Strong GDP Revision Amid Market Turmoil

by Thomas Cooley and Peter Rupert

The past week has been a wild and crazy ride, capped by a strong GDP report, boosting Q2 growth from the advance estimate of 2.3% to 3.7%. This morning, the personal income release reveals personal income growth of 0.4% for July, the same growth rate as the previous three months. The week began with a Dow drop of about a 1000 points during the morning, but closed down “only” 588 points (-3.57%)…followed by -1.29% on Tuesday, +3.95% on Wednesday, +2.27% on Thursday. That turmoil was puzzling given that most observers saw the U.S. economy as fundamentally strong even before the latest update of Q2, with low unemployment and steady growth in real output.

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That the economy has grown steadily, albeit slower than during other recoveries, has given monetary policy makers the opportunity to begin to normalize operations. However, given the length of the recovery, are some now worried about another possible dip…as seen in the 1973 and 2001 cycles below?
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The fundamentals of this recovery are strong as well. Consumer spending growth was up 3.1% and has been strong for the past year.

Investment, particularly intellectual property investment was strong.

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What Next for The Fed?

The market turmoil of last week led many, including William Dudley , President of the New York Fed, to call for caution in normalizing monetary policy and beginning “liftof”as many expected them to do at the September meeting.  Why the turmoil in markets should cause them be cautious is a puzzling question because it can be argued with some credibility that the state of financial markets has been significantly distorted by the Fed’ policy of the last seven years.  It is even more bizarre to see former Treasury Secretary Larry Summers calling for more asset purchases by the Fed. The fact of the matter is that the U.S. economy is looking extremely normal with low unemployment, steady job growth, and decent growth in real GDP in spite of significant headwinds from the rest of the world and a strong dollar.  If now is not the time to return to normal monetary policy, when will be?

Labor Market Remains Solid

By Tom Cooley and Peter Rupert

The employment report released today by the BLS was in line with expectations and so no surprises anywhere to speak of.

Establishment Survey

The establishment survey reveals total nonfarm payroll employment increased by 215,000 in July; both May (+6k) and June (+8k) were revised up slightly from the previous estimate, although the average monthly gain for the previous 12 months is 246k. While employment growth has remained steady, though slightly below its 12 month average, today’s report appears to keep the Fed on track for liftoff…most likely in September.

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Average weekly hours ticked back up to 34.6 after four straight months at 34.5. Average hourly earnings for all employees on private nonfarm payrolls rose by 5 cents to $24.99, up 2% over the past 12 months.

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Household Survey

The household survey conveys a slightly weaker picture of the labor market. Household employment grew only 101k. Moreover, the increase over the past five or six months has been much lower than that for the establishment survey. The unemployment rate was virtually unchanged as was the employment to population ratio and the labor force participation rate.

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The Fed

Overall, then, it appears that given the steady performance of the labor market and the commentary from various Fed folks: Atlanta Fed President Lockhart, “It will take a significant deterioration in the economic picture for me to be disinclined to move ahead.” And St. Louis Fed President Bullard, “We are in good shape,” to raise rates in September, leads one to believe a rate hike is quite likely. But here is where one should give pause.

What is the rush to start “liftoff” when there is so little evidence of inflation? One argument might be that keeping interest rates so low creates distortions, but those distortions have been in place now for several years and might be described as the new normal. The Fed of yore would have waited to see some signs of inflation. While many have latched on to the Summers’ quote about not raising rates until you see the whites of its eyes, it is not a new concept nor a new phrase. Alan Blinder said this in a Minneapolis Fed meeting back in 1995. His point then was that it takes time for monetary policy to work,( long and variable lags):

So what is a poor central banker to do? When you look at this set of difficulties—forecasts are not very good, theories and statistical evidence are much in dispute—it is tempting to say: Why don’t we just wait and see what happens? If inflation starts rising, hit the economy with higher interest rates. If unemployment starts rising, do the reverse. I call this the Bunker Hill strategy: Wait until you see the whites of their eyes and then fire. Why don’t we do that?

The answer is very simple: The Bunker Hill strategy will fail. It is sure to lead you into error because by the time you see the whites of their eyes, they’ve already shot you right through the heart.

Is this why the Fed today believes it should raise rates? If not, what is/are the reasons? The labor market has been steadily improving, but certainly has not been on fire. There are no signs of inflation anywhere, not current or expected. Wages have been fairly stagnant. Forward guidance and the Fed’s “threshold” unemployment number, 6.5%, have come and gone. The only explanation seems to be that there is a desire to return to normal monetary policy making and  rates have to go up at some point.

Tepid GDP Growth Could Keep The Fed at Bay

by Thomas Cooley and Peter Rupert

Today’s GDP report reveals Q2 growth of 2.3% for the advance estimate. Overall, this tepid increase provides is not going to be an inducement to hike rates at the next meeting of the FOMC. First quarter GDP was revised upward to 0.8%, better than the initial estimate of  a  -0.2% decline.

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But, as the above graph makes clear, the last three quarters do not show much evidence of robust growth. The bad news in the report is that second quarter growth was fueled in part by a big surge in inventories, a fact that could weigh on growth prospects in future quarters. Also discouraging was the downward revision to the longer term picture of GDP growth.

Annual Revision

Each year the BEA performs an annual revision, mostly covering the previous three years, but for some components goes back even farther. The result of the revisions show somewhat weaker growth compared to the previously published estimates. From the BEA release:

  • From 2011 to 2014, real GDP increased at an average annual rate of 2.0 percent; in the previously published estimates, real GDP had increased at an average annual rate of 2.3 percent. From the fourth quarter of 2011 to the first quarter of 2015, real GDP increased at an average annual rate of 2.0 percent; in the previously published estimates, real GDP had increased at an average annual rate of 2.2 percent during this period.
  • The percent change in real GDP was revised down 0.1 percentage point for 2012, was revised down 0.7 percentage point for 2013, and was unrevised for 2014.

Since the “end” of the recession in 2009 growth has been lackluster, although investment has experienced faster growth, having declined more dramatically as is usual over the business cycle.

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The FOMC and Moderate Growth

The recent policy statement from the FOMC used the word “moderate” twice in the first two sentences when talking about economic activity and household spending. As can be seen in the graphs above, both GDP and PCE grew in lock step over that past several years, and grew 2.3% and 2.9%, respectively for Q2.  The GDP price index grew at 2.0% (1.4% for the core) and the PCE price index grew at 2.2% (1.8% for the core PCE price index), all of them right around the 2.0% FOMC target. And, while they mentioned the housing sector has shown additional improvement, “business fixed investment and net exports stayed soft.”

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Evidently, the FOMC is putting more weight on what happens in the labor market: “The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.”

Cyclical and Structural Issues in The Labor Market.

by Tom Cooley and Peter Rupert

The employment report released on Thursday, before the July 4 holiday on Friday, revealed an employment gain of 223k, but the overall report left a little something for everyone, depending on point of view. The 223k number was slightly less than what many had forecast. All of the increase came from private employment as there was no change in government employment. On tempchgm-2015-07-05he negative side,  there were downward revisions for the past two months, April down by 34k and May down by 26k. In fact, the revisions have all been down since January.

Average weekly hours remained at 34.5 for the fourth straight month and hourly earnings were basically flat.

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The household data from the CPS was a little more discouraging. Yes, the unemployment rate fell to 5.3%. However, the labor force fell by 432k and the number employed fell by 56k, as did the employment to population ratio, falling to 59.3.  Labor force participation is at an historic low.  So there is no way the labor market could be described as in a robust state. The long term unemployment rate – those unemployed 27 weeks or more  diped sharply.

Many of the remaining problems in the labor market – participation rates, long duration unemployment – appear to be structural, not cyclical.  The structural issues have a lot to do with the way the economy changes over the business cycle, the loss of mid-level human capital jobs, a feature that has been pronounced over the past few cycles. It seems unlikely that the Fed will view these problems as impediments to a more normal monetary policy.

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The JOLTS data released this morning shows the number of vacancies, 5.4 million, is the highest since the series began in December 2000, and the job openings rate also remains high, higher than at the peak of the previous cycle! However, the hiring rate fell in May, to 3.5% from 3.6% in April. Layoffs and discharges fell slightly and quits were basically unchanged.

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Forward Guidance or Fog?

By Zach Bethune, Tom Cooley and Peter Rupert

Today’s GDP release from the BEA reveals a modest upward revision in GDP for the 1st quarter from -0.7% to -0.2%. Though still in negative territory the upward revision is certainly welcome. As noted by the BEA, “…primarily reflecting upward revisions to
exports, to personal consumption expenditures, to private inventory investment, to nonresidential fixed investment, and to state and local government spending that were partly offset by an upward revision to imports.” The revisions were pretty much across the board.

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Real personal consumption expenditures increased 2.2%, the weakest recording since the first quarter of 2014. Tomorrow, the personal income report comes out that will give a little clearer picture of the path of consumption to date.

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The signals coming in concerning the economy are mixed, making it extremely difficult to gauge upcoming policy moves. The latest meeting of the FOMC along with their statement seems to have left many Fed-watchers, prognosticators, and others suggesting that the Fed is on a path to raise rates in the fall or possibly winter. For example, Jon Hilsenrath of the WSJ says,

The Federal Reserve signaled Wednesday that it was moving toward interest-rate increases later this year, with the economy now firmer after a winter slump, but officials emphasized they would move even more cautiously than expected.

While many seem to suggest that the Fed is on pace to raise later this year, there is certainly nothing in the Fed statement that leads to such a conclusion. Just in case you are confused with Fed-speak, here is another statement…from 2011,

To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent. The Committee currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.

The point is that, as the June statement emphasized, the risks are balanced. Meaning that raising rates soon is kind of 50-50. And, as the statement now always reminds us, any future moves are data dependent. So, looking forward, while the risks might be balanced, the risks are many:

  • Uncertainty in Greece continues to plague policy makers and investors….but it seems now likely that many have already priced these risks in the market.
  • Europe continues to have winners and losers, making it difficult to have much faith in any overall forecasts.
  • How will China respond to what appears to be lower growth?

In terms of the US, nothing seems to really stand out yet that would call for the beginning of liftoff. Yes,  employment has risen steadily, albeit slowly…much slower than earlier recoveries…and the unemployment rate is relatively low but labor force participation is also low.

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Still, there are many signs of either slow growth or real weakness to offset those indicators. There is really no sign of inflation anywhere, not recently nor in expectations. While the labor market is seeing signs of strength there does not appear to be any wage pressure, and the employment cost index has popped a little recently, but again, is still relatively subdued.

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Average hours have remained pretty flat after picking up several months ago. Moreover, one indicator many use to gauge the health of the economy is output per hour of work (productivity). There also isn’t any real positive news here either as productivity has fallen for two consecutive quarters, the last time this happened was back in 2006.

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While job openings are near all time highs, the hiring rate continues to climb, but quite slowly.

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Some economists look at the Beveridge Curve (vacancies vs. unemployment) to see how the labor market is matching job seekers to job vacancies. While the Beveridge Curve has “looped” back, the unemployment rate is about a percentage point higher, given the vacancy level, that it was back in the early 2000’s. One interpretation is that the market is having a more difficult time matching workers to firms, for example, from skill mismatch.

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The labor market also looks quite different compared to the early 2000’s in both the employment to population ratio and labor force participation. Both are a long way from their peaks and have remained remarkably flat. Unfortunately, there is little by way of economic theory to enlighten us on what the “right” long run value should be for either statistic. Perhaps the late 1990’s and early 2000’s were unsustainable, and now we are back at more sustainable levels.

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Moreover, there is still a substantial fraction of the unemployed who have been in that state for more than 27 weeks. This certainly does not bode well for such workers and it remains to be seen where and when they will eventually land.

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So, in the end, what does all this mean? It simply means that the shape of the economy is in the eye of the beholder. Data can be presented to bolster either view…to raise or not raise this year. Indeed, the FOMC statement was clear about the cautious outlook:

This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.

The latest inflation numbers do not seem to suggest yet that one would be “reasonably confident” that inflation has moved back to its 2% objective, as the chart below shows, that inflation indicator has often been below the 2% (red line) for much of the time…and the latest reading shows a 2.0% decline. The quarter before saw a 0.4% decline.

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