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Weekly Commentary by Dr. Scott Brown

On The Cusp Of Job Growth
March 8 – March 12, 2010

Nonfarm payrolls fell by 36,000 in the advance estimate for February, and would have likely been positive if not for the weather. It’s impossible to estimate precisely the impact that the snowstorms had on payrolls and average weekly hours, but we should see a rebound in the March employment figures. Hiring for the 2010 census is underway, and is expected to peak in May. Unfortunately, those temporary census jobs will be shed in June and the months that follow. Still, looking beyond the impact of the census, job growth is nearly here.

While the housing bubble was the catalyst for economic weakness and excessive leverage in the financial sector was a compounding factor, the most unsettling factor in the recession was the collapse of confidence in the fall of 2008. The thing about panics is that you don’t simply unpanic and get back to normal. It takes a long time for confidence to be restored. Worried about weak economic conditions, firms cut back on capital expenditures and trimmed their workforces. In a way, the worst part of the downturn was a self-fulfilling prophesy.

Recovering from the depths of the recession was going to take some time. The fiscal stimulus package may not have immediately resulted in employment growth, but it kept job losses from being more severe. Some of the stimulus was cast as aid to the states – effectively, plugging holes – preventing budget shortfalls from causing sharper job cuts. Unfortunately, state budget strains are not going to go away anytime soon. Efforts to reign in state deficits, whether through tax increases or spending cuts, have a contractionary impact on growth.

The fiscal stimulus is currently peaking, but the maximum impact on GDP growth is already behind us. The stimulus has checked the decline in business confidence, but has yet to create much optimism. That will come from improvement in the private-sector economy over time.

The data show that the pace of private-sector job destruction declined significantly over the course of last year. Private-sector payrolls fell by 18,000 in February. That compares to a 707,000 drop in February 2009. If not for the snowstorms, private-sector job growth would likely have been positive last month.

Many schools, government agencies, and businesses were closed temporarily due to the snow (government payrolls fell by 18,000, despite an apparently census-related gain of 16,100 in federal government ex-the U.S. Postal Service). In the establishment series, anyone who works anytime (even an hour) during the survey week (the pay period that includes the 12^th of the month) is counted as employed. So not all business closings lead to reductions in official payroll figures.

Last week, Congress worked toward passage of a jobs bill. From an initial target of $80 billion or more, the package was whittled down to $15 billion. That’s not much considering that we’ve lost 8.5 million jobs since the start of the recession. The main part of the bill will be a temporary reduction in payroll taxes paid by employers.

Hiring for the 2010 census has begun. In 2000, census hiring was strongest in March and May. The census will have 800,000 temporary jobs at the peak, although some workers could have more than one job (the largest part, at 635,000, is for the non-response follow-up). How long these workers are employed by the census will depend on the survey response rates. Anti-government sentiment could lead to a higher percentage of non-responses this year. In 2000, temporary census jobs were unwound mostly from June to September.

Beyond the impact of the census and the pending jobs bill, private-sector job growth should pick up over time. However, the economy still faces a number of serious headwinds, which will likely keep job growth moderate this year.

Under The Weather
March 1 – March 5, 2010

The recent economic data have been generally weaker than expected, casting some doubt on the prospects for the recovery. However, economic recoveries are not usually associated with steady growth across sectors. Growth is inherently uneven. That means that some economic reports will be strong and some weak – and that is especially true in the current environment, where the economy has to deal with a number of serious headwinds. Economic statistics are also subject to seasonal adjustment difficulties and, as we’re likely to see in much of the February data, the peculiarities of the weather. Bad February weather will not cause a double dip, but it may add to the unease in the financial markets in the near term.

Consumer confidence fell unexpectedly in February. Monthly changes of one or two points in the headline figure are not unusual, but a 10-point plunge is hard to ignore. The details of the report showed that evaluations of current job market conditions remained depressed. In addition, respondents were somewhat more pessimistic about future job availability.

Consumers don’t spend confidence. Income, wealth, and the ability to borrow are the main drivers of spending. However, the confidence figure is reflective of these drivers (technically, consumer confidence, by itself, does help forecast spending, but if you know income, wealth, and interest rates, consumer confidence doesn’t add much forecasting ability). The drop in consumer confidence likely reflects broad pressures on the household sector. The estimate of 4Q09 GDP growth was revised higher, but that report also showed a downward revision to consumer spending growth and income figures were revised significantly lower back to the third quarter. That income revision implies, all else equal, a somewhat weaker outlook for consumer spending in the near term. Revised figures also show a lower personal savings rate.

The estimate of personal savings is a poor statistic. Savings are not measured directly. They are calculated as a residual (income less taxes and outlays). The savings rate is subject to large revisions. Think back to a few years ago, when it was reported that the savings rate had gone negative. Well, in revisions, that didn’t happen. It would be nice to know what is going on with saving habits. Anecdotally, most households appear to have cut back significantly on their spending. However, the personal savings rate was revised down to 4.1% for the fourth quarter, which seems a bit low. It’s likely that consumers have cut back on spending because their incomes have declined (or grown more slowly).

The savings rate was a key unknown during the economic downturn. If everyone decided to save an extra 5% of their income, we would have a depression. That extra savings implies less spending, and that spending is someone else’s income. Through a multiplier effect, overall demand would be a lot lower and aggregate savings would actually decline (that’s called “the paradox of thrift”). With housing prices and equity investments down, it seems natural that people would be inclined to start saving more for their retirements.

Ultimately, consumer spending growth will be driven mostly by income growth – and income growth depends on jobs. There’s a clear seasonal pattern in private-sector payrolls. Most new hiring occurs between February and June. The jobs data for February are expected to be distorted by the weather. The next few months will tell the tale. Yet, as Fed Chairman Bernanke testified last week, it’s uncertain whether economic growth will be strong enough to generate much growth in jobs this year.

Investors are not going to get much clarity in the upcoming economic data. Yet, the figures are unlikely to suggest convincingly that we’re off the moderate recovery path.

Everything You Wanted to Know About The Fed...
February 22, 2010 – February 26, 2010

The Federal Reserve’s Board of Governors raised the discount rate last week. The financial markets were concerned that this was the first step in a tightening of monetary policy. Rather, it was a further step in the normalization of the Fed’s lending facilities. This week, Ben Bernanke will present his semiannual monetary policy testimony to Congress. The Fed chairman is expected to expand on the Fed’s exit strategies and present a cautiously optimistic economic outlook.

The Fed’s toolbox: Banks are required to hold a certain amount of deposits in the form of reserves. Banks can lend excess reserves to other banks or deposit them at the Federal Reserve. The federal funds rate is the rate that banks charge each other for overnight borrowing of reserves. It is a market rate. The Federal Open Market Committee sets a target (currently it’s a range: 0% to 0.25%) and tries to hit that target (through open market operations, the buying and selling of Treasuries on a short-term basis – hence the name “Federal Open Market Committee”). The discount rate, also called the primary credit rate, is the rate that the Fed charges banks for short-term borrowing. Changes in the discount rate are requested by one or more of the Fed’s 12 district banks and approved by the Fed’s Board of Governors. Prior to 1994, the discount rate was the Fed’s chief monetary policy lever. However, in January 1994, the Fed began to announce changes in the federal funds rate target, and it became the main policy tool. In October 2008, the Fed was granted the authority to pay interest on bank reserves held at the Fed (this was supposed to happen in October 2011, but the change was pulled forward in the Economic Stabilization Act of 2008). Note that this could be two rates, a rate paid on required reserves and a rate paid on excess reserves (IOER). In normal conditions, the federal funds rate would trade in a corridor, with the interest paid on excess reserves at the bottom and the discount rate at the top (banks would not lend reserves at less than the IOER nor borrow reserves at rates above the discount rate, for obvious reasons).

Prior to the financial crisis, the discount rate was 100 basis points over the federal funds target. During the crisis, the Fed lowered the discount rate (to 0.50%, 25 basis points above the upper end of the federal funds target range) and lengthened the maturity of discount window lending (first to 30 days, then to 90 days, with no impediment to rolling loans over). Last November, the Fed’s Board of Governors shortened the maximum maturity of discount window loans to 28 days. Effective February 19, it shortened the maximum maturity to overnight and raised the discount rate from 0.50% to 0.75%, but stressed that the moves were not expected to lead to tighter credit for consumers and businesses. The increase in the discount rate was a surprise only in the timing. On February 11, Fed Chairman Bernanke had testified that “before long, we expect to consider a modest increase in the spread between the discount rate and the target federal funds rate.” As part of the “normalization,” the Fed ended most of its special liquidity facilities and canceled its swap lines with other central banks on February 1. Bernanke also cautioned that the move “should not be interpreted as signaling any change in the outlook for monetary policy.”

In his testimony, Bernanke also indicated that “the federal funds rate could for a time become a less reliable indicator than usual of conditions in short-term money markets.” The Fed was considering whether it would “for a time use the interest rate paid on reserves, in combination with targets for reserve quantities, as a guide to its policy stance, while simultaneously monitoring a range of market rates.” Eventually, the Fed would work back to more normal conditions, where the federal funds rate would again be the main tool of monetary policy.

The Fed’s economic outlook has not changed much over the last few months. The recovery is expected to be gradual, with only moderate improvement in the labor market.

The Fed’s central tendency forecasts, which exclude the three highest and lowest forecasts of the five governors and 12 district bank presidents (growth and inflation projections are 4Q-over-4Q, the unemployment rate is the 4Q average for that year):

The Fed continues to view excess capacity as the main factor in keeping inflation low. However, minutes of the January 26-27 FOMC meeting show that officials differed in their views on how much excess capacity was out there. In January, the FOMC continued to signal that conditions are likely to warrant exceptionally low levels of the federal funds rate “for an extended period.” Those conditions include an elevated unemployment rate, a low trend in core inflation, and well-anchored inflation expectations. None of that has changed.

The Fed chairman’s monetary policy testimony has often been a big deal for the financial markets. If there’s a sea change in the monetary policy outlook, it’ll likely happen here. However, we already know the Fed’s outlook and most of its exit plans.

The opinions offered by Dr. Brown should be considered a part of your overall decision-making process. For more information about this report – to discuss how this outlook may affect your personal situation and/or to learn how this insight may be incorporated into your investment strategy – please contact our office today.

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