U.S. Economic Snapshot

Steady growth in employment

The BLS Employment Situation report for total nonfarm employment in June indicates a 195,000 increase in employment and upward revisions to April (from 149,000 to 199,000) and May (from 175,000 to 195,000). Expectations were in the 160,000 range.

Private employment increased 202,000 while government employment fell 7,000. Most of the increase in employment came from the private service producing sector, rising 194,000. The largest increase there was in leisure and hospitality, increasing by 75,000. The following two charts show how employment has behaved over the month and year, respectively. The first graph depicts the employment change over the month by sector. As mentioned above, leisure and hospitality had the largest increase, 75k. The width of each bar represents the fraction of employment in that sector as of June, 2013. For example, the largest sector in terms of employment is Trade, Transportation and Utilities, representing 19% of total nonfarm employment; Leisure and Hospitality is 10.5% of employment. The year-over-year graph below shows, in percentage terms, the growth from June, 2012 to June, 2013. Over the past year Manufacturing posted the largest percentage gain, 9.3%; and Construction was the only sector with a yearly decline.

Overall, the level of employment in the private sector still lies below that seen in the previous peak, December, 2007. The employment-to-population ratio remains very low…the last time it was this low was back in the early 1980’s. Clearly, the labor market is still suffering.

The number of unemployed persons (11.8 million) as well as the unemployment rate (7.6%) were little changed from the previous month.

The labor force participation rate of 63.5% was up slightly from the month before, but it still remains far below the level in 2007.

According to the Atlanta Fed’s job calculator, if the labor force participation remains at 63.5% and employment growth is similar to the last 3 months, say 197,000, then the unemployment should fall to 6.5% toward the end of 2014. Note that there have been indications, as mentioned in an earlier post, that the threshold for changes in monetary policy is 6.5%. This seems to jibe with other reports saying that the Fed Funds rate will remain at its current level until the end of 2014. Of course there are a lot of “ifs” there. For example, if the labor force participation rate rises to 65%, somewhere between where we are today and where it was in 2007, then the economy would need to see an increase of 380,000 jobs per month to get to 6.5% unemployment in 18 months.

The Bureau of Economic Analysis announced here that real GDP in the first quarter increased at a seasonally adjusted annual rate of 1.8%, revised down from the second estimate of 2.4% and the advance estimate of 2.5%. This revision, down 0.6 from the second estimate, is quite large historically. As can be seen here, the average revision from the second to the third estimate (without regard to sign) for real GDP from 1983-2009 is 0.2 with a standard deviation of 0.2.

The weakness of current real GDP growth compared to other recoveries can be seen in the graphs below. First, in the GDP Growth chart below, the current value of gdp growth, 1.8% is highlighted in red. The visual makes it pretty clear that the current recovery lies below that of the earlier periods going back to 1995. That is, the year-over-year change (the blue line) is mostly higher from 1995-1999 than it was 2002-2006; and 2002-2006 looks to be higher than 2009-2013.

The graph below shows that over the period 1947-1983 average real gdp growth was 3.64%; since 1983 it has been 2.72%. The latter period has been referred to as the Great Moderation as it is evident that the volatility in gdp growth has been, well, more moderate compared to the earlier period. Evidently the Great Moderation has also witnessed a moderation in average growth.

The graphs below show how this recession and recovery compares to others. Typically, 22 quarters past the previous peak we are about 15% above the previous peak–in the current recovery we are less than 5% above. In all of the graphs below, what is evident is that the rate of growth for every statistic is lower than that of all previous recessions and recoveries since the 1970’s, i.e., the slope of the dark blue line is flatter than any of the other lines. This underscores the fact that the weakness of the recovery is pervasive.

The large decline in output growth from the second to third revision was due in large part to personal consumption expenditures that were revised down from the second estimate  (3.4% down to 2.6%), of which services saw a large downward revision (3.1% down to 1.7%).

The only component of GDP that does not look unusually sluggish is fixed private residential investment. It reflects the widely reported broad recovery in the housing markets.  But, any optimism should be tempered by the extraordinary collapse and the duration of the collapse in residential investment.

The employment report issued by the Bureau of Labor Statistics on Friday revealed an increase in total non-farm employment of 175,000, close to the median expectation of 170,000. However, the revisions over March and April showed a net loss of 12,000. In addition, about 25,000 of the employment increase came from temporary help services. While the labor force increased (420,000) the labor force participation rate was little changed at 63.4%, and remains substantially below the level in December of 2007. At 7.6% the unemployment rate crept up slightly and number of unemployed persons essentially unchanged.

Given this employment report and the fact that GDP continues a slow and steady rise , the policy debate is about when and how fast the Fed will begin to alter its stance on monetary policy. The Fed has repeatedly indicated that its target range for the federal funds rate of 0 to 1/4 percent will be

“…appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”

This still leaves two uncertainties: (i) when will the unemployment rate fall below 6.5% and (ii) how fast will the Fed increase the federal funds rate after unemployment surpasses the threshold.

The Atlanta Fed’s handy jobs calculator provides some indication on (i).  The calculator tells you the average monthly change in payroll employment needed to bring the unemployment rate to a certain threshold in a certain amount of time. Suppose the monthly net employment gain continues to be around 187K (its average over the past year and a half). Then, it would take approximately 18 months to reach the Fed’s unemployment threshold of 6.5%.

As for (ii) what the Fed will do once it reaches this point remains unclear. However, about 20 years ago John Taylor proposed a “rule” that would provide more clarity, i.e., a rule the Fed should (or has been following) follow rather than discretion. The Taylor Rule has become the standard tool that financial market participants look to for guidance about the path of interest rates. The Taylor rule is a sort-of guide to how the fed should ( or does) respond given its targets and the current state of the economy. The idea being that if inflation or output is above some target then the Fed should respond with higher interest rates. How aggressively the Fed should respond (the coefficients of the Taylor rule on deviations from targets) is, of course, debatable. And, in the meantime, there is very little inflationary price pressures, whether one looks at the CPI or PCE or the median CPI.

The current environment is such that the Fed seems to be using a “non-linear” Taylor rule. That is, the Fed will leave the current funds rate alone until the economy reaches the 6.5% rate. It is also unlikely that when the economy does reach that number that the Fed will raise rates in very large steps. It is likely that the Fed will use a “smooth” Taylor rule that be a weighted average of the current rate and the rate implied by the Taylor rule, with more weight on the current rate.

That said, the following graph shows a fairly standard interpretation of the rule. Note that here we use the unemployment rate gap rather than the original output (GDP) gap, since that is what the Fed says it is looking at in the current economic environment.  The red line is the effective Fed Funds rate. The blue line is what the Taylor rule prescribes, given a long-term target of 6.5% unemployment and 2% inflation.

The fact that the Fed has emphasized a stance on monetary policy with ‘forward guidance’ is a step toward using a rule. Secondly, that the language of the forward guidance is in terms of the deviation of unemployment from a threshold is a step toward using a Taylor rule. Precisely which rule the Fed will plan to use after the unemployment rate is below 6.5% is debatable.

What is quite evident is that it is easy to identify different regimes. The next graph shows the deviations from the Taylor rule. When the green line is below zero it means that the Fed Funds rate was below that implied by the Taylor rule as given in the preceding graph. Of course it may well be that the unemployment rate target was not 6.5% in these earlier periods, the picture below is certainly informative. Moreover, Minneapolis Fed president Kochelakota suggests some benefits if the threshold unemployment rate  were 5.5% as he argued here.

That said, there are issues with such an accommodative policy: It is fairly easy to spot the Nixon-Burns years in the 1970’s. The Volcker tightening between 1979 and 1987. The Greenspan years after Volcker were very tightly aligned with the implied Taylor rule until the late 1990’s. In the early 2000’s the Fed maintained a stance of policy with lower interest rates than the Taylor rule suggested.

The near-zero Fed Funds rate has been in existence for some time now while the economy continues to improve–leading to a rate below that specified by the Taylor rule above. While not casting aspersions on leadership…it appears that when the Fed Funds rate has deviated substantially below that implied by the Taylor rule bad things seem to ensue.

All financial market participants know that interest rates have only one way to go – higher. If the Fed were to follow such a rule then changes in the funds rate may occur sooner rather than later.  If not, then some clarity about targets and threshholds would probably help given the we are supposed to be operating in a new era of transparency and communication.  Markets have been quite volatile in recent weeks and seemingly very sensitive to every signal from the Chairman. Indeed, the Chairman has remarked here that this is an issue that has not gone unnoticed, as the following excerpt shows:

“That said, the Committee is aware that a long period of low interest rates has costs and risks. For example, even as low interest rates have helped create jobs and supported the prices of homes and other assets, savers who rely on interest income from savings accounts or government bonds are receiving very low returns. Another cost, one that we take very seriously, is the possibility that very low interest rates, if maintained too long, could undermine financial stability. For example, investors or portfolio managers dissatisfied with low returns may “reach for yield” by taking on more credit risk, duration risk, or leverage. The Federal Reserve is working to address financial stability concerns through increased monitoring, a more systemic approach to supervising financial firms, and the ongoing implementation of reforms to make the financial system more resilient.”

The Bureau of Economic Analysis announced here that real GDP increased by a seasonally adjusted annual rate of 2.5%. The increase was fueled largely by personal consumption expenditures (contributing 2.24 percentage points to the overall 2.5 percentage point increase).

What worked against the increase in real GDP growth was a large decline in government spending along with a big rise in imports.  Although this report represents yet another quarter of growth below the long run trend, it was positive growth in contrast to Europe which is sinking back into recession.

On the bright side, the economy continued to generate positive growth without the boost from Government spending.  Signs that housing markets contributed to the positive growth represent an encouraging phase in the recovery–historically, housing  has led the economy out of contractions.

The bar graph shows another way of looking at the recent behavior of real GDP. The bars in the graph show the quarter-to-quarter change (s.a.a.r.) in real GDP while the blue line indicates the year-over-year change (s.a.a.r.). The first thing that stands out is the very large decline in real GDP during the last recession. The recession in the earlier part of the decade hardly looks like a recession at all in comparison. And, while the quarterly change in Q1 was 2.5%, the year-over-year change between 2013Q1 and 2012Q1 was 1.8%. Moreover there appears to be somewhat of a decline in the average year-over-year change: the average pre-2001 recession year-over-year change was higher than that in the years between the 2001 recession and the recession beginning in 2007 and that is higher than the recovery phase starting in June, 2009 (according to the NBER business cycle dates).

An alternative way to think about long-term economic growth is to decompose real GDP into a trend component and movements around this trend, that is, the cyclical component of the business cycle.  Many economists use the Hodrick-Prescott (HP) filter to do this decomposition. The HP filter, however, has some issues that we have pointed out previously here about estimating the growth trend at the end of the data series.

If one believes we will eventually get back to 2% real growth, the trend line will be something like the dashed red line in the following two graphs. The green line represents the HP filter’s trend which equates to about 0.8% annual GDP growth.

The implication of this is that the recent recession and recovery will appear much worse if we believe that GDP will grow at 2% over the long term. The red dotted line in the graph below has shown no signs of returning to the historical trend, and won’t, as a long as the quarterly report consistently comes in below 2 percent. On the other hand, if you believe that the financial crises and Great Recession inherently altered the growth potential of the US economy and that the long-term growth trend has shifted down, as the green line shows, then the recovery doesn’t look nearly as anemic. In fact, with this view GDP has already recovered and is above trend.

Many may be aware of what has been called the Great Moderation, a period where the volatility of real GDP declined markedly–between the mid 1980’s and 2007. While some have mentioned that this may be the result of better policies, the recent episode may suggest that the great moderation was nothing but a series of smaller, or less consequential shocks.

If one believes that we will once again move to the sustained 2% growth path, then the graph above leaves plenty of room for concern in the short-term.

Meager growth in employment

The tiny increase in total non-farm employment reported in the  Employment Situation for March undershot analysts expectations…or rather their hopes? However, there was a little good news. First, January and February employment were revised up, from  +119,000 to +148,000, in January and from +236,000 to +268,000 in February, as can be seen in the employment change graph below.  Second, the average workweek for all employees actually rose to 34.6–only one other time, February of 2012 was it that high since June of 2008. The picture that emerges is of a labor market that usually turns out to be a little bit stronger than first estimates suggest. But, while the economy has continued to add jobs, it has not done so at a pace that is consistent with population growth.  The employment to population ratio ticked down once again from its stubbornly low ratio and the labor force participation continued its steady decline. It is now as low as it has been since the early 1980s. The household survey paints an even more dismal view of the labor market.  Employment declined by more than 200,000, the biggest decline in a couple of years.

Unlike previous months, employment in the government sector didn’t change very much but that is likely to be temporary.  Early indications are that the sequester is gooing to further impact employment in the sector

Solid growth in employment

The increase in total nonfarm employment, +236,000 as seen in today’s Employment Situation, beat most analysts expectations, although January employment was revised down slightly, from +157,000 to +119,000, as seen in the Net Employment Change chart below.

Private sector employment was up +246,000 while the government sector continued to shed jobs, -10,000. State government was responsible for 80% of that decline. The largest gain came from private service workers, +179,000. Professional and business services added +73,000. Goods producing employment was also up, +67,000, led mainly by construction, +48,000, and in that sector the largest gain was in specialty contractors. Total employment continues to grow steadily, but is still not back to its level in December of 2007.

The unemployment rate ticked down from 7.9% to 7.7%, and at 12,032,000 there were about 300,000 fewer unemployed persons compared to last month. However, those unemployed more that 27 weeks edged up by 89,000. Overall there are about 4.7 million persons who have been unemployed more than 27 weeks.

The employment to population ratio was unchanged from last month at 58.6%, moreover, it was also 58.6% in February of 2012 and was close to that level three years ago. While this picture reveals no growth over the past year, it is not necessarily a sign that labor market is still under considerable duress. There are many factors that drive this statistic, such as decisions about entering the labor force,  retiring, or staying in school. The point is that while the employment population ratio is indicator of labor market health, there are lots of things that drive it. The ratio at the beginning of the recession in December of 2007 may have been “cyclically” high, and now has adjusted to a new level. This can also be seen in the labor force participation rate, which actually declined slightly over the month, from 63.6% to 63.5%.

The Beveridge curve depicts the relationship between the reported vacancies and the unemployment rate. As is evident in the graph, the unemployment rate is much higher given the vacancy rate than it was before the last recession. The first red dot to the  left shows that at the beginning of the recession the vacancy rate was about 3% (3 vacancies for every 100 employed) and the unemployment rate was under 5%. Today, the vacancy rate is just under 3% yet the unemployment rate is 7.7%. Why those unfilled vacancies remain unfilled given that level of unemployment remains an open question.

Data released by the Federal Reserve shows that household sector debt outstanding rose at a 2.5% annual pace in the last quarter of 2012. It was the first time since the beginning of the recovery that household debt didn’t fall as a percentage of GDP. Households had been steadily de-leveraging until the most recent quarter. Debt to GDP remains 15 percentage points below its level at the peak of the cycle and those levels will not likely be seen again soon. Total borrowing by the household sector also increased in the fourth quarter, indicating that the household sector is willing to take on additional debt in this very low interest rate environment.

In terms of net worth (assets minus liabilities), households’ balance sheets are slowly improving, aided by a recovery in the housing sector and rising equity prices. As a percentage of GDP, the fall in household net worth from the peak in 2007 was 4 times as severe as the fall caused by the dot-com bust that spurred the 2001 cycle. The difference, of course, was the collapse of the housing market. The total market value of real estate assets fell 40 percent more than the fall in GDP. This was combined with a similar fall in the value of household’s holdings of financial assets.

Non-financial business corporate debt rose at an even faster pace in Q4 (8.75% annually). A large portion of the increase was due to increased corporate bond issuance.

There has been a lot of talk (here is one example) about how corporations are hoarding cash and are reluctant to invest earnings. The figure below shows the amount of checkable deposits and currency held by the non-financial corporate sector (only one form of liquid assets corporations hold).

The total size of this cash hoard is now nearly twice as high as it was before the peak of the cycle and nearly $400 billion higher than at the trough. Before you make the call in favor of hoarding though, take a look at the evolution of total currency and deposits as a percentage of total assets.

As a percentage of total assets, the business corporate sector’s holding of currency and deposits is relatively low and is returning to the levels of the 1980’s. A similar picture can be shown looking at a broader category of liquid assets (including savings, time depots, mmmfs, etc.). There doesn’t seem to be any extraordinary behavior on the side of firms. Similarly, households appear to be carrying relatively low levels of cash and deposits relative to total assets.

The second estimate of Q4 Real GDP, released yesterday indicates that output grew a tiny bit in the fourth quarter and there was an upward revision in the third quarter. than previously estimated at 2%. On the face of it this seems like good news but it is really insignificant and is much smaller than typical revisions. The fundamentals that we look to for evidence of a robust recovery were not encouraging.

The BEA also released January 2013 personal income and savings. Personal income declined by 3.6% compared to a gain of 2.5% in December and the personal savings rate dropped with it, plunging back down to 2.5%. As we showed last month, the effects of fiscal policies were clearly evident in the December 2012 personal income gain, as companies shifted dividend payments forward to avoid the end of the payroll tax holiday. January’s numbers reinforce this idea.

As always, we show the components of GDP measured from the peak of the business cycle.

The advance estimate of Q4 Real GDP released on Wednesday showed that US output contracted by 0.1 percent in the final quarter of 2012. The effect of fiscal policies as well as weakness of the European economy and the rest of the world can clearly be seen in the negative aspects of the report.  The overall decline was due to a reduction in  exports (-5.7%) and a rundown in inventories as well as a large decline in government spending (-6.6%) caused by a 22.2% cut in defense.

The negative headline number hides overall positive growth in domestic fundamentals. Consumption expenditures on durables increased at a faster pace than in Q3, and both residential and non-residential fixed investment recorded the highest combined growth since the second quarter of 2010. There are signs that spending on services and non-durables are slowing down, which will be a cause of concern if the trend continues into 2013.

Fiscal policies matter. The expected end of the payroll tax holiday had a large effect on personal income and savings toward the end of the year. In the final two months of 2012, real disposable personal income increased by 1.3% and 2.8% in November and December. This is in stark comparison to the .14% growth in the first 10 months of the year. The run-up in income can almost entirely be attributed to companies shifting dividend payments forward. The result lead to a jump in the savings rate, up to 6.5%, but no apparent change in personal consumption expenditures.

                           Aug.     Sept.    Oct.     Nov.     Dec.
                           (Percent change from preceding month)
Disposable personal income:
  Chained (2005) dollars  -0.3      0.1     -0.1      1.3      2.8
Personal consumption expenditures:
  Chained (2005) dollars   0.0      0.5     -0.2      0.6      0.2

Personal Savings Rate      3.6      3.3      3.4      4.1      6.5

Inventory Changes

Interpretation of the downward change in business inventories is difficult. The negative view is that businesses are cutting back on production for fear of weak demand in the future perhaps in anticipation of tax and spending cuts in the New Year. The positive view is that sales in the fourth quarter were unexpectedly high. So the question that really should be asked is when are negative inventory changes indicative of a slowdown in output?

A first step is to see how inventories are related to the business cycle. The graph below shows the real change in private inventories adjusted for the level of output (in red) and the business cycle component of real GDP (in blue) since 1970. Inventories are positively correlated with output and tend to lead the business cycle, meaning that generally inventories decline before output. However, the change in inventories is noisy. A quarter decline is much less informative than a prolonged period of inventory depletion. The implication is that we will have to wait a bit longer  to understand the full importance of the recent decline.

 

As always, we show the components of GDP measured from the peak of the business cycle.