Thursday, February 25, 2016

Evaluating the Fed...By the Numbers: Why it is Failing

Why the Fed is blowing it
Incorrect priorities lead to incorrect conclusions

I have been offering piecemeal rankings week by week of the topical indicators of the week, ranking them in their recent historic context. My conclusion has consistently been that economic variables are far too weak to justify Fed policy. I have weekly calculations (performed on ranked growth rates going back to 2010) for data since late October of last year that produce this same result/conclusion week by week without fail. And yet the Fed hiked rates in December and it continues to assert that its program of rate hikes is still on path even though that path might take a lower gradient. What gives?  

In the table above I have finally taken the full approach by ranking a broad set of 50 variables instead of just taking whatever was offered up new, week-by-week. Again I rank variables on their growth rates or levels since January of 2010 to date and I have sorted them into groups and averaged their standings to create readings on different measures. These group rankings are revealing. And not surprisingly they give substance to a criticism I have been levying at the Fed for some time. But here we have data to support it and context for the Fed’s missteps.

The Fed has a labor market centric view of the world. And, while the world outside the labor market is unraveling, the labor variables have remained relatively strong. This means that the Fed, with its blinders on, views what appears as a strong economy (through the lens of that strong labor market). However, when we look at other variables what we observe is a much weaker U.S. economy and one that would hardly support the policy that the Fed chose to pursue in December and is still pursing.

The table above shows that the labor market variables over about the last 70 months have an average ranking in the top 5% of their queue of data since January 2010. No wonder the Fed sees a strong economy. However, the next strongest sector is housing which has only a 53 percentile standing. After that it is services with a 43 percentile standing. After services the consumer sector has a 33 percentile standing. After the consumer sector price trends have a 26 percentile standing. After price indicators, the general economy, including trade, has a 16 percentile standing. With a 9 percentile standing, the factory sector comes in as the weakest of all. There is no surprise there.  

So the factory sector has been weaker only 9% of the time since January of 2010. And only two of these seven categories have rankings that push them above their medians in what has been a disappointing economic recovery. And the strongest of these categories is - SURPRISE - the one the Fed has chosen to target for its policy focus, the labor market. It’s as though there is some bizarre form of Goodhart’s law at work. The Fed chooses to target the labor market and the labor market stops being representative of the economy.

The Fed decision to make the labor market primary in its analysis of the economy is why policy is running amok. In the last FOMC minutes the Fed even included language defending the use of the labor market as a focus over and above GDP figures (GDP is not used in the table above since I have only used indicators with a monthly frequency).

The Fed has set up a straw man choice (labor vs GDP) to justify the use of labor data (GDP is too often revised). But, focusing on the labor market is not the best forward looking indicator-and there are many other choices. We do not have to accept the Fed’s strawman. Right now, for example, the growth in the index of leading economic indicators leaves it ranking in the 39th percentile of its historic queue of growth rates back to 1969. The coincident index sits in its 34th percentile. Needless to say, the LEI’s strength is not very comforting. Of course, it has slowed like this before without signaling recession. But this is a significant slowing and it is occurring with the Fed’s gas pedal still nearly to the floor… and the Fed has few options to do more should the economy sour. Since the Fed has no latitude to help should things continue to slide, that limitation should be part of the policy decision.

As I have said before, this the most disturbing thing about Fed policy. It is not that I think that Fed policy is wrong. It is that, objectively, the Fed’s policy course is dangerous since it assumes that the economy will not backslide in an environment where everything already is backsliding except the ONE INDICATOR that the Fed has chosen to focus upon (the job market). If the Fed has chosen badly in terms of its focus or in terms of its forecast there is no fallback position for policy. And several Fed members are quite dogmatically attuned to keeping rates moving up because they are convinced that they must make up for past sins and that inflation is gaining on them. This is the view that (1) rates were too low for too long, or that (2) the Fed balance sheet is just too big or (3) that the unemployment rate is just too low. This spectrum of ‘just-toos’ brings Monetarist and Keynesians together in a love fest of agreement and gnashing of teeth over inflation risks and so obseesed with teh past that they cannot see what is happening or appreciate that the future might different from what they obsess over. That’s why they call it an obsession.

Meanwhile incoming data make a different point altogether.

The table at the top shows that economic data have been weak- almost everything outside of jobs data has been weak. What are the odds that the jobs data will lead us out of the wilderness while everything else remains weak or gets weaker? Probably not very good... This is where I start calling the Fed dogmatic and accuse it of not really being data-dependent, as it claims it is, unless data dependency means that it depends on what data they want to look at. Oh. Now I get it. 

 Data classification used for these calculations is

Sunday, February 21, 2016

Where is the Fed’s objectivity?

Objective evaluation of last 2 week’s data
Where is the Fed’s objectivity?

So here is a summary table:

I focus on the RANK of the 12 mo. percent change of all data since May of 2011. We rank each series on its growth over that period. Based on that frame of reference, all monthly reports from the last 2-weeks, average a standing in their 25th percentile. They have been this low or lower since May of 2011 only one –quarter of the time. Price data have been this low or lower 29% of the time. Activity data have been this low of lower 21% of the time. MFG data have been this low or lower 12% of the time. Inventory growth has been this low or lower only 1.8% of the time. U of M sentiment has been this low or lower only 17% of the time.

These all are very weak readings! What the heck is the FED looking at?

Recession signals- Not yet
Does any of this signal recession? No.

The economy is in recession only about 6% of the time. But readings that are in or at the bottom quartile of their range are not reassuring readings. And to be clear the Fed is planning to hike rate with these indicators on weakening trends. That is what is most outrageous and disconnected from reality. It’s not just these levels of the growth rates; it’s the growth plus its momentum. Seven of 20 indicators were lower month to month in their most recent observation. Nine of them are lower year over year. Eleven indicators (out of 20!) are actually below their respective 20th percentiles. Only one is above its 80th percentile – that is real negative asymmetry. These are extremely skewed results – skewed to weakening.

And some these are important reports like industrial production, retail sales, the index of leading indicators, consumer sentiment, the NFIB survey and others. It’s not a collection of dribs and drabs of data.

No wiggle room/No Room To Move Vs the vast expanse of space on the upside
With the Fed having virtually no wiggle room to ease, as this economic slippage continues, it is an outrageously dangerous strategy for the Fed to not at least announce that policy is on hold. The ‘MINI-MAX’ rule says when policy is in an uncertain environment it can be a good strategy to act so as to MINIMIZE the effects of a policy decision SHOULD the wrong policy direction be chosen. Where do you think the Fed stands relative to this rule?

Dead WRONG. But hey, maybe the Fed policy tilt actually is right? Maybe it will draw to an inside straight and all will be forgiven…and then again maybe not. That’s why the ‘mini-max’ rule was developed because…MAYBE NOT.  What is the Fed’s forecasting record like anyway?

There is NOTHING dangerous about slowing the tightening cycle… should the economy continue to grow and if inflation pressures were to mount the Fed has so much room (infinite) to move on the upside compared to almost no room on the downside- there is no risk (Queue John Mayall. ‘Room to Move’ Here).  The Fed is driving close to the edge here...and for what reason? 

Smell the handwriting on the wall…
I find this policy obstinacy an astonishing choice. Especially since GLOBAL forces are pushing BACK at inflation. I have called the Fed dogmatic. Some call it ideological, some say it has hubris. Others call it arrogant. All of these descriptions express frustration with a Fed that refuses to smell the handwriting on the wall (I’m just guessing here that they can’t read it)...

Frustration with the Fed mounts
There is a group of economists –of no particular ideological purity- that is increasingly frustrated with a Fed that embarked on a tightening policy, lacking the justification that it had set for itself to move.

Let’s pretend?
Still, it moved and now it has momentum. A policy choice was made and now the Fed wants to stick to it and it is seemingly reluctant to pause and admit that it may have made a mistake and moved too soon like so many other central banks before it IN THIS VERY CYCLE. Is the Fed really whistling past the graveyard because it thinks it can protect its reputation by compounding one bad decision with another?  This is a high stakes riverboat double or nothing Fed policy gamble, and there is no payoff commensurate with the risk that the Fed is taking. So…why is it doing this? Under most circumstances ‘Let’s Pretend’ is not a policy option.

Thursday, February 18, 2016

Having read the news…On February 18, 2016

Having read the news…
I’d love to turn…you…off?

The morning news does not make a ‘good read.’ The FOMC minutes released yesterday show a seriously conflicted Fed that seems to have lost its way. The more that the Fed protests that is not on a pre-set course, the more it looks like it is, based on reports it releases to the public.

With the Fed lacking a serious backbone, the OECD has injected a sense of urgency into the mix. It is not clear that this is aimed at the Fed or at the US but other countries are acting or preparing to act. The U.S. (i.e. FED) alone has dug its heels in and refused to even give a clear signal that will leave its tightening path- and has more clearly declined to step up any stimulus- However let me ass that the use of fiscal policy is dead almost everywhere outside of China (genuflect, I said ‘China’).

The Fed’s die has been cast even as the Fed argues that it remains open minded. And this is a Fed that wants to pride itself on transparency. no No NO. This is the same old Fed. It is shrouded by the use of obscure language and wedded to issuing a new policy statement each month, but one that reads more or less like the one issued before it. And it wants to have its wiggle room on language but also to speak clearly and wants to have its cake and eat it too, while extolling the metis of a high protein diet.

The Fed’s choice in the ‘minutes’ to rely more on labor market data because GDP is often revised sets up a straw man that ignores other reports perhaps best summarized by the weak MFG ISM and the weakening Non-MFG ISM.  Whatever the reality behind the Fed’s bizarre choices, there seems to be a few voices of reason at the Fed but we have heard few of them in public recently. As for Janet Yellen we seem to have progressed from having strong Fed chairman like Volcker and Greenspan to a consensus builder in Bernanke to one who is afraid to speak anything other than what the committee already has decided. Janet Yellen may be our first Japanese Chair as she acts as though she has no power and has been coopted by the opinions of the committee. Her statements about negative rate prospects were classic Yellen: one day saying that the committee had considered and rejected that course at one point and the next day saying that she was not taking anything off the table. Now that’s leadership! At least it is what passes for it from Ms. Yellen. Policy by committee is one of the worst possible.  Committees need strong leadership. I, increasingly, get the sense that this one does not have it.     

The News

OECD…Governments in the U.S., Europe and elsewhere should take “urgent” and “collective” steps to raise their investment spending and deliver a fresh boost to flagging economic growth, said the OECD.

ECB view- The euro zone's modest economic recovery was progressing but risks are on the rise and there were also signs that low energy prices could feed into the price of other goods and services, the European Central Bank said on Thursday.

Wal-Mart- Wal-Mart cut its sales forecast for the current year because of the stronger dollar and store closures, as it reported core sales growth in its U.S. business that was softer than expected for the holiday quarter. 

Nestle… Shares in NestlĂ© dropped more than 4% after the Swiss food giant reported its slowest sales increase in six years and held back from buying more of its shareholders’ stock.

Like to watch?... Swiss watch exports continued to decline at the beginning of the year, figures from the Federation of the Swiss Watch Industry showed Thursday. Watch exports fell notably by 7.9 percent year-over-year in value terms in January to CHF 1.5 billion. All main price segments recorded significant decreases.

Bridgewater’s founder offers this… Ray Dalio, founder of the world's largest hedge fund Bridgewater Associates, says the next big monetary and fiscal move should include an airdrop of money from helicopters to stimulate the U.S. economy.

Tuesday, February 16, 2016

Central banks, rabbits, printing presses and dead ends

Central banks, rabbits, printing presses and dead ends

The Wall Street Journal has an article about money and the printing presses.  At the end it quotes Ben Bernanke for his ultimate belief in the printing press. Here. But should we join him in that belief?

Money supply continues to perform more or less normally. Monetary velocity has slowed but that in and of itself is not particularly odd.

What is most peculiar in an historic context, but totally understandable by today’s standards, is that the money multiplier no longer works. Under the old system we would see banks get fully ‘loaned out.’ That is, they would loan funds until the banking system’s excess reserves were negligible.  But now the amounts of excess reserves in the system are vast. The Fed has pumped up its balance sheet and there are billions of billions of excess reserves that are not being lent. This is the ultimate example of what economists call pushing on a string. And it is now NORMAL- not a special case of sorts. So do the printing presses still work?

Banks do not lend funds because they now have strict capital requirements to make loans. Loans not only need to be funded with deposits but they to be backed by capital and the bank needs to pass stress tests imposed by the Fed based on what is on its balance sheet. Because of the capital requirement, banks are more careful about making loans. For one thing bankers will not engage in so called ‘riskless arbitrage’ and blow up their balance sheets as they once did. Bank loans are the way money is created. If banks make loans more slowly, then money creation itself will slow. Banks make loans under much more restrictive conditions these days. And bank loans have more competition these days, too, as banks are being paid returns on the excess reserves they own.  Banks can hold excess reserves and earn the return on reserves nearly risk free. That raises the hurdle for risky lending as well.

Not all bank reserves become money supply in this model. They do not get turned into M2 assets/liabilities. And a wedge is created between the Fed’s balance sheet growth and the growth of conventional monetary assets held by the public. When Bernanke talks about the printing presses saying that they will have an eventual impact, it depends on what he means by ‘the printing press.’ Since the reserve channel is not functioning and that does not seem to be particularly temporary ‘the printing press’ is not bank reserve growth.  

It is not clear how much monetary stimulus matters in this environment. QE worked by removing safe assets and forcing the public to acquire riskier assets. It pushed rates lower through asset purchases LSAP (large scale asset purchases) - at least for a while- there were at least announcement effects. And while some have said that QE has many of the same effects of a traditional Fed policy easing, those similarities appear to be fleeting and there are side effects from QE. If this were a drug, I’m not so sure that the FDA would so easily approve it. In short there is no one for one equivalent between QE and a cut in the Fed funds rate.  

Negative rates of interest are being considered apparently in the U.S. (‘not off the table’ to use Yellen’s lexicon) and are being used in some countries.  That distortive policy seems particularly dangerous. Central bankers are getting desperate and have done their best to try portraying some novel policies as analogs to tried and true conventional policies. This is just like in the financial crisis when the private sector employed derivatives that were poorly understood while they pretended they had been fully vetted and were well-behaved. I think markets are also coming to this point of view regarding central bank behavior especially since the BOJ implemented negative rates and got the opposite exchange rate reaction that it expected.  

It is now clear that some of these novel policies are starting to show their quirks and how they are different rather than the same as traditional policy. And markets are frightened. Central banks seem to be overstepping the boundaries of their understanding. Are they going down the rabbit hole? Have they reached a dead end and have all the different ways that central banks have to run the printing presses stopped working?

Sunday, February 14, 2016

Tweedle Dee Dee Tweddle Dee Fed

Tweedle Dee Tweedle De Dum
 Tweddle Your toes Tweedle your thumbs
Side on the sidelines when things get tough
Decide to act when its not soon enough

Tweedle Dee De, Tweedle de Fed
Tweedle time away until you are dead
Tweedle the short run don't make up your mind
Until the data kick your behind 

Why this? see below

The WSJ reports as follows: about Janet Yellen... "

But she reiterated her view that a contraction isn’t imminent. “There is always some chance of a recession in any year, but the evidence suggests expansions don’t die of old age,” Ms. Yellen said. “It is not what I think is the most likely scenario.”
She also emphasized that the Fed is staying flexible on the outlook for rates, noting several times that interest rates aren’t on a “preset course.” Yet she added that it’s premature to say whether recent developments have shifted the balance of risks to the downside."

Friday, February 12, 2016

Fed Policy Magnifies Risks for the Global Economy As Well As At Home

The risks step up...
I don't know if there will be a contraction this time around,  but if policy does not swerve, conditions will get more dangerous. The Fed should at least be pursuing a Mini-Max strategy, guarding against making the biggest mistake instead of dogmatically pursuing  a course of action that it has no idea if it is correct. (tighten because we are already on the golden path to 2% inflation and full employment...Amen.) Fed policy is magnifying economic risks. Usually we do not think of that as the Fed's job...

I'm not sure if the Fed got that policy on stone tablets from Mosses, but they act like it. Maybe someone named Mosses was stoned and gave it to them? That seems more likely.  The policy looks more like a golden calf they are worshiping than something handed down by an agent of God...   

Fed policy is focused on the labor market. Really? ...a lagging or coincident variable at best. And it seems to put that market on a pedestal to the exclusion of all else. Really? Does the puny US job market trump the global surplus? How is that possible? A market consisting largely of services-workers insulated partially from international competition will call the shots. I don't think so.  

This is high risk high stakes double or nothing all chips in the middle policy. There is nothing prudent here. And yes I am talking about central bank policy. Staying the policy course with the economy and market as rattled as they are is dangerous at a time that downturn is the most dangerous thing that could happen to this economy.   

Yes, I am worried. I do not think stock markets are irrational. The BOJ move to negative rates that left the yen STRONGER (OOPS!) has shocked everyone. Now markets see that central bankers do not have rabbits to pull our of hats. Maybe they don't even have hats. Maybe they reach in and grab a rattlesnake by the tail instead. These policies are risky. 

No one speaks of it this way but these are the financial (policy) innovations that are the  equivalent of the hybridized mortgage products that caused the blow-ups the last downturn. (Did you see THE BIG SHORT??) 

These are policies that are untested using tools that are untried. What's worse is that they are untested in any business cycle and yet there they are being put in use as though they are understood. And by CENTRAL BANKERS!!! Oh Yeah! 

Just like any other rate cut so what if it winds up below zero....?? (the culinary equivalent of 'tastes just like chicken!!- but is it nutritionally? ) These policies may not be successful. Or might make things worse. Its like an alien space ship landed and we are going to begin randomly to press buttons. HMMM is this one to take-off or is it for the death ray??? Just press, it...everything will be fine. 

And so the central bankers are running out of things to do, things to try and, of course, running out of things they really understand, nothing is safe anymore. And now markets know it... NO more putting a brave face on. The over-sized shoes and the seltzer bottle are on full display along with the red noses - Bozos one and all.      

The oil market is a mess and out of control. With fracking and technology, supply has found a way and you can't put that toothpaste back in the tube. The Saudis long knew their role in OPEC as they have oil for the long run: it was to contain oil prices and keep innovation at bay. They blew it. They just blew it. Oil now is a loose cannon of excesses. 

China is in a terrible debt overload and has a difficult policy switch to accomplish. Everyone who can wants to leave China because of the environmental disasters policy has made. Money is just gushing out like someone cut a monetary artery on Grey's anatomy. Clamp! I said CLAMP! What? No Clamp??? Dang...

When Stevie-baby Roach said they knew what they were doing in China he was just blowing smoke up all our.. well hind-quarters... He was Morgan Stanley's shill for China (non-executive Vice Chairman- what a title). No one stood up to the Chinese. Stevie cheered them on and encouraged all of us to trust them and to invest there. Thanks for that Stevie!  So now they have this mess and we have a mess too. 

The South China Sea Gambit is just a natural result of failed domestic policy in China. It is text book foreign policy diversion.  Create an international event to bring the people together behind you. China wants conflict in the South China Sea. It will not settle anything. It wants an 'event.'

and on it goes...   

Don't you think?

Obama's giving Bernanke the Bum's rush out if office to replace him with Yellen looks more and more like a fool's move. Listen to what Ben is saying these days- he does not think we are on 'The Path'. This is not The Matrix. 'The Path' is not the same as 'The One'. Yellen does  not have the judgement of the Matrix's Lawrence Fishburne. The Fed is stabbing in the dark. As the knight in the room of chalices in the movie 'India Jones and the last Crusade' said  she  has not chosen wisely...

No lie... 

Janet, time to choose wisely. Time to stop really blowing it. You need to stand up to the hawks. You need to change your mind. You need to stop sleep-walking.  You need to drop the Fed-speak and deal with issues. You need to look at all the data not just the stuff that makes you comfortable... You need to make policy to protect the economy from the Fed making the worst mistake possible... Terrible testimonies. Clumsy Q&A answers. Stop with the bureaucratic babble and Fed-speak. Speak English! Address issues. Throw some FOMC members pressuring you to hike rates under the bus. Do it now. Just DO IT. Maybe Nike will sponsor you...  

Tuesday, February 9, 2016

Central bankers make inspector Cluseau look smart

Japan's negative yield conundrum:
Negative yields on a (Japanese) ten year note...That does not bode well for expectations that Japan is getting inflation back to 2%. I wonder what the BOJ thought when it went to negative short rates, since lower rates seem to imply ongoing low inflation. Now- of course- if the short rate is negative and the yield curve steepens you have your cake and eat it too.  That's what the BOJ wants. But that is not happening.

Instead, like the Fed it is Ready! Shoot! Aim!!! Fed policy which is geared to keeping rate hikes in play will keep the dollar strong and that will keep the economy weak and inflation low- NOT at 2%... Ready! Shoot! Aim! In short it is no way to achieve your inflation objective.

What the heck do these central bankers think they are doing? Just anything that comes to their mind?  I have never before seen so much policy at cross purpose to the central banks' ostensible policy objective. Is the Fed really about normalcy? Do you put rates at normalcy when the economy is still wounded and no where near normal?  On what planet does that make sense?

Planet Pink Panther?

Monday, February 8, 2016

Yellen to testify twice this week- be prepared

Yellen to testify twice
It went so nice she did it twice? Not likely…

The Fed Chairman’s twice yearly testimonies one set of two testimonies before the Senate Banking Committee and the other before the House Financial Services Committee, is a legacy of the old Humphry-Hawkins legislation.   The Fed reports twice-yearly to each of these committees usually in testimonies that are back-to-back or nearly so, one early in the year, the other after mid-year. This week they will be on Wednesday and Thursday

This year there may be fireworks. The Senators are the better-prepared while House of Representatives has a lot of members who are only tangentially acquainted with finance and really know far less about the Fed than they should for being members of this ‘oversight’ committee. For many of the members this is a chance to score political points and rake the Fed over the coals for ideological issues.  

This year ideology should loom large as the Fed is being blamed for the stock market sell-off as a result of its attempt to get back to normalcy. The argument is that the excessively long period of excessively low rates boosted stocks and now that it is ending, the temporary boost to stocks is going away making the Fed responsible for the sell-off (Martin Feldstein holds this belief). To another set of Fed detractors, the problem is simply Fed policy and raising rates at a time that is inappropriate. To yet another group it is the Fed hiking rates at a time and under conditions that are not the conditions that the Fed said would have to exist in order to raise rates- to this group the Fed rate hikes have shattered Fed credibility as inflation is too low and is nowhere near 2% and far from being credibly on a path to 2%.

There are other related issues here that are intertwined and complicated. There is the issue of Fed communication and Fed credibility. For example the Fed has a policy statement and it also has member speeches. The public is confounded about which of these represents policy. Last year a number of members (most of them, actually) had declared that they thought interest rates would finally go up by year end. Despite the Fed not seeming to have the conditions for a rate hike it laid out in its post meeting policy statements all year long, it did hike rates in December.

Some in markets had cast the event of a hike or no hike as a Fed credibility issue. Many argued that since members were ‘expecting a hike’ if a hike were not forthcoming, Fed credibility would suffer. Yet in a speech in Lima, Peru, before an IMF meeting late last year, Fed Vice Chair, Stanley Fischer, had noted that Fed speeches about expected policy actions represent member expectations - not policy. Policy is made in the Fed policy statement released after each meeting. Apparently it is also made in the Yellen Press Conference as it was there that Janet Yellen last year suggested that a further tightening of the labor market could be taken as evidence than inflation would be rising to the Fed’s goal of 2% even if inflation itself were lagging. Fed Governor Lael Brainard had pushed back against that notion. The making of Fed policy and its communication to the public has become quite complicated. It seems it can no longer be singularly expressed as the Fed’s post meeting policy statement. And that IS confusing.  And it’s fair to say that even among Fed experts you are likely to find different assessments of what the Fed is telling us that constitutes policy.

These various descriptions about Fed policy illustrate how confusing Fed communication has become. Let me add to the mix another significant complication, the Fed’s so-called SEP. Four times a year the Fed polls FOMC members and memorializes their averages and central tendencies as well as providing a time series of the member’s independent outlooks for selected economic variables. Even Fed officials themselves seem to have different ways to refer to this exercise. It is not a ‘Fed’ forecast. It is the personal view of Fed members based on what each thinks the right monetary policy should be given the conditions each member sees. As such these scenarios provide us with some information but also add to the confusion of where the Fed stands and how much these scenarios influence Fed policy among other existing Fed communications.

Wednesday Thursday February 10 and 11, 2016
Against this background Yellen will testify to the House and Senate Committees. In addition she will undoubtedly be grilled over just what policy is and how it views the ongoing state of affairs with the economy and markets. The NASDAQ is hitting its lowest reading since June 2014 ahead of this testimony. Everybody will be tuning in on this one. It’s a presidential election year putting the Fed even more on the hot-seat.

There is a lot here for Yellen to defend or simply explain. These have not been the Fed’s brightest days. There is a lot of dogma in Fed policy, too. By dogma I mean that the Fed is making policy now for the conditions it believes will occur in the future based on its view of the world and its view of ongoing economic progress.  Policy is not reacting to or doing much for the economy’s current needs. Martin Feldstein thinks this is just the right approach. Is it? That question is intrinsically unanswerable at the moment because we will need to see the future and how it pans out to know if the Fed really is doing the right thing today. For today Fed policy is uncomfortable and has been made with too many warts to boot.

We could see Janet Yellen this week looking more uncomfortable than she ever has looked. The stakes remain high.


Friday, February 5, 2016

The Job Report in Fed Context- Or Bull-riding

Is the show run by dogma and is the phrase 'data dependency' just for show?

In some sense... to the Fed the jobs report means almost nothing.

What I mean by that is that Fed officials are now speaking to us much more in 'Fed Speak' about what they expect; The new reality is what their 'model' is telling us - and the job report simply is NOT part of their model.  

Models and tracking
So, for the jobs report to 'MEAN SOMETHING' it has to address a Fed official with a model and throw that member's model 'off track'. Let's just say if you have ever seen bull-riding, staying on a bull is about as hard as throwing a model off track. Models have huge standard errors and given the vagaries of the data a lot of things can keep an economist saying "my model is still on track," "my model is still on track,"  "my model is still on track"...when it isn't. 

Models and Ideology
Models of course are imbued with the ideology of their maker. So the model also represents that ideology and since it is believed by the model's creator it also represents the prevailing dogma of its estimator. While users will tell you that their models change and are flexible for all practical purposes that is not true. What you have is a continually re-estimated (and re-based model) undergoing some very minor changes each time it is run while the main characteristics stay in place. So incoming data really have to do something spectacular to put a model's forecast in doubt. And, since so many of these Fed members use models for their outlook... let's remember that models really never project a recession ahead of time. They won't see it coming... 

Models...and reality
I fact I think they call these things models because they are like the women on the fashion runways. The way they can wear clothes is just a way that real people simply can't. They wear this stuff on the runway then sell it to normal people who wonder how come this looks like this on me? The same can be said about economic data that is claimed to look so consistently fine within a Fed official's model, but appears quite different to the unemployed man-on-the-street. And this is not just a case of illusion...     

So as we look at the employment report, what do we see looking through the lenses of these sorts of models?

1. The unemployment rate is falling- check that fits with my tightening model
2. Average hourly earnings rose and are up 2.5% Yr/Yr - Check that fits with my labor market tightening inflation is on track Phillips curve is not a dead model - It is not dead! What? You buried it? DIG IT UP!! NOT Dead!!
3. Jobs grew again in manufacturing and the gain was in the top 10% of all changes in MFG jobs since jobs began to grow in this recovery. Check- that fits with my, 'hey this manufacturing sector is not as bad as people say' model ...go chuck the ISM.
4. The labor force participation rate rose AND the unemployment rate still dropped- Check Labor market is still really strong. The Household reports knows...Rising participation rates are the manna from heaven we have been waiting for. There is a God and he still likes economics...
5. Hours worked rose 0.4% in the month and that is real solid/strong CHECK-a-roonie
6. The service sector slowed and its puny gain this month stands in the bottom 12% of all changes in private services jobs since jobs began to grow in this recovery. Ok... Check so there is some slowing in services but still enough job growth overall to drive the unemployment rate lower. Still, consistent with my overall tightening model. 

and we could go on...but I'll stop here

Models, jobs and context
Above you see how easy it is to keep your view and to see confirmation in the monthly numbers. Some things fit more seamlessly than others...As for AHE, there is minimum wage legislation that kicks in on the first of the year requiring another batch of wage re-boots and that will bounce wages higher. Maybe the average hourly earnings gain has some regulatory fluff in it? Job growth was still centered in low wage industries...but also construction and manufacturing this month -and government employment fell. The job gains in MFG are hard to fathom, they are not present in the ISM, but there they are there in non-farm jobs, at least for now. Bad seasonal factors? Who can say? But SOMETHING here is inconsistent...     And of course there is a job growth slowdown in January even it it is not yet a multi-month slowing...there is a weak MFG ISM there was a sharp pullback in the Non MFG ISM. When we try to square the employment results with other similarly topical reports we don't get full corroboration. 

That should be another reason to not simply feed this gunk into your model. Garbage in, garbage out as they say.  

Wealth and wealth (poverty) effects
Moreover, the international signals are still weak. The dollar has been pulled to and fro and it seems to have finally sided with the notion that the rate hike in March may still be on.  Oil is slipping, stocks fell (as of this writing anyway). The market remains a dynamic if confused discounting mechanism. Ignore it or assert that it is disconnected from the real economy at your own peril. There is a massive loss in wealth taking place... IT IS REAL. As I wrote yesterday after the European Impressionist art auctions tanked- that was real. There was less wealth supporting that market and it showed. What's next? WHAT'S NEXT?? God help me for asking but is it...will it be real estate? Please say NO!

Still in the eye of the storm and it is a - GLOBAL- not just International storm
One problem we may have is being still in the eye of the storm making the current data reports too-recently affected by events to have fully reacted to them. Whatever is the case here, it is clear that there is a lot of confusion. The Fed for now HAS NO ASSESSMENT of risk. We all are waiting for the Yellen monetary policy testimonies (Formerly Humphrey-Hawkins) before Congress to see if the Fed's message will change. For the reasons I express above I think it may not have changed by much. The Fed language may be a bit more equivocal, but in all cases the Fed remains accommodative to a rate hike in March. The Fed has been careful not to take any action that might push that off. Perish the thought...

Dogma IS what DOGMA DOES
And that is why I continue to see Fed policy as based on DOGMA. There is no reason to stick with a March rate hike. A hike has not been promised. The economy is out of sorts. There may still be legacy strength in the job market even as it cools...Jobs are a lagging, not a leading, variable. Challenger layoffs are up to the 10th highest in December in the last 21 years after ranking much lower in earlier months.  Jobless claims are drifting higher, the ISMs both are weak and weakening stocks are volatile and lower overall. There are lots of reason to be circumspect. What is so sacrosanct about getting four rate hikes in this year? Really? Keeping that door open in the wake of this turmoil is making the Fed look more and more like the show is run by dogma and that statements of being data-dependent are just for show.     

We will come to know the jobs report better as more months reveal themselves. It is reasonable to think that there has been some shift. The ISMs are saying so. January was ambiguous- something for everybody. That does not mean we are not at a point of inflection or something more severe.


I hope you find the above discussion useful. It is my impression that it is more useful at this point than a PowerPoint full of slides about trends that may be shifting.