Friday, November 24, 2023

 

November 24, 2023

 

Robert Brusca, PhD

Fact and Opinion Economics

(FAO Economics)

 

FAO economics is an economic research consulting firm that delves into the analysis of macroeconomic data and policy analysis.

 

There is a strong focus on central bank behavior and how the Federal Reserve makes policy announces it to the public and implements it.   

 

I am currently writing a substack at this address:

 

https://robertbrusca.substack.com/

 

 

BIO Summary:

 

ROBERT A. BRUSCA is Chief Economist of Fact and Opinion Economics, a consulting firm he founded in Manhattan.  He is also a past professor graduate program at the Zicklin School of Business at Baruch College in Manhattan. Mr Brusca has been an economist on Wall Street for 48 years. He has visited central banking and large institutional clients in over 30 countries in his career as an economist. Mr. Brusca was a Divisional Research Chief at the Federal Reserve Bank of NY (Chief of the International Financial markets Division), a Fed Watcher at Irving Trust and Chief Economist at Nikko Securities International (for 16 years). Mr Brusca currently is a consultant. He is operating the second of two consulting firms he has founded since 2001. He is widely quoted and appears in various media. Mr. Brusca holds an MA and PhD in economics from Michigan State University and a BA in Economics from the University of Michigan. His research pursues his strong interests in non aligned policy economics, investing, as well as international economics. FAO Economics’ research targets investors to assist them in making better investment decisions in stocks, bonds and in a variety of international assets. The company does not manage money and has no conflicts in giving economic advice. Mr Brusca, or his comments, appears in a wide variety of media outlets.

 

 

 

 

 

 

 

 

 

 

An October Surprise from Jobs

How much of it do we really believe?

 

Job growth in October ratcheted down gaining only 150,000 jobs after gaining nearly twice that much at 297,000 in September. The slowdown in private jobs was more severe as September's 246,000 gain turned into 99,000 in October.  Government sector jobs led the job growth parade in October. 

 

Markets reacted strongly to this news that job growth was weaker in October than September knowing that it meant that job growth was weaker in October than it was in September…  And although that's all we really know, people in markets jumped to many, many, other conclusions based on this report that seemed to fulfill their hopes and dreams...

 

A month ago, the headline gain was even stronger as it has been revised down in this report but at that time markets did not react strongly to it because they didn't completely believe it. Markets have continued to believe the economy is going to slow. Indeed, markets have been looking for the Fed to pivot almost from the moment the Fed began to hike rates. This month on news of weakness. markets are even more certain that they're right, more certain than they were last month when the numbers showed them that they were dead wrong, at least for a while - unequivocally wrong.  The Market view is undeterred.

 

Job growth in the economy has wrong-footed forecasters for quite some time… but that's not surprising after the tremendous amount of fiscal stimulus that had been poured into this economy on top of an enormous dose of monetary stimulus.  Stimulus is in the process of being unwound and certainly based on the current level of rates, and that level compared to inflation, monetary policy is no longer stimulative. However, monetary policy works with the lag and that works both after stimulus as well as after rate hiking and we can't be sure that all the effects of the monetary stimulus have been boiled out of the system yet. For example, in this report, construction jobs increased by 23,000, more than the 13,000 that were created in September, and greater than the three-month average of 22,000 per month, and greater than the year-over-year average of 18,000 per month. So, the spike in rates and the high mortgage rates themselves have not caused the construction sector to roll over. People looking at this report are saying that it's evidence that the interest rate hikes are working but when you look at the interest sensitive sectors that doesn't seem like a provable hypothesis.

 

The BLS tells us that part of the reason for the downward revision to job growth in September was because of the UAW strike and some misclassified workers. Since the UAW contract gives a raise of 11% in the first year and more to come later as auto production gets back to normal, we can expect to see a reduction in these headwinds. We've seen in the last several months while the strike was going on some pretty good job growth! Perhaps now there will even be stimulus from the greater income that workers will have in the wake of the new contract.

 

I'm not terribly excited to take this weak October job report and to run with it and call it the start of a slowdown in the economy. It may be that, but then again it may not because this is not the only game in town. Monthly job creation is a volatile thing; the 150,000 jobs come after a 297,000 job gain which had come after a 165,000-job gain. Over the last three months job creation averages 204,000 pretty similar to the 207,000 and average in the previous three months and this month's number of 150,000 isn't really all that much weaker than the average of 204,000 for me to jump up and down about it. 

 

However, in the job report there was also a reduction in hours worked. There was a rise in the unemployment rate and there was some ongoing moderation in wage gains. But as we look ahead, we have the UAW contract kicking in and its potential to be a bellwether for other wage gains in the economy. The unemployment rate has risen half a percentage point from its low and it's within 1/10 of a percentage point of triggering a recession warning according to some of the signaling mechanisms that I'm acquainted with.

 

It's true that there are several aspects of this report that point to things slowing down but again we'd like to see some trend rather than just one month's worth of data and particularly one month after a very strong month.  I urge vigilance and looking at the numbers and anticipating the future we need to make the numbers show us what's happening rather than to bet too much on anticipation because anticipation has been so wrong in the wake of the COVID recession. We continue to have cross currents in this economy and it's still true that while the federal funds rate is no longer at a stimulative level it's not at a very restrictive level either. So, when comes to braking the economy, I don't think that interest rates are providing much braking although we could be looking at the dissipation of the stimulus from monetary policy in the past as well as a tailing of fiscal policy. Be open-minded about the trends we're observing and about extrapolating them too far into future.  It’s been a tough time for forecasters.

 

 

 

 


 

Good fences make good neighbors

Except on our Southern border?

What would Robert Frost think?

 

What a fence does: Having a clear boundary between your house and your neighbor’s, and respecting that boundary, helps to keep the peace between neighbors, and thus good relations between neighbors are partly dependent on fences as a marker boundaries.  ‘Good fences make good neighbors’ pithily expresses the need to have clear boundaries between properties, as well as the need for neighbors to respect these boundaries, if relations between neighbors are to remain amicable and ‘good’.  Source

 

With that prelude I have never understood the Democrat’s opposition to Donald Trump's desire to have a wall on the southern border. It is quite clear that the southern border has been porous for some time and that people can get into the country without too much difficulty and beyond our control because the border are is so open and vast.  What's the point in having a border if the border doesn't mean anything?

Why don’t we rename the county: The United States and the Americas?

As a further point Democrats who belittled and berated Donald Trump for wanting to build a wall accusing him of racism, among other things, laid the groundwork for the belief by all people South of our border - or anywhere else - that if Democrats gained office the border would be open.  And so the incredible problems we have had with undocumented aliens coming in droves across the border into the country straining social services can only be put at the feet of Democrats. They wound up encouraging this because they were so eager to damn the policies of Donald Trump. Lesson be careful how you hate?

 

It's hard for me to understand why anybody in any political party would want to fail to define and defend the border. The US has such a problem with that southern border not just with undocumented aliens coming across but with drug smuggling it would seem that a more secure border would be an objective of any political party with a sensible view of geopolitics.

 

Mayor Adams in New York has called the migrant crisis in the city- the city in which I live – one that is very serious and the first time that he has seen a problem in his professional career that he's not sure has a solution or an end.  It is not surprising that border state governors have taken action to try to ship immigrants who come into their state to other states because these undocumented aliens create just as much strain on the Texas economy as they do on the New York economy or any other economy. And Democrats are the once who have strongly supported this porous border policy, so Democrat run states need to share the pain. Since Texas is on the border and since the federal government that is supposed to be guarding the border hasn't done that Texas has wound up bearing the brunt of the burden along with other border states.

 

It is often pointed out that allowing people to flood across the border and get in a queue for citizenship undermines other avenues for citizenship that have been in place far longer and that have required a thorough vetting of applicants who have had to wait many years for their applications to be considered and approved. Why do that?

 

This is another example of the Democrats creating a policy much like French foreign policy at the end of World War Two period. At that time the French were determined to be on their own and not necessarily to follow the United States. French foreign policy became the opposite of US foreign policy. Whatever US foreign policy objectives were the French objectives were the opposite. And this is precisely what the Democrats have done with Donald Trump. Whatever Donald Trump likes, whatever he endorses, whatever he supports, they are instantly against, without even thinking about it. And this border situation is the perfect example of how that kind of cancel-culture has gotten them into a great deal of trouble.

 

Joe Biden put the border problem in the hands of Kamala Harris who decided it was a toxic problem that it had no solution and she didn't want to be anywhere near it. And as far as I can tell nobody in the administration has done anything to try to deal with the issues that came to the border with the election of Joe Biden. The Democrats insistence that Donald trump's closed border policies were wrong led to this mess.

 

There are many examples of Trump supported policies that were subsequently blocked by Democrats or by medical experts during the COVID crisis. And while there's no sense that Donald Trump had any kind of magic touch it's also clear that he had a number of ideas and policies that never should have been dismissed out of hand the way they were. But this is the new world in which we live and in which Democrats have supported this culture of cancellation as well as an approach to assert that they know what is right and have implemented policy based upon their view of science even where science is in dispute.

 

Just a reminder here… science is much less in dispute than it is in flux. When policy needs to depend on some aspect of science that's in dispute, we need to have a better way to decide what we think the approach should be rather than have one party dictate and steamroll its own view into the future.  The Democrats bull on the China shop approach to the southern border problem should be enough to convince just about everyone that when it comes to dispute resolution, they don't have a clue, let alone the answer.

 

But we do have complaints from some politicians such as the mayor of New York City who are very concerned about how they are being overrun by immigrants and about the financial burdens being placed on their cities. We do not find the liberal press engaging in any criticism of the open border policy. Instead, if you want to consider the positives and negatives of Trump's wall all you need to do is go to this article on Vanity Fair (here).  I think you'll agree that the article displays a lot of vanity and little fairness. 

 

What to expect if you are expecting (low-inflation) but shouldn’t be

...and why you probably shouldn’t be

 

Economists put inflation expectations and term premium effects on treasury securities in different boxes when analyzing the yield curve but maybe they should not.  I have had a bit of a ‘running feud’ with Fed officials as I have been haggling with different visiting Federal Reserve officials when I have been able to catch them in New York and query them on Fed policy, real interest rates, and interest rate expectations. The Fed has only one position on these things and there is a reason for it. I am convinced the reason is not just because the Fed thinks it is right.

 

What is at issue here and now is that the yield curve is getting steeper without any explanation! The Fed asserts that term premia are rising (for some reason) but that inflation expectations are anchored- and not a reason for this. One conjecture is that the size of the federal deficits, political conflicts, the risk of a fiscal event, and huge slate of bonds to be auctioned are causing investors to seek greater premia on US treasuries.

 

As Peggy Lee once asked…is that all there is?  

 

Maybe not…

 

The Fed is conveniently leaving itself out of the picture (ignore that man behind the curtain…). And yet, the Fed has allowed inflation to flare, run high, and has only reluctantly chased it, and vigorously raised rates, then stopped suddenly, when interest rates reached the level of trailing inflation.  After letting inflation run hot, I do not recognize this Fed rate hiking effort as a strong anti-inflation move. The Fed wants to tout its string of 75bp rate hikes but those were essential for the Fed to catch up after it sat on its hands for a year doing nothing as inflation surged over its target.  To cut to the chase… I greatly suspect one of the reasons the yield curve’s term premia are rising is the loss of Fed credibility mixed in with perceptions of higher inflation risk because of that.  The Fed of course will not go there. My argument is below:

 

The Issues are…

When I have complained about Fed policy, I point out the real Fed funds rate in the past cycle was as deeply negative as it had even been. Sixteen of the twenty lowest real Fed funds rates since 1960 (exceptionally low negative values) occurred in this cycle. When confronted with this FACT Fed officials reject this argument since you need to compare the level of interest rates to expected inflation not actual inflation from the past- so they say. Really? Well, full points to the Fed on that academic argument. But how does that work in reality?  Answer: it does not work…  

Chart 1



 

The University of Michigan provides several series on CPI inflation expectations five years ahead.    There are two here, the mean and the median. The mean is higher so naturally the Fed usually refers to speak of the median. You can clearly see that inflation is much more volatile than inflation expectations here. The CPI’s variability is over two times as volatile as the mean and nearly four times more volatile than the U of M median. The Fed wants to argue now – and every Fed member who gives a speech these days - reports this bromide: ‘that inflation expectations are well anchored.’  But if you look at the history of these series, they seem to be perpetually anchored! Especially the median!  The chart here plots inflation expectations at the time they are formed not shifted against the period five-years ahead to which they apply.  But it’s obvious that these series do not predict future inflation well at all.

 

Now I am going to show you something that is shocking!

 

Chart 2





This chart plots the U of M mean inflation estimate Vs the actual CPI inflation rate at the time the U of M estimate is formed. The greatly improved fit is achieved by plotting inflation expectations as rankings against the CPI also plotted as a ranking over the same period.  What these charts help to reveal is that the level of inflation expected is not well correlated with the level of current or future inflation. But when ranked, expectations are higher when inflation is higher and with that an expectation-inflation link is established. 

 

What this demonstrates, in fact, is something that can be seen in chart 1 if you look closely, that inflation expectations are not anchored at all. Presented as rankings inflation expectations are exceptionally high- compared to the range of values that historically it has taken on.   People who form inflation expectations in this survey are affected by the current environment but are not willing to be very bold in making projections…that is the Achilles heel for the Fed.

 

To me this observation significantly blunts the usefulness of inflation expectations that the Fed relies on so much. In fact, it seems to me that it is more likely that we should conclude that investors really do not form inflation expectations in a formal sense the way theory assumes. Still, the ranking data strongly indicate they are aware and perceive inflation risk as higher or lower from time to time. Because of this I believe that it is likely that inflation risk becomes embedded in the yield curve as part of the term premium – it’s not a separate issue. That opens the door to saying that the yield curve is steepening because of a too-tepid monetary policy and perhaps also for various fiscal reasons.

 

The Fed will not go there. I will. I have made somewhat more detailed arguments on this topic in an article you can read on Seeking Alpha here.   The Fed’s unwillingness to take a reasonable position on the subject of real interest rates and its unwillingness to accept that it made real rates exceptionally low in the post Covid period, is just a way for it to try to avoid the blame for what is happening.  

 

But what is worse is that the ranking data confirm my suspicion that whether they are good or not, inflation expectations, in fact, are formed. And they are not good because they do not anticipate future inflation well. But the relative rise in expectations is clear and demonstrates that investors inflation hackles are raised.   That means they may in fact be marking up inflation risk much more than the Fed thinks. That maybe part of what the yield curve is telling you…

 

You can accept or reject this argument. I put it on the table. And I think the Fed’s approach of refusing to look at the traditional real Fed funds rate measures that have been a reliable gauge of the tightness of monetary policy historically is a real mistake. We are witnessing a Fed that is being extraordinarily influenced by politics. I am quite concerned that the Fed will not talk about policy and what it has done in an even-handed way.  The Fed’s fingerprints are all over this inflation rate and now it is hoping that inflation continues to ratchet down.  I think the inflation deceleration period is about to slow dramatically. That will then put the Fed in a more difficult spot with elections coming. How long can the Fed continue to pretend a soft landing lies ahead? Maybe we should take bets on that…