 | Improving Economy, Weaker Guideposts |
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| Posted Under: Employment • Government • Inflation • Research Reports • Fed Reserve • Interest Rates |
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Apparently, an improving labor market and higher inflation are not enough to get any signal from the Federal Reserve that short-term interest rates should be higher or QE should end faster than they thought before.
The Fed did what almost everyone expected, leaving short-term rates unchanged and continuing to taper by $10 billion per meeting. As a result, the Fed will buy $25 billion in bonds in August and remains on a path to end quantitative easing at the end of October.
The Fed did make some important changes to the wording of its statement. On the labor market, it removed language saying the jobless rate “remains elevated.” It’s about time considering how consistently the unemployment rate has been dropping faster than the Fed has anticipated.
But the Fed also added important new language, saying “a range of labor market indicators suggests that there remains significant underutilization of labor resources.” So, despite the jobless rate approaching the Fed’s long-term objective, the Fed isn’t going to provide any firm guideposts on how changes in the labor market are going to influence monetary policy. This is very opaque – the opposite of transparency.
Meanwhile, the Fed acknowledged inflation is approaching its long-term target of 2% and removed language about how inflation running persistently below 2% could hurt the economy. However, it’s important to note that what matters most to the Fed isn’t actual inflation but its own forecast of future inflation. And the Fed has yet to issue a forecast that shows inflation higher than 2%.
Unlike the last meeting in June, there was one dissent from a Hawk. Philadelphia Fed bank President Charles Plosser, who thought the Fed shouldn’t pre-commit to leaving rates low for a “considerable period” after QE ends. After his editorial in the Wall Street Journal, we thought Richard Fisher, President of the Dallas Fed would dissent, but surprise, surprise, he voted with the majority. We assume he was mollified by the minor changes in language to the Fed statement.
Overall, today’s statement is consistent with our view that the Fed is already behind the curve and will end up accepting higher inflation in the longer-run than its current 2% target. Fed policy is easy, the Fed is making a commitment to keep its balance sheet larger for longer, and it sees no real urgency to raise rates. All of this will create a boost for equity markets and the economy over the next 12-24 months. And we still think the bond market does not appreciate the danger it faces.
Brian S. Wesbury, Chief Economist
Robert Stein, Dep. Chief Economist
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| | The Truth About Full-Time vs. Part-Time Jobs |
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| Posted Under: Employment • Research Reports |
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Following the June employment report, negative stories about the economy proliferated. Here is a sampling of headlines:
“US jobs report shows growth in part-time, low-wage work”
“The Full-Time Scandal of Part-Time America”
“June jobs report is great for part-time workers, not so much for full-time”
In one sense these headlines spoke “a” truth. According to the Household Survey of employment, part-time jobs increased a whopping 799,000 in June, while full-time jobs fell. So, if all you did was isolate June data, the case against the economy creating meaningful jobs was pretty darn easy.
The problem is that monthly employment statistics, especially from the household survey, are incredibly volatile. For example, just two months earlier, in April, part-time jobs were down 398,000 while full-time jobs were up 412,000! In other words, please be careful when playing with these statistics.
As the table above shows, most jobs added in this recovery have been full-time jobs. In 2013 alone, 1.5 million full-time jobs were added while 188,000 part-time jobs were lost.
June was what statisticians call an outlier. If we look at the first five months of 2014, January through May, total jobs rose 1.23 million, while part-time jobs fell 153,000. And, during the twelve months ending in June, total jobs are up 2.15 million, with only 10,000 of them being part-time.
In other words, focusing solely on June data is a misdirection. According to Bureau of Labor Statistics data, total part-time jobs were 19.2% of all jobs in June 2014. Back in 2009, total part-time jobs averaged 19.5% of all jobs.
And, just to be clear, we do believe that Obamacare and other regulatory actions, higher taxes and more government spending in the past decade have created a less dynamic economy and more part-time jobs. We just don’t agree with spinning one month’s worth of data into an entire world view. It’s not appropriate, it’s a misuse of data and it’s probably politically motivated rather than any attempt to get a handle on the real economy.
The July data will be released this Friday. We expect it to show about 220,000 new jobs according to the Payroll Survey. We would forecast the same for the Household survey, but no one forecasts the household survey. It’s just too volatile. We can’t promise that it will reverse the June data on the part-time front, but we expect it to.
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| | The First Estimate for Q2 Real GDP Growth 4.0% at an Annual Rate |
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| Posted Under: Data Watch • GDP |
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Implications: What a difference one report makes. Real GDP came in higher than the consensus expected for Q2, growing at a 4% annual rate. The rebound more than offset the weather-related hit in Q1, when real GDP fell at a (revised) 2.1% annual rate. Today’s report includes revisions to the GDP data going back several years and shows an economy that was a little weaker in 2010-12, but stronger than originally reported in 2013. New figures show real GDP grew 3.1% in 2013 versus a prior estimate of 2.6%. The one drawback in today’s data was that much of the growth in Q2 came from faster inventory accumulation, which will be tough to duplicate for the rest of the year. We still expect growth between 2% and 3%, but wouldn’t be surprised if it continued to come in at the lower end of that range. Nominal GDP grew at a 6% annual rate in Q2, is up 4.1% versus a year ago and is up at a 3.7% annual rate in the past two years. Nominal GDP is a good proxy for the level of interest rates over time and suggests that the Fed is falling behind the curve. Even though we think they should move faster, the Fed will stick to ending QE by Halloween and then start lifting rates in the first half of 2015. The BEA also released its first estimate of GDO - Gross Domestic Output for Q1 last Friday. GDO attempts to measure “all” economic activity. In other words it includes more business-to-business sales along the value-added chain of production. GDO shows that rather than steeply declining in Q1, the economy was roughly flat. This is not surprising given brutal winter weather and it suggests that the drop in Q1 real GDP was not as sinister as many wanted to believe. In other news today, the ADP index says private payrolls increased 218,000 in July. Plugging this into our models suggests the official Labor report (released Friday) will show a nonfarm gain of 220,000. On the housing front, the Case-Shiller index, which measures home prices in 20 key metro areas, dipped 0.3% in May, the first decline in 28 months, although prices are still up 9.3% from a year ago. The dip in May was led by Atlanta, Chicago, and Detroit. Look for price gains in the year ahead, but not as fast as in the past couple of years. Pending home sales, which are contracts on existing homes, declined 1.1% in June after rising 6% in May. Combined, these figures suggest a 2.4% gain in existing home sales in July. After all that, it’s still the Plow Horse.
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| | The Fed’s Massive Power Grab |
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| Posted Under: Government • Research Reports • Fed Reserve |
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Take your pick of these two jobs. You get to manage a $4+ trillion bond portfolio and have omnipotent control over banks and other financial institutions. Or, you can manage an $800 billion portfolio, control the level of the federal funds rate and manage some regulatory issues. Is this really a hard choice? Well, it certainly doesn’t seem to be for the Federal Reserve.
The Fed has seamlessly morphed from an institution that occasionally intervened in financial markets to a monster that apparently wants to control a great deal of the US financial system. Federal Reserve Board Chair, Janet Yellen, and her fellow central bankers, with virtually no pushback from Congress, are in the process of adopting an entirely new economic management technique called “macroprudential regulation.”
The definition of macroprudential regulation is hard to pin down. In short, it means managing systemic risks. This is done by regulating specific financial system behavior in an attempt to avoid cascading economic problems. The idea is that the Fed can reduce the risks of financial instability for the economy as a whole by regulating certain behaviors.
In practice, what this really means is that the Fed wants to run a monetary policy that it believes is appropriate for the economy as a whole – to keep unemployment low. But, if this overall monetary policy causes too much financial risk, the Fed wants to micro-manage that risk by deeming it a macro-risk. At its root, this is hypocritical.
Everyone knows that when the Fed holds rates too low, this encourages some investors to leverage up more than they would otherwise. For example, in 2004-05, the Fed held the federal funds rate at 1% which helped cause a bubble in housing. But, rather than raising rates at that point, the Fed wants to have the right to regulate home lending activity. It could do this in any number of ways, by raising the capital required by banks to make home loans or possibly putting a limit directly on certain types of loans. That’s macroprudential regulation.
In effect – and the Fed has argued this – the Fed blames banks for bubbles, not its strategy of holding interest rates artificially low. This is central planning to the second degree. The Fed wants to set rates first and then police the impact of those rates as if these decisions are not related.
This is a very dangerous precedent and it moves the US away from the free market while continuing to concentrate the power in the hands of the Fed. In a true free market, monetary policy should not be used to manage the economy. Rather, monetary policy should have one goal – to keep the value of the currency stable.
Unfortunately, as is true with all government institutions, the Fed is always looking to expand its influence and power. Remember when Rahm Emmanuel said, “never let a crisis go to waste.”? The Fed has taken this to heart. In the thirty years, between 1977 and 2007, its balance sheet (the monetary base) averaged 5.4% of US GDP. Today, it’s 22.4%. Never, in the history of the United States, outside of the military in World War II, has one government institution been so dominant.
And, under Janet Yellen, the Fed is making a steady, insistent and disciplined argument that growing the Fed’s power is necessary for economic stability. The Fed wants to keep its balance sheet large, hold interest rates low, and regulate banking activities. From a distance this behavior looks awfully like that of the Bank of China.
The alternative would be for the Fed to shrink its balance sheet, hold interest rates where economic fundamentals and the Taylor Rule suggest they should be, and have faith that the free market will police excessively risky behavior. But, the US has entered a new era of doubt about free markets.
This was pre-ordained when Congress passed the Troubled Asset Relief Plan (TARP) in October 2008 – a $700 billion slush fund for the government that was sold as a way to save the world from Wall Street. As President Bush later said, “[We] abandoned free market principles to save the free market system.”
But, by violating free market principles, politicians created conditions which allowed the Fed to justify regulation of the economy in new and broadly expansive ways. Republicans were always the defenders of free markets, but TARP signaled a new era. Now, because the GOP won’t say TARP was a mistake, it has no effective argument against the Fed grabbing more power.
What this means for the economy is that flawed economic models, combined with the very visible hand of regulation, are distorting economic activity and leading the US toward more politicized control of financial markets. What could keep the Fed from lowering capital requirements on clean energy and raising them on fossil fuels? After all, many argue that fossil fuels are destabilizing.
But even more dangerous is that the Fed will hold rates down at artificially low levels for long periods of time in order to bring unemployment back down, all the while believing it can control the risks of easy money by using macroprudential regulation tools.
There are many reasons to disagree with this policy, but the most important is that artificially low rates distort decision making. High-return businesses will lever up unnecessarily and probably show up as bubbles. But some low-return enterprises will wrongly assume that borrowing to expand is still profitable. If resources flow too heavily to low return businesses, the economy will be less efficient and have more danger of inflation.
When rates eventually rise, both these behaviors will be tested and perhaps crack. Rather than trying to figure out where dangerous leverage is being employed, the Fed should put rates at the correct level and keep the whole boom-bust process from happening in the first place.
Congress needs to push back hard against macroprudential regulation, but it’s highly doubtful they will because they don’t understand it. The Fed is expanding its mandate in massive and unprecedented ways. Who is going to stand up and say stop?
Brian S. Wesbury, Chief Economist
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| | Tax Reform: The Real Anti-Inversion Solution |
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| Posted Under: Government • Monday Morning Outlook • Taxes |
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Inversions – a financial deal where a large US company merges with a smaller foreign one and then reorganizes so the US wing of the new firm is the subsidiary and the entity pays a lower foreign corporate tax rate – are the rage these days.
Well, sort of. A few companies have done them, and, according to one lawmaker, maybe 25 more are in the works. The rage is coming from politicians. They argue that inversions are unpatriotic and want to stop them.
There might be some law that could stop inversions, but if politicians are serious, they will push real tax reform. The US has the highest corporate tax rates in the world and it applies that rate to income from anywhere in the world.
A company cares about its customers, employees and shareholders, not the tax collector. Inversions offer US companies a “three-fer.” First, they cut taxes owed on income from foreign operations. Second, the company gets access to foreign profits without repatriating them and paying high US taxes. Third, the new company can, in theory, use the US-wing to borrow money for global operations and deduct the interest it pays from any US income it makes.
Despite the hysteria about inversions, federal corporate tax receipts were $303 billion in the past twelve months, an increase of 11.4% versus a year ago. Taxes on profits have risen faster than profits themselves. So, inversions haven’t crimped anything yet. Moreover, profits get taxed again when they are distributed to shareholders as dividends. So, $1 of corporate profits first gets chopped to 65 cents (from the 35% corporate tax rate), then to 52 cents when it is paid as a dividend and taxed at 20%. This is an effective federal tax rate of 48%.
Any ability to avoid those taxes means lower prices for customers, higher salaries for employees, and greater returns for shareholders. And because the US doesn’t have a territorial system, if a US company makes money anywhere around the world, the IRS wants a share, even if the activity had nothing to do with the US. No wonder companies want to move abroad.
Rather than demagoguing, lawmakers ought to reform the corporate tax code, cutting tax rates on capital and limiting the reach of the IRS to activity that happens here. That would encourage more capital investment and keep US companies from moving abroad for tax purposes. In turn, more investment means higher productivity and higher wages.
Don’t hold your breath, though. That kind of reform will have to wait until at least 2017.
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| | New Orders For Durable Goods Increased 0.7% in June |
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| Posted Under: Data Watch • Durable Goods |
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Implications: A Plow Horse report for durables goods orders in June. The good news was that new orders for durable goods increased 0.7% in June and 0.8% excluding transportation, both narrowly beating consensus expectations. The bad news: orders for most major categories of durable goods have been growing more slowly in the past few months. So, despite strong profits and cash on the balance sheet, many companies are still waiting to ramp up business investment. In addition, shipments of “core” capital goods, which exclude defense and aircraft – a good proxy for business equipment investment – declined 1% in June. However, core shipments were still up at a 4.1% annual rate in the second quarter and our models suggest that businesses increased “real” (inflation-adjusted) equipment investment at about a 9% annual rate in Q2. As the broader economy continues to grow, look for orders to pick up some steam. Signaling future gains, unfilled orders for “core” capital goods rose 1.2% in June, hitting a new record high, and are up 8.9% from a year ago. We believe we are nearing a large increase in business investment over the next couple of years. Consumer purchasing power is growing and debt ratios are low, leaving room for an upswing in bigger ticket items. Meanwhile, profit margins are still high, corporate balance sheets are loaded with cash, and capacity utilization is near long-term norms, leaving more room (and need) for business investment. Plugging all of this week’s data into our models suggests real GDP grew at a 2.7% annual rate in Q2. That’s slightly lower than we were estimating a week ago (2.9%) but well within the normal range for a Plow Horse economy.
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These posts were prepared by First Trust Advisors L. P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.
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