the trouble with living beyond your means. It never lasts indefinitely and always leaves you worse off than had you refrained from the get go.
The latest household data for 2015: Disposable income, $13.4 trillion. Debt, $14.2 trillion.
The prognosis? Mortgage debt is rising, credit card usage is back in vogue and student debt continues to spiral upwards. Car lending meanwhile, may be taking its last gasp for this cycle as fresh reports show used car prices have fallen for four straight months, a classic precursor to a downturn in the auto sector.
As for the fair chair, Janet Yellen, by all accounts she is running scared, pulling out all stops to forestall a recession in the hopes that there is such a thing as The Great Moderation, Part II.
To say Yellen is just now waking to the dangers of over indebtedness would be disingenuous. She was President of the San Francisco Fed when the housing bubble literally inflated and burst in her backyard.
No, perhaps what she is now realizing is the deep trap she is in. Her cabal of economists have long since assured her that government, corporate and household debt service is so low that history itself has been rewritten. But therein lies the mother of all Catch 22s, wrought by nearly 30 years of central bankers encouraging, enticing and imploring debt-financed spending while punishing, penalizing and all but outlawing saving.
Yes, the debt service is at record lows, but the mountain of debt that’s been accumulated dictates that the only thing the economy can withstand is low rates in perpetuity. The alternative is simply unimaginable. There would be widespread ruin and perhaps even the bankrupting of a great nation.
If only we didn’t know how we got to this point. But we do. We were duped by Liar’s Brokers and now have to live with the consequences. To quote Michael Lewis one last time, “In the land of the blind, the one-eyed man is king.”
Penelope Pussycat might not be the most iconic of Generation X cartoon characters, but she does stand alone in her capacity to confuse. Penelope, a lovely black and white fluff ball of a cat, had a seemingly inescapable penchant for finding herself the unsuspecting wearer of an unnatural and very skunk-like white stripe. A stripe which would of course render her irresistible to the resolutely romantic, albeit malodorous, Pepé le Pew. And so with the stage set, the chase would ensue to Penelope’s long-suffering protestations.
As is the case with all things in love and war, complications arose. There were exceptions, moments when the shoe would find itself on the other foot and Penelope became the pursuer and the dapper, prancing skunk the pursued. This half-century long chase has led some skeptics to ask whether Penelope was not in fact just playing hard to get all along.
The recent string of robust job gains has led others to ask whether workers have finally broken through to the stronger position of pursued as well, with employers in the hunt for their increasingly valuable skill sets.
It’s even rumored that Federal Reserve Chair Janet Yellen’s favorite gauge of labor market strength is the so-called ‘quits rate’ which rises in lockstep with the percentage of workers who feel confident enough to tell their employers where they can put their jobs (the sun doesn’t shine there). Hence the hysteria when the quits rate ticked up to 2.2 percent in December, the highest in over eight years. The conclusion: workers had finally gained the upper hand.
Suffice it to say, the party didn’t last for long. The quits rate retreated back to 2.0 percent in January (the data series is quite lagged and that is the most recent data on hand) and other forward-looking indicators suggest momentum is waning.
A superficial glance at the headline data is misleading on several levels. For starters, at 195,000, the number of jobs cranked out by the private sector slid in at 38,000 fewer positions than the past six-month average. Dig deeper, though, and you’ll note that the 4,000-job downward revision to January’s numbers masked more troublesome figures. The numbers behind that number: Temporary employment was revised downwards by 22,000 while government jobs were revised up by 23,000.
You may be familiar with the tendency of rising temporary workers portending positively for future permanent job gains. Sensing an accelerating rate of gross domestic product (GDP) growth, employers dip their toe in the water by bringing in temporary workers that can in turn be converted to permanent employees if preliminary signs of growth pan out.
The opposite is true of a slowing economy. Firms tend to reduce workers’ hours and trim temporary staff to prepare for what’s to come. “It’s easier to cut hours and contract workers when the economy is slowing, and that is precisely what the data show,” observed AIG’s Jonathan Basile following the data’s release. “Neither the workweek or temporary employment are in a recovery mode.”
To be precise, temporary job growth has decelerated to an annualized pace of 1.9 percent; it was growing at 4.6 percent a year ago. As for the workweek, it fell to 34.4 hours dragged down by a 0.4 percent decline in the manufacturing workweek. The factory sector itself defied forecasts calling for a gain of 2,000 for the month. Instead the sector shed a net 29,000 jobs, the most since December 2009.
The truly good news in the report was that so many sidelined workers endeavored to re-enter the workforce. Only 246,000 of the 396,000 re-entrants were able to find jobs thus causing the unemployment rate to tick up to 5.0 percent from February’s 4.9-percent cycle low.
As for the prospects for further gains in those actively participating in the labor market? A Morgan Stanley report noted that the number of people not in the labor force but saying they want a job fell to 2.3 percent of the working age population. That puts those who are down but not out of the workforce near an eight-year low and not much higher than the prerecession average of 2.1 percent.
The report’s takeaway: “There do not appear to be too many discouraged workers remaining who could potentially keep reentering the labor force to continue offsetting the demographic downtrend of 0.2-0.3 percent a year in the participation rate.”
And it wasn’t only the unemployment rate you read about in the paper ticking up. The underemployment rate, which adds in those who are working part-time for economic reasons, also rose off its low for the cycle. While it’s a cardinal sin in economics to equate one month to a trend, other data have been flagging today’s rising unemployment rate for some time.
“Why would unemployment stop falling?” Basile asked. “With GDP growth at or below trend for the last three quarters, including the current quarter, Okun’s Law should eventually catch up.”
The Law Basile references is the relationship economist Arthur Okun discovered to exist between the unemployment rate and GDP growth in the United States. As unemployment drops, GDP rises, which is intuitive enough. But when the economy slows, as has been the case of late, it also follows that the unemployment rate will rise.
Basile’s analysis being spot on is critical to his Street cred given he’s anything but a plain vanilla economist. As Head of Business Cycle Research, he’s tasked with sniffing out trends when they are in their infancy. That’s why he’s had his eye on the particular query inside the Conference Board survey that gauges workers’ perceptions of the job market – that of whether workers perceive jobs as harder to get.
“The ‘Jobs Hard to Get’ is a leading indicator that turns before the end of a business cycle,” was Basile’s observation. “Ask consumers about jobs and money and they can give you a good idea. They know if they have a job. They know what they make.”
As for the recent string of survey data, Basile worries that, “Jobs ‘hard to get’ troughed seven months ago implying we’re in the latter innings of the current cycle according to historic indicators.” Nine consecutive months of deterioration has historically coincided with recession.
In a seemingly heretical moment, Basile threw out one last nibble to add to all that food for thought with his unorthodox suggestion that there is a form of unemployment that is the economy’s friend. “Yes, Virginia. There is such a thing as good unemployment,” Basile quipped.
It goes like this: When the number of folks leaving their jobs are added to those who are unemployed for extremely short stints (five weeks or less) you get a feel for the underlying velocity of the labor force. If you’re sure you can get a better job and quick, you’re apt to have less anxiety about being among the unemployed. And if you do indeed replace your paycheck as quickly as you’d hoped, then your bravado is validated. Make sense?
Well, there just happens to be an economic indicator for that, one that combines these two metrics into ‘Job Leavers who are Very Short-Term Unemployed.’ It does a bang up job of explaining the last three decades of income growth, or lack thereof. And if you must know, it stopped improving three quarters ago, which indeed qualifies as a trend.
Add to this the rolling over in Conference Board help wanted online ads and it’s hard to deny the data are lining up to give credence to the notion that labor market strength has peaked and is in remission.
Of course, it helps to know where to look to get a first read. Just think of Penelope the next time you tune in to a talking head assuring viewers all is well in the job market. Especially at first glance, looks can, and do, deceive.
Edgar Allan Poe was intimately familiar with our deepest, dreaded fears. In Poe’s characteristically dark The Cask of Amontillado, the murderous main character Montresor, lures the inaptly named Fortunato to his death. Montresor believes he is exacting revenge upon his noble peer for a grave insult and entices the drunken Fortunato with the promise of a select sampling of a rare vintage Amontillado.
At one portentous point in the stumbling journey to the cellars, Fortunato, dressed in a jester’s motley, makes a secret sign of the “speculative” Freemason brotherhood. Montresor does not recognize the gesture but refuses to deny that he too is a Mason. Proof is demanded prompting Montresor to produce a trowel from beneath his robes, evidence he belongs to the original Freemasons, one in the same with those who built the medieval cathedrals. Shaken, Fortunato exclaims, “You jest!” but pride blinds him to Poe’s brilliant foreshadowing. You see, that trowel would soon be used to entomb a living and breathing Fortunato making Montresor a Mason in fact.
Who knew that Poe, best known for anything but jesting, gave us “Surely you jest!” to use at times when we need to express ironic incredulity? And yet here we self-described and deeply derided nattering nabobs of naysaying sit, peering into yet another recessionary reprieve. Thanks to recent dollar weakness, U.S. manufacturers appear to have caught their breath. That same decline in the value of the greenback, which has fallen in five of the last seven weeks, has placed a floor under commodities, which have rebounded smartly. The recovery, especially in oil prices, has unleashed joyous jubilation in the junk bond and stock markets. Are we last-standing contrarians being sent to our curmudgeonous corners?
Before getting ahead of ourselves, let’s consider what triggered this relief rally in the first place. That is, dollar strength, rocket-fueled by the currency war raging among our developed country peers and turbo-boosted by the Federal Reserve’s December rate hike. The resulting growth recession in profits and pullback in manufacturing persisted for long enough to infect the U.S. services sector. That last straw, along with some depressing retail sales figures, was sufficient to scare the Fed to the sidelines, which was what the markets were jockeying for all along.
So has the world economy avoided the foolish jester Fortunato’s fate? Blackrock, which reigns supreme as the biggest money manager in the world, certainly seems to think so. Sell your Treasury holdings now, Richard Turnhill, the firm’s chief investment officer, has instructed the masses, before it’s too late. Of course, Treasuries are perceived as the ultimate safe haven asset class, after gold of course. It stands to reason that if we have no recession to fear, there’s little reason to settle for Treasuries’ paltry returns.
Mr. Turnhill is not alone in his cocky confidence. The VIX, the so-called ‘fear gauge’ tracks the risk the stock market is sniffing out in the near term. It’s recently descended to its lowest reading since last summer. The lower the level, the safer the perceived investing environment.
Market pricing in junk bonds tells a similarly benign tale. The spread on high yield bonds, or the excess over Treasury yields investors demand for taking on incremental credit risk, has taken a fully refundable round trip. After peaking at 887 basis points (bps), or hundredths of a percentage point, spreads have settled back to where they ended the year, at 695 bps.
As Merrill Lynch’s Michelle Meyer pointed out in a recent report, the surest signposts that credit stresses are contaminating the real economy just aren’t there. For one thing, the decline in high yield new bond issuance has yet to manifest in curtailed bank lending. When capital markets freeze, strapped companies are forced to tap their unused lines of credit for relief. The fact that the size of credit facilities continues to grow, however, indicates the supply of, and demand for, loans remains healthy.
The second channel through which debt distress seeps into the economy is bankruptcies that mount to a sufficient extent to cause rising layoffs. Even with what have been splashy job cut announcements in the energy sector, initial jobless claims have been running below 300,000 for 54 remarkable, consecutive weeks.
As for China, which after all, originally catalyzed global market unrest last August with an unexpected depreciation of the yuan, the worst appears to have passed. The government announced a record budget deficit to lessen the blow of softening economic growth. In addition, down payment minimums in second-tier property markets have been eased and even margin debt to prop up the stock market is once again being encouraged.
Not to be left behind, Super Mario, as in Draghi, head of the European Central Bank (ECB), is doing his fair share to shore up confidence. The ECB has gotten clever in endeavoring to push liquidity into the system by effectively paying banks to lend. If that doesn’t work, what will?
If you note a vacant seat at the what-have-you-done-for-me-lately stimulus table, that would be the one not occupied by Japan. Fresh data confirm that a strengthened yen has pushed manufacturing into contraction. With new export orders at a three-year low, it’s only a matter of time before the Bank of Japan once again rides to its own economy’s rescue.
For all of these central bank exertions, this year’s April will likely bring more than one Fool’s Day, with the International Monetary Fund (IMF) expected to lower its forecast for global growth below the 3.4-percent level it was lowered to in January.
In a recent Washington speech, The IMF’s David Lipton tied the expected downward revision to the “sharp retracement in global capital and trade data flows” over the last 12 months. His prescription: a “three pronged approach” combining bold fiscal policy, structural reform, and of course, continued support from your local neighborhood central bank.
Of course, Lipton’s tone places him in the fast-shrinking minority. None other than Olivier Blanchard, the IMF’s former chief economist, was quick to refute Lipton’s pessimism remarking that the financial markets have overreacted. For good measure, he added, “the probability of another 2008 (financial crisis) is inconceivable.”
If Blanchard is right, the sea of humanity short the U.S. stock market is about to experience some serious discomfort. In fact, the only time since 1989 that shorts, who profit from market declines, did not get caught out was 2008, when markets would retest their lows and keep falling.
Compounding matters for the worrywarts is that companies continue to buy back their own shares with abandon. According to Standard & Poor’s latest tally, one-in-four firms in the S&P 500 index used share buybacks to reduce their share count by at least four percent in the final three months of 2015.
As S&P’s perennially pithy Howard Silverblatt observed, “The report of buybacks’ death was greatly exaggerated. For the eighth quarter in a row, over 20 percent of companies are buying their earnings per share via buybacks.”
Looking ahead, companies are sitting on near record cash levels while interest rates hover close to record lows affording firms the option of using debt to finance share reductions, a practice the current era of C-suite occupants has embraced with open arms. Companies have thus retained, “the ability to set record shareholder returns,” Silverblatt added.
But what if Lipton is right? What if slowing global trade does pose a true threat to a foundering recovery? There are some signs lenders are pushing back as they typically do late in a credit cycle. Lending terms for commercial real estate loans and leveraged buyouts have tightened markedly leaving riskier borrowers at the mercy of private lenders sure to demand richer terms.
At the risk of blaspheming, a recession sooner rather than later would be the better of the two outcomes given the current starting point. If the riskiest corners of the credit markets are on the verge of reopening to yet another round of go-go lending, the stock market will be reduced to a single point of historic comparison.
You see, a rally that extends into April crowns the current run a prince, second in line only to the longest in history. In other words, the bulls are collectively betting on a repeat of the party that started in 1998 and ended with a bang in March 2000.
The difference between then and now, though, is key. In 2000, a stupidly-valued stock market presented a clear and present danger. In 2007, it was U.S. residential real estate. If this discussion is still ongoing come 2018, fiscal and monetary policymakers alike will be challenged as never before with bubbles in stock, debt and real estate markets. There won’t be a three-pronged approach strong enough to effectively address this trifecta of thrice-pricked bubbles.
Like today’s investors, Poe’s Fortunato clearly did not want the revelry to end. Despite deadened taste buds, hubris drove him to partake of one more cherished chalice. But the promised rare vintage proved to be nothing more than a murderous mirage that left him moldering, insidiously immured in a newly-troweled wall.
The absurdity of the whole situation is that investors have become their own worst enemy. If there’s one thing that will put the Fed back into play, it’s a raucous celebration in the financial markets that all but double-dog-dares the very rate hike that would end today’s fetid fete. Such is the case with bad-news-is-good-news cycles. They inevitably devolve into self-fool-filling prophesies that prove lower for longer never makes us stronger.