Quick read on the economy, June 2015

• Today’s payroll number adds a bit of evidence for the idea that the first quarter’s economic weakness was temporary. The gain of 280,000 jobs was the best reading of the year, tough still below the average for the second half of 2014. The secondary numbers from the report were also either steady or slightly stronger.
• In this quarter the data, as interpreted by the Atlanta Fed, point to another below average growth, but stronger than the first quarter. There is some reason to think that the actual state of the economy was stronger than these readings of GDP lead us to believe. GDP tallies up all the expenditures in the economy over the year and calls that “the economy” another version counts up all income, to people and businesses, and calls that (which is known as Gross Domestic Income or GDI) ‘the economy”. In principal they should be equal but it may be the case that income is easier to measure than expenditure. For the first quarter of 2015 GDI showed a dip, but a much less dramatic one than GDP. See this post for more on GDI.
• The chart below emphasizes the steady growth in payrolls as well as a continued positive reading for the US. Steady as she goes.

US total payroll employment, ISM Purchasing Managers index, source: Bloomberg

US total payroll employment, ISM Purchasing Managers index, source: Bloomberg

• My expectation is still for the Fed to be raising rates this year, though modest inflation expectations may give them pause. I will have a detailed preview of the FOMC before the June 17th meeting.
• Internationally, the chart below weighs the PMIs of 20 countries by their GDP. This measure showed its first uptick since last August. Perhaps lower oil prices is helping the rest of the world. Most of the major economies had stronger readings last month, though a China was essentially flat and its growth transition is still a concern.

Source: Bloomberg, Markit, Astor calculations

Source: Bloomberg, Markit, Astor calculations

• Overall, I am a getting less concerned about the economy stalling into recession in 2015, though I would love to see some stronger growth in the US and overseas.

Employment day economic read

Employment day is a good day to check in with the economy.  Overall, we remain cautiously optimistic and hopeful for stronger growth in the second half.

This month’s payroll number came in at 233,000 net new jobs, only slightly below its one year average of 250,000 jobs and at a pace to move the economy close to full employment. At Astor we had been assuming that the first quarter’s weakness – while real – should turn out to be transitory. My favorite summary chart on the economy is printed below, showing the level of total non-farm payrolls and the ISM manufacturing index since 2012

Source: Bloomberg, Astor calcuations

Source: Bloomberg, Astor calculations


I feel that as long as people are still getting jobs, and the manufacturing activity as measured by the ISM survey continues to expand, we can hope for continued reasonably strong growth in the economy. We would need to see employment growth falter or sustained contraction in the manufacturing sector to begin to get nervous about the economy.


The global manufacturing environment continues to be a source of concern. The chart below averages the PMIs of the g-20 group of countries, weighted by GDP.


Source: Bloomberg, Markit, Astor calculations

Source: Bloomberg, Markit, Astor calculations

Despite noticeable improvement in Europe, this measure continues to decline dragged recently by China and to a lesser extent, Asia broadly. The heatmap below gives the details, click for a clearer view.

Source: Bloomberg, Markit, Astor calculations

Source: Bloomberg, Markit, Astor calculations

Is the economy returning to moderation?

I heard a comment at the Volatility Institute’s annual conference last week which made me want to do a little digging. Charles Himmelberg of Goldman Sachs wondered aloud if the US is returning to what economists call the Great Moderation. This is period of a fairly stable economy as measured by the volatility of macroeconomic variables starting in the 1990s.


I general I think reduced uncertainly about the likely evolution of the economy is a good thing as it allows businesses and households to plan for the future, take the risk of new ventures and to hold lower levels of precautionary savings. There is a sort of unburnt scrub theory of finance drawn on analogy to forest fires. If the rangers run and put out every little forest fire as soon as smoke is sighted, then fuel builds up and the fire which eventually comes is devastating. In the economy, it could be the case that long periods of low volatility could make the eventual shock even more devastating.


The chart below shows the 5 year standard deviation of output, employment and inflation. On this chart, the volatility of CPI, Employment and GDP all look substantially lower in 1990 – 2005 than 1970-1990. To some extent how you answer the question about a renewed period of moderation will be based on where you think the economy is in relation to the Great Recession. If you consider us still in the grip of post crisis aftershocks, then no number crunching is likely to convince you.



Source: Federal Reserve Bank of St. Louis, Astor calculations.


To me, however, it looks like Mr. Himmelberg is onto something. I see volatility of the most important macro variables returning (for now!) to their low 1990-2005 levels. I am not drawing a sharp lesson from this, I highlight it only because I had not quite realized the extent to which the this aspect of economy has returned to pre-crisis patterns.

New directions for the Fed in 2015

The big decision for the Fed next year will be if they should start raising interest rates. Remember that the fed is charged to try to maintain price stability and full employment. This chart shows unemployment and inflation along with the Fed’s inflation target (in blue) and the unemployment rate consistent with stable prices (in pink). The economy has improved without inflation over the last five years.


The argument for raising rates is that it is necessary to control inflation.  This this post from The Economist for example.  I disagree for a few reasons:

  • As the chart below shows, over the last 20 years actual inflation has spent a good deal of time below a band around 2% inflation except and only brief episodes above, suggesting that the Fed is too hawkish on average.


  • There is mounting evidence (for example this note published by the Fed) that the recessions, the possible outcome for raising rates prematurely, can involve permanent reductions in the level of output. Simply put, if you have a million people working for a year they make a certain amount of stuff. If there is a recession and they are out of work, they don’t make up all of the lost output once the economy recovers. To take this risk the threat to price stability must be substantial.
  • Finally, inflation expectations (based on surveys or derived from market prices) remain stable.

Of course, what I think doesn’t matter, only the opinions of the voting members of the FOMC count. Every year a shifting cast of regional presidents serve as voting members on the FOMC. This year sees 4 new presidents along with the chair of the NY Fed who is always a voting member in deference to that bank’s constant connection with the markets. We have two members I would characterize as patient about raising rates and two who seem eager

  • Richmond Fed’s Jeffrey Lacker says that “the unemployment rate is an accurate gauge of labor underutilization. ” Suggesting that rates can rise soon.       Interestingly, he not only expects to raise rates, he wants the Fed to sell securities held under quantitative easing, not just cease to purchase. “I believe the Fed’s efforts to normalize monetary policy must include the sale of mortgage-backed securities in order to reduce the Fed’s role in credit allocation. ” Lacker speech
  • Similarly, the San Francisco Fed’s Williams says “Rate hike likely by mid-2015” Williams speech
  • On the other hand Chicago’s Charles Evans sees risks to tightening: “I am concerned about the possibility that inflation will not return to our 2 percent PCE target within a reasonable period of time.” And he emphasizes caution: “As I think about the process of normalizing policy, I conclude that today’s risk-management calculus says we should err on the side of patience in removing highly accommodative policy.” Evans speech
  • At the Federal Reserve bank of Atlanta Dennis Lockhart believes the United States will approach conditions consistent with full employment by late 2016 or early 2017 and in his view undershoot of the inflation target is currently a bigger risk than overshoot. Lockhart speech
  • The New York Fed president William Dudley seems to be willing but not eager to raise rates next year: “The consensus view is that lift-off will take place around the middle of next year.  That seems like a reasonable view to me.   But, again, it is just a forecast.  What we do will depend on the flow of economic news and how that affects the economic outlook” Dudley speech

Incidentally, NY Fed President Dudley says

In assessing inflation expectations, I currently put more weight on survey-based measures of inflation expectations as opposed to market-based measures.  Survey-based measures have been generally stable, consistent with inflation expectations remaining well-anchored.  However, market-based measures, such as those based on breakeven inflation derived from the difference between yields on nominal versus Treasury Inflation-Protected Securities (TIPS), have registered declines over the past few months, even on a 5-years forward basis.  Research done by my staff suggests that much of this decline in market-based measures of inflation compensation reflects a fall in the inflation risk premium—that is, what investors are willing to pay to protect themselves against inflation risk.  Adjusting for the fall in the inflation risk premium, inflation expectations appear to have declined much less than implied by TIPS inflation breakeven measures.

If he is using this as a reason to raise rates, I cannot agree. First of all, surely a decline in inflation risk premiums means that the market is less concerned about sudden jumps in inflation. That is, the market is telling you that the market is not worried about inflation. I am not sure why a policymaker would want to discount that. Second, it is not clear that Survey based inflation expectations are indeed stable. See this chart of expectations for next year from the Consensus Economics survey.


Whatever is ahead, our next landmark is the final FOMC meeting of 2014 which will feature new forecasts from the committee members and a Janet Yellen press conference on December 17. Hopefully we will get more insight into the Fed’s plans then. In the meantime it is worth noting that for Fed Funds to get to what the median member expects of about 1% by the end of 2015 and they proceed in bite-sized 0.25% steps, they will need to start raising rates in their fifth meeting of the year in July. Given the Fed’s reluctance to surprise the markets, I would expect clear warnings at the March press conference at the latest.

Interestingly, the Fed Fund futures seem to expect less easing overall with year-end 2015 rates in the market at 0.5% which implies starting later or not raising rates at every meeting after they start.

Fed Watch – Jackson Hole

The Kansas City Fed is hosting its annual Jackson Hole conference this weekend (motto: “interrupting Wall Street vacations since 1978”) . Several times in the last few years we have gotten a good preview of the Fed’s concerns for the year ahead by listening to the Chair’s speech. The last two rounds of Quantitative Easing, for example, were foreshadowed by Chair Bernanke’s talks.

The detailed agenda has not been announced yet (watch this space) but it may again be worth taking a day off the beach as the theme of the conference is “Re-Evaluating Labor Market Dynamics” and Janet Yellen’s speech is titled simply “Labor Markets.”

This is timely as one of the most important economic questions of the day is how much slack is truly remaining in the labor market. My forecast, along with many other Fed watchers, is that Yellen will make a point of emphasizing the slack remaining in the labor market.

While the unemployment rate is approaching more normal levels digging deeper we do find evidence of slack beyond the unemployment rate. The number of involuntary part time workers, which I noted in this post, is very high, perhaps three million above typical levels. In addition, the lake wage gains above the level of inflation indicates that despite record corporate profits, employers are not finding it necessary to compete on price. The labor participation rate is more complicated. A large number of people have dropped out of the labor force since the recession though a mixture of the median American getting older and through the difficulty the long-term unemployed have in getting a new job. These contending forces are examined in an interesting report by the Council of Economic Advisors find that about half of the reduction in the labor force is due to aging and about half due to other factors we might hope to be reversed.

Against these indicators of slack what do we see when we look for tightness? I noted the improvement in the unemployment rate above and referring again to my post from July, the quit rate and the job opening rate are both looking as good as they have since the recession and about as good as they did during the last recovery.

Where does that leave the Fed? We can look at the Fed Dual Mandate Report Card below. The X axis show the unemployment rate (with the Fed’s estimate of long run unemployment in pink) and the Y axis shows five-year-ahead expected inflation (with the Fed’s 2% target plus an error band in blue). The details are explained in my post Janet Yellen’s Report Card.



My interpretation of this chart is that the Fed is in the happy situation when its two mandated goals (price stability and full employment) are not in conflict so there should not be a reason to raise rates any time soon.

In thinking about what the Fed will do in the future we need to bear in mind that by law they are mandated to try and manage both inflation and employment. My sense is that Yellen and most of the FOMC see today’s balance of risks tilted toward problems of employment and will let inflation expectations drift somewhat above their target. This may be a change in tolerances from what many of us are used to from the Fed policy in the 1990-2007 period, as economist Tim Duy writes: “Yellen can point out that since the disinflation of the early 90’s, the Fed has not faced an inflation problem, but instead has struggled with three recessions. This on the surface suggests that monetary policy has erred in being too tight on average.” I hope Chair Yellen will give us some clarification and some arguments to shape the discussion.

Janet Yellen’s Report Card

Listening to FOMC Janet Yellen’s press conference last week, we were struck by the same comment that the always-insightful Gavyn Davies noticed:

When we see some conflict between achieving the two objectives …we would consider … just how far we are from achieving each of the objectives and if the distance from achieving an objective is particularly large, it would be consistent with the balanced approach that we would tolerate some movement in the opposite direction on the other objective.

The Fed, by statute, has two explicit jobs it needs to balance: price stability and full employment, with no guidance from Congress about how to define or weigh those goals. This is in contrast to most other central banks which typically only have an inflation mandate.

What to do? Well, under Chairman Bernanke the Fed choose to define price stability as 2% year over year inflation as measured by the Personal Consumption Expenditure Deflator, a slightly different index than the more familiar CPI. The FOMC also polls its members as to the likely long run unemployment range. Given that the Fed assumes that inflation is exactly on target in the long run, this is relevant unemployment rate. As of June 2014 the FOMC saw the long run tendency for unemployment at 5.2 -5.5%, the projections can be found here.

The chart below shows the recent evolution of the Fed’s objectives since 2010 along with the long run targets. The pink band is the long run unemployment rate as of the FOMC, the blue band is the Fed’s inflation target +/- a 0.25% band. The Fed should try to adjust monetary policy with a goal of getting closer to the intersection of the two bands, bearing in mind of course that there is no long run inflation / unemployment trade off.


The central insight provided by this chart is that there is no conflict in the Fed’s two mandates: inflation and employment are both below target and the fed has no need to raise rates soon.

But the Fed will use its expectations as to how inflation is likely to evolve rather than driving by looking in the rear view mirror. We cannot get inside the heads of the Board, but the Cleveland Fed does put together an interesting series of expected inflation based on professional forecaster surveys and manipulations of some market prices. Our scorecard chart is repeated below, but with inflation expectations on the Y-axis. We can see on this chart inflation expectations over the next 5 years are running slightly below the Fed’s long term target. So on this measure as well we expect the Fed to have substantial room to allow keep rates low.


Returning to Janet Yellen’s quote above, it is possible that even if inflation or inflation expectations drift above their target, if the unemployment rate is still 1 percent above its long term level, the Fed may be slow to cut rates.

Bottom line: the Fed is not behind the curve on inflation and will not tighten any time soon absent evidence of increased inflation. Janet Yellen gets a passing grade.