Friday, April 3, 2015

Climbing a slow-growth wall of worry

The March jobs report was disappointing, but there is little reason to think that the first quarter weakness in the economy goes beyond the effects of bad weather, West coast port slowdowns, cutbacks in energy-related investments and statistical "noise." The economy most likely slowed down in the first quarter (the Atlanta Fed is now forecasting zero growth), but it is just as likely to resume moderate growth of 3% or so going forward. The market, however, continues to worry about slower growth, just as it has worried about other things in the past (e.g., Ukraine, Eurozone/China slowdowns, sharply lower oil prices). I suspect we will eventually overcome this new "wall of worry" just as we have overcome many others in recent years.


The March ISM report added fuel to the slowdown worries, coming in much lower than expected. But as the chart above suggests, the drop in the ISM manufacturing index is still consistent with decent underlying growth conditions of 2% or so.


As the chart above shows, swings in payroll growth such as we have seen in recent months do occasionally happen. We're likely to see a bounce back in the months to come.


As the chart above shows, the six-month annualized rate of growth in jobs hasn't changed much at all, and is likely to be around 2-2.5% for the foreseeable future. In order to see an acceleration from recent levels, we will need to see growth-friendly changes in fiscal policies (e.g., lower and flatter taxes on income and capital, reduced regulatory burdens).


Part-time employment is behaving exactly as it has during previous business cycles. There has been almost no growth in part-time employment since 2009, while it has fallen relative to total employment by a substantial degree. This is still the weakest recovery in modern times, but it is fairly typical in many other respects.


Real yields on 5-yr TIPS have fallen about 100 bps from their recent highs, which is a good sign that the market has repriced to much lower growth expectations (as low as 0-1%, as the chart above suggests) going forward. Weaker growth is priced in and pessimism has returned, at least for now. Barring a recession, this leaves the market vulnerable to upside surprises; arguably, this could take the form of simply avoiding another recession. The following all suggest that a recession is quite unlikely: the yield curve is still steep, real yields are very low, and swap spreads are firmly in "normal" territory.


The principle source of the recent rise in the Vix/10-yr index is the decline in 10-yr yields to 1.84%, which in turn has been driven by reduced expectations for economic growth. That has pushed back the timing of the Fed's first interest rate hike. If the economy continues on its current relatively weak path, the Fed is not likely to raise rates in May. Previous episodes of spikes in the Vix/10-yr ratio had more to do with nervousness in general (reflected in a rising Vix index).

15 comments:

Benjamin Cole said...

Excellent review.

The unpleasant question for some is whether the Federal Reserve Board needs to consider quantitative easing as conventional policy.

Should the Fed go to QE in advance of a recession, and thwart contraction or must it wait until there is an ongoing recession before resorts to QE?

With interest rates trapped near zero, it is only a question of time.

Zero growth in Q1? Inflation and interest rates falling? And the Fed is talking about a rate increase?

Andrew Ross said...

Not only has the private sector six month annualized rate of job growth not changed much, it is also about as good as it has ever been.

Wish the political situation was more focused on reducing taxes and regulations.

steve said...

"In order to see an acceleration from recent levels, we will need to see growth-friendly changes in fiscal policies (e.g., lower and flatter taxes on income and capital, reduced regulatory burdens)."

AIN'T gonna happen! not while O in office at least. given we're 6 years into a recovery, why is it hard to imagine economy is rolling over? bond market is clearly making that argument.

William McKibbin said...

Our problems are neither fiscal nor monetary -- watch for real working wages, real home values, and the employment to population ratio to continue to stagnate over the balance of the 21st century -- do not base investment decisions on emotions such as "worries" -- base investment decisions on reality -- my advice is for savvy investors to acquire world-class skills that earn premium wages that convert in high quality dividend and rent-earning equities over a lifetime -- everyone else should be under cover watching out for the four horsemen of the apocalypse...

William McKibbin said...

PS: A national default on debt would be the fastest route to economic (and political) recovery in my view...

Benjamin Cole said...

William M---Well, John Cochrane advocates converting entire national debt into bank reserves through QE. So there are people thinking about eliminating debt...but not defaulting. Greece can default and it is a, "So what." The US?

I sense repercussions...

Jim said...

QE masked the unemployment problem by allowing corporations to buyback stocks and prop up their earnings. All of course with the courtesy of banks allowed to shift that money from excess reserves to reserves and allow the leveraged borrowing.

All smoke and mirrors this economy is.

Matthew Grech said...

Yes, excellent review. And Benjamin's comments are excellent, as well. Other than the general (ignorance-based) discomfort with ZIRP, why would we be considering rate increases now? I don't believe the It'll-Be-Too-Late-Once-We-See-Inflation crowd doesn't properly consider the power the Fed has to arrest any inflation by simply raising the rate on excess reserves.

But while we all babble on about monetary policy, is it too much to ask for some positive direction on fiscal policy? I think I'm right to be impatient. Our tax codes, both individual and corporate, are laughably complex and self-defeating. Is it naïve to think some improvement should be in the cards?

xr-3609 said...

Scott: There is one group that does not appear to be worried, NYSE margin debt appears to be at extreme levels. Can this be fully attributed to the low yield environment or does it point to high optimism and speculation?

http://www.advisorperspectives.com/dshort/updates/NYSE-Margin-Debt-and-the-SPX.php

Scott Grannis said...

Re margin debt. On the surface the increase in margin debt would, I agree, be something to worry about. But there are so many things to take into consideration. As I show here

http://scottgrannis.blogspot.com/2015/03/us-wealth-hits-new-high.html

Households' overall leverage has dropped significantly in recent years and is back down to the levels of the early 1990s. Total household liabilities are only about $14 trillion compared to net worth of $83 trillion. Margin debt is up but all other forms of debt are down. As a result, I'm not particularly worried.

William McKibbin said...

The problem is not household debt -- the problem is the national debt -- cutting household debt does nothing to cut the national debt...

xr-3609 said...

Scott: Thank you for a really great web site particularly regarding your educational approach and the thoughtfully unique economic analysis.

The "many similar posts" link was very helpful regarding corporate profits:

http://scottgrannis.blogspot.com.ar/search?q=corporate%20profits%20valuation

William McKibbin said...

The fastest way to reduce household debt would be for the US to outlaw consumer lending -- as for the national debt...

John McCormick said...

Household debt is down because individuals walked away from mortgages they couldn't afford, past it on to banks, which past it onto the Fed.

Currently very few can afford to buy a house. With new mortgages down, sure household debt will be down. No real wage growth coupled with fake house prices held up by phantom low interest rates. Just a small part of the structural problems we now face.

The Fed can't raise rates because to do so will strengthen the dollar to a point that it will cripple corporate profits, toppling the equity markets.

Lets just blame the weather!

Problems we face go far beyond Monetary or Fiscal shortfalls. Structural change is long overdue!

Hans said...

When the Central Bank is used to prop up an economy, you know you are near the end game.

The FRB cannot raise rates! All the talk of rates are nothing more than hot air for public consumption.

Long live, FedZero!