Blogging has been light this week and will be light next week, since I am in the midst of our annual Guys ski trip—this week in Park City and next week in Big Sky, Montana. I am still following things, nevertheless, and was somewhat amused to see today be one of those "good news is bad news" days.
February jobs growth was stronger than expected, confirming that labor market conditions have improved. But not by much. The economic outlook has not improved dramatically, it's simply gotten a bit better. Whether the Fed tightens one month earlier than expected as a result of this number is almost a trivial matter. Short-term rates are not going to be problematic for the economy for a long time, no matter what. I see no reason the economy couldn't continue to (very slowly) improve even as the Fed raises short-term rates a couple of hundred basis points over the next two years or so (that's a forecast drawn directly from the bond market's current expectations).
The chart above documents the improvement in the labor market over the past year. The 6-mo. annualized growth rate of private sector jobs (the ones that really count) has inched up from 2.1% early last year to 2.9% as of last month. That's hardly enough of an improvement to transform the economy within the foreseeable future, since the number of jobs is still roughly 10 million less today than it could be if this had been a normal recovery. Even with 4% jobs growth it would take many years for the economy to get back to a level at which the Fed might begin to worry about the economy "overheating." For things to get dramatically better we'd need to see some big changes coming out of Washington: reduced tax and regulatory burdens, to name just a few. Sadly, that doesn't seem to be right around the corner.
Arguably, the more important developments in the economy are being overshadowed by the modest improvement in the jobs market: monetary developments.
Banks are lending, and at a fairly rapid pace. C&I Loans, as shown in the chart above, are growing at a 12% annual pace. This is an important indicator of rising confidence: banks are more willing to lend, and businesses are more willing to borrow. Banks have huge supply of "excess" bank reserves on hand, enough to support a terrifying increase in lending and money supply growth if they chose to do so. Hiking short-term interest rate by a few notches is not going to change that equation.
The relatively fast growth of lending is a sign of rising confidence and a sign of declining demand for money. When you want to borrow more, you want less exposure to money; you want to be short money. When you want to borrow less, you want more exposure to money, etc. The whole point of the Fed hiking the interest rate it pays on reserves is to keep the banks from increasing lending too much; to keep them satisfied with holding bank reserves, which are effectively T-bill substitutes and the quintessential "money" asset—risk-free, default-free, and with a floating interest rate.
The thing to worry about today is not whether the labor market is growing a bit faster, but whether the Fed is failing to raise rates by enough to keep the growth of bank lending within acceptable limits. Too much lending would result in a large increase in the money supply and it could eventually debase the dollar, resulting in rising inflation (too many dollars chasing too few goods and services).
As the chart above shows, the growth of the M2 measure of money supply has averaged about 6.5% per year over the past 8 years. Since 1995, M2 has grown about 6.2% per year, so it would appear that nothing unusual is going on. But over the past several months, the 3-mo. annualized growth of M2 has climbed to 10%. Money supply growth is really picking up, most likely because of the increase in bank lending. Total bank credit is up 8.3% in the past year, which is the fastest pace of growth since prior to the Great Recession.
So far, there are no alarm bells ringing. Despite the more-rapid pace of bank lending and the more-rapid pace of M2 growth, the dollar is doing very well. Demand for dollars is outpacing the supply of dollars, so the Fed is not yet "behind the curve."
Add it all up: the labor market is gradually improving, confidence is gradually building, and the Fed has managed to keep the supply and demand for money in balance. What's not to like?