Jobs and War: the Fed needs to ease

The February jobs report was a lot weaker than expected (-92K vs an expected +130K). But viewed from a broader perspective, it's just more of the same slower growth that we have seen over the past year. Jobs numbers are notoriously volatile to begin with, and on top of that, in February most of the country was hit by a huge winter storm while a nursing strike resulted in a loss of 28K health care jobs.

Chart #1

Chart #1 shows the monthly change in private sector jobs (-86K in February). These are the jobs that really count. Notice how volatile they have been in recent years. Almost every move up or down in the monthly numbers has been reversed in the subsequent month, and after-the-fact revisions are frequent and can be huge. I've been arguing for many years that you can't draw conclusions from one month's jobs numbers—you have to look at the underlying trend in the numbers. 

Chart #2

Chart #2 is a more the sensible way to look at these data: how do they change on a year over year and a 6-mo. annualized basis? The 6-mo. annualized change in private sector jobs has been consistently low (between 0.2% and 0.4%) since last June. Viewed from this perspective, today's number was just more of the same slow growth that we've been seeing since last summer. Closing the border has resulted in a big slowdown in jobs growth, but not a crash landing. The economy is most likely experiencing a soft landing which will be followed by a pickup in growth once the uncertainties of the Iran War are resolved, and the world learns to love AI-fueled productivity.

As we await further developments on these fronts, the following charts are "green shoots" that augur better times ahead.

Chart #3

Chart #3 shows an index of housing affordability (a function of interest rates, home prices, and incomes). For most of the past four years housing has been very expensive for almost everyone, thanks to high interest rates, soaring home prices, and modest real income growth. Fortunately, the most recent datapoint suggests that things are beginning to turn for the better, albeit slowly.

Chart #4

Chart #4 compares the level of 30-yr fixed mortgage rates to an index of new applications for mortgages (i.e., excluding refinancings). Here it is easy to see how high mortgage rates depress the demand for new mortgages, and how lower mortgage rates in the past six months have resulted in a modest uptick in new mortgage applications. Things are improving on the margin, but it's going to take a long time before we see a boom in the housing market. Too many people are still locked into 3% mortgages and are thus reluctant to give them up; at the same time, many millions of new buyers are locked out because mortgages are still quite expensive. 

One potential source of optimism: Trump is said to be considering the elimination of the capital gains tax on real estate. This would likely result in more homes for sale and for lower prices, since sellers could lower their asking price knowing that they won't have to pay a capital gains tax. 

For that matter, Trump ought to go the full nine yards and reduce or eliminate the capital gains tax on all asset sales. At the very least he should allow people to index their cost basis for inflation. Taxing inflation gains is morally unjust. Ah, you say, but wouldn't lower capital gains taxes result in a huge increase in budget deficits? No, on the contrary! It's important to remember that the capital gains tax is the only tax that one can legally avoid—forever—simply by not selling an appreciated asset. Cutting the capital gains tax would likely result in a surge in capital gains tax collections. I for one would celebrate this by selling some highly appreciated stock in order to redeploy the funds elsewhere. 

Cutting or eliminating the capital gains tax would provide a powerful boost to economic growth by making homes more affordable and by freeing up capital everywhere that is locked into appreciated assets. 

Chart #5

Chart #5 compares the rate on 30-yr fixed mortgages to the level of the 10-yr Treasury yield, which traditionally has been the main determinant of mortgage rates. Two factors are behind the lower mortgage rates of recent months: lower Treasury yields and lower spreads. Since the Covid crisis the spread between the two has been high and volatile, but it has returned to relatively "normal" levels over the past year. Thus, to get a meaningful decline in mortgage rates going forward, Treasury yields are going to have to do the heavy lifting. The case for lower Treasury yields depends on lower inflation expectations and an easier policy stance from the Federal Reserve.

Consider this: the Iran War has caused a huge increase in uncertainty in the world, not least by interrupting the flow of oil. Any increase in uncertainty tends to increase the demand for money, because people on the margin try to reduce their risk in exchange for cash or cash equivalents. If the Fed does nothing to change the supply of money (such as by lowering interest rates), an increase in money demand will result in a tightening of monetary policy. That in turn will create deflationary pressures and likely disrupt or slow economic growth.

The Fed should not worry that higher oil prices will be inflationary; they should worry that Iran War uncertainty that is not offset by easier monetary policy will be contractionary. 

Chart #6

Chart #6 shows the latest ISM survey of service sector purchasing managers. This is arguably one of the most bullish indicators of late. With 3 stronger readings in the past 3 months, it's a good bet that the economy's largest sector is improving.

It pays to remain optimistic.