Thursday, November 5, 2015

Random charts and thoughts

Just eyeballing the chart above tells me that the BLS's estimate of private sector employment tends to be more volatile than ADP's, and both tend to track each other over time. That further suggests that the BLS jobs number—to be released early tomorrow—has a decent chance of beating expectations (currently about 170K), since the ADP numbers have have been averaging just under 190K for the past 7 months. This ostensibly "good" news would probably be disappointing for the market (at least initially), since it would raise the probability of a Fed rate hike next month. The market wouldn't be caught totally by surprise, however, since the implied probability of a December rate hike has risen from 30% two weeks ago to 56% today. I think the market is beginning to realize that the economy is in decent enough shape (growth unlikely to change much from the 2-2.5% trend of recent years) to withstand a very modest increase in short-term interest rates.

In my view, the Fed can hike rates any time they like and it's not going to worry me. Rates naturally move higher as optimism increases and the economy matures. Higher rates would be a confirmation of growth, not a threat to growth.

As the chart above shows, large companies have not been very dynamic over the past two business cycles. Payrolls at large companies (500 or more employees) today are still about 10% below where they were in early 2001. Meanwhile, small and medium-sized companies have posted much more impressive growth.

Manufacturing hasn't been very impressive in the past year or so (weakness in the oil patch), but the service sector (which is far bigger) has been pretty impressive. The ISM service sector business activity index is at the high end of its range. More evidence of the hot-cold economy we're in: some do very well, others not so much. But on average things are growing at a fairly steady pace.

The employment sub-index of the ISM service release yesterday bounced back to a very strong level. This suggests that businesses feel pretty good about the future, because they plan to increase their hiring.

The service sector of both the U.S. and Eurozone economies are doing reasonably well. Between them, they account for a significant share of global GDP. Reason to remain optimistic or at least refrain from being pessimistic.

The prices of 5-yr TIPS (here proxied by the inverse of their real yield) and gold continue on a downward trend. The market is gradually losing its pessimism (which, at its height drove gold to $1900/oz and real yields to -2%) and coming to accept that the economy is likely to continue to grow, albeit slowly, and that the Fed is likely to acknowledge the improvement in expectations by raising rates a bit.

This last chart illustrates how real yields tend to track the economy's real growth rate. Both have been rising a bit in recent years. Nothing to get excited about, but somewhat reassuring nevertheless. Wake me when real yields on 5-yr TIPS break through 2%, and I'll wager the economy will be doing a whole lot better. And the Fed will be paying IOER of 3-4%.


Benjamin Cole said...

The Bank of Japan pays 0.10% interest on excess reserves and the islands have an unemployment rate of 3%.

The Bank of Japan, of course, has an ongoing QE program. The Fed should look to the Bank of Japan for guidance.

I doubt I will see 3% to 4% IOER in my lifetime, and I figure I got a decade or two left.

But then, who knows? Perhaps the GOP will nominate a bearded black pacifist (Seventh-Day Adventist) for the Presidency. Life is full of surprises.

Benjamin Cole said...

OT to Scott Grannis: the nation of Switzerland is considering mandating 100% reserves for their commercial banks. In this situation, commercial banks would not have the ability to create money, and that ability would fall solely upon the Swiss National Bank. Tyler Cowen has a post on this. Interesting.

What does this mean for money creation?

William McKibbin said...

Useful information, thanks.

Matthew Grech said...

Thanks for the charts, Scott.

One point, though... The standard for whether or not the Fed should raise the Fed Funds rate shouldn't be whether the American economy can "withstand" a small hike. The question should always be, directionally, where the money supply should move.

TIPS spreads, both level and direction, suggest the Fed should, if anything, be loosening. Ditto the PCE deflator, which is both low and declining. Finally, gold's direction is highly suggestive that the Fed is too tight. (I know you'll put up a long term chart of gold to come to a different conclusion.) Industrial metals pricing corroborates my interpretation of gold's message (that the Fed is too tight). Finally, other central banks' actions and highly-likely coming actions suggest the Fed may be very wrong to raise rates.

Never has the Fed-is-too-tight-if-anything crowd (of which I'm a member) suggested that we couldn't "withstand" a small hike. We'll withstand it much as we would any negative occurrence. But it's a (small) step in the wrong direction. (Btw, futures markets have clearly signaled that the likelihood of a hike in Dec has risen and is well above 50%. But I'm not so sure they'll follow through.)

Incidentally, if we still have $2.5 trillion in excess reserves in a few years, on which the Fed is paying 3-4%, then something will have gone very, very wrong. Neither one of those things would be a sign of economic health.

Scott Grannis said...

Matthew: I agree that the standard for raising rates should not be whether the economy can withstand a tightening, but that is how the Fed apparently looks at things. I don't agree, however, that TIPS spreads, gold, and commodities suggest the Fed is too tight. 5-yr TIPS spreads are being driven primarily by oil prices, and that is not something the Fed should be trying to manage. Longer-term TIPS spreads (5-yr, 5-yr forward spreads) are saying inflation will very close to 2%, and that is presumably exactly what the Fed wants to see. Commodities, including gold, are still well above their long-term averages, and therefore they do not suggest policy is too tight—as it was in the early 2000s, when commodities were at very low levels.

I think the Fed fully expects that one day they may be paying IOER of 3% or more. They have run extensive simulations which I'm sure have included this possibility. It's not a big problem per se, since what matters is the spread between what they pay and what they own, which is currently pretty generous. If that spread goes negative in a big way, then they will have a problem, but that is still far in the future.

Credit spreads were pushed out because of 1) sharply lower oil prices and 2) a general perception that the weak payroll numbers of recent months reflected a significant slowing of the economy. Both those problems have been mitigated to a significant extent more recently, and most importantly, swap spreads remain very low. So it's not clear at all that credit spreads suggest more easing is necessary.

Benjamin Cole said...

FYI 100% reserves

No more "endogenous" money supply.

From Marginal Revoluation:

"A Swiss group has collected the 100,000 signatures necessary to require a national referendum on requiring banks to hold 100% reserves.
In a nut shell, the proposal extends the Swiss Federation’s existing exclusive right to create coins and notes, to also include deposits. With the full power of new money creation exclusively in the hands of the Swiss National Bank, the commercial banks would no longer have the power to create money through lending. The Swiss National Bank’s primary role becomes the management of the money supply relative to the productive economy, while the decision concerning how new money is introduced debt free into the economy would reside with the government.
After interest in the 1930s Chicago plan of Fisher and Simons died off, Murray Rothbard and other libertarians were virtually the only people calling for 100% reserves. More recently, however, the idea has almost become mainstream. Consider Martin Wolf’s FT column:
Printing counterfeit banknotes is illegal, but creating private money is not. The interdependence between the state and the businesses that can do this is the source of much of the instability of our economies. It could – and should – be terminated.
…Banks create deposits as a byproduct of their lending. In the UK, such deposits make up about 97 per cent of the money supply. Some people object that deposits are not money but only transferable private debts. Yet the public views the banks’ imitation money as electronic cash: a safe source of purchasing power.
Banking is therefore not a normal market activity, because it provides two linked public goods: money and the payments network. On one side of banks’ balance sheets lie risky assets; on the other lie liabilities the public thinks safe. This is why central banks act as lenders of last resort and governments provide deposit insurance and equity injections. It is also why banking is heavily regulated. Yet credit cycles are still hugely destabilising.
What is to be done? A minimum response would leave this industry largely as it is but both tighten regulation and insist that a bigger proportion of the balance sheet be financed with equity or credibly loss-absorbing debt.
…A maximum response would be to give the state a monopoly on money creation. One of the most important such proposals was in the Chicago Plan, advanced in the 1930s by, among others, a great economist, Irving Fisher. Its core was the requirement for 100 per cent reserves against deposits. Fisher argued that this would greatly reduce business cycles, end bank runs and drastically reduce public debt. A 2012 study by International Monetary Fund staff suggests this plan could work well.
Similar ideas have come from Laurence Kotlikoff of Boston University in Jimmy Stewart is Dead, and Andrew Jackson and Ben Dyson in Modernising Money.
Hat tip on the Swiss proposal to Dirk Niepelt who offers further comment.
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