Weekly Economic Commentary by Scott J. Brown, Ph.D.


Fed and markets still divided on growth outlook

March 20 – 24, 2017

“The median projection for the federal funds rate is 1.4 percent at the end of this year, 2.1 percent at the end of next year, and 3 percent at the end of 2019, in line with its estimated longer-run value. Compared with the projections made in December, the median path for the federal funds rate is essentially unchanged.” – Fed Chair Janet Yellen (March 15)

The Fed’s outlook on the economy hasn’t changed much since December. In turn, policy expectations are largely the same as well. Officials are comfortable enough in their outlooks to continue gradually normalizing monetary policy, but they don’t see enough pressure to move more rapidly.

Officials continue to expect GDP growth of around 2% over the course of this year and over the next two years. That’s largely because we are approaching full employment. While increased business optimism may fuel a pickup in the pace of business fixed investment in the near term, the consumer is the driving force. Jobs and wage growth will be the key drivers.

A tighter job market should lead to increased wage growth and there have been some moderate signs of pressure in prices of raw materials. However, the outlook for consumer price inflation is still moderate. Obviously, the Fed could raise rates a little faster if inflation pressures pick up more forcefully in the months ahead, but there’s little sign of that currently.

Over the last several quarters, financial market participants have placed far too much emphasis on the dots in the dot plot (these are the projections of individual Fed officials of the appropriate year-end federal funds rate). There’s a fair amount of dispersion among the dots and there’s a lot of uncertainty surrounding each of the dots. Yet, here was Fed Chair Yellen emphasizing the median number of rate increases. Go figure.

With the FOMC meeting behind us, we can get back to the larger conflict. That is, investors are optimistic that policies out of Washington will fuel a much faster pace of growth in the economy. In contrast, the Fed (and most economists) are expecting labor market constraints to limit the pace of the expansion. Something’s going to have to give.



The February employment report

March 13 – 17, 2017

“Indeed, at our meeting later this month, the Committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate.” – Fed Chair Janet Yellen (March 3)

Prior to seasonal adjustment, the U.S. economy added more than a million jobs in February (unadjusted payrolls rose by 831,000 in February 2016 and by 832,000 in February 2015). Mild weather likely played a part and there is the normal statistical uncertainty, making it hard to tell how much of the job gain is due to improved business confidence (weather and statistical noise will wash out over time). However, job growth is still expected to slow as the labor market tightens.

The unemployment rate edged back down to 4.7%, as labor force participation edged higher. The unemployment rate held steady at 4.1% for the key age cohort of 25-54. The employment/population ratio for this group continued to trend higher (not terribly far from the pre-recession level).

A tighter labor market should generate wage pressures. Average hourly earnings rose 0.2% in February (+2.8% y/y). Monthly wage figures are normally choppy, but the underlying trend in the year-over-year pace is only moderately higher. Wage gains should be higher in sectors where employees are more difficult to hire, but results appear mixed. For the three months ending February, average hourly earnings in tech rose 4.0% y/y. Retail rose 1.5% y/y, while leisure and hospitality led the way at 4.2%. Three-month averages can themselves be uneven over time, but the data do not suggest a sharp rise in wages. Of course, benefits also factor into the hiring decisions.

Job market data can be distorted by a number of factors in the early part of the year, but the broad range of indicators and recent anecdotal evidence suggest that, while labor market slack is being reduced, there’s still a fair amount left over from the recession. There’s nothing to indicate that the Fed needs to slam on the brakes at this point, but officials do need to gradually take the foot of the accelerator.

Investors were quick to take away Yellen’s message that the Fed is almost certain to raise short-term interest rates again on March 15. However, investors appear to have missed the other important signal in her March 3 speech on the economic outlook. That is, a number of factors kept the Fed from tightening more aggressively in the last two years – and absent a softening in job market conditions or a slowdown in economic growth, “the process of scaling back accommodation likely will not be as slow as it was in 2015 and 2016.”

Tighter monetary policy need not be a negative for stock market investors. After all, it depends on why the Fed is raising rates. In this case, it is because officials are more confident. There appears to be little danger that the Fed will be choking off growth or causing major disruptions to the global financial system. Still, the pace of tightening is expected to be gradual.




February 27 – March 10, 2017

“Facts are stubborn things, but statistics are pliable.”

– Mark Twain

The majority of U.S. economic data are based on statistical samples and the various figures are typically adjusted for seasonal variation. That means that the numbers are subject to some level of uncertainty. For some reports, the uncertainty is low. For example, the weekly jobless claims data are simply the total of state reports (occasionally, one or two states may need to be estimated due to late reporting). At the other end of the scale, new home sales results are reported with a gigantic level of uncertainty. Sales were reported to have risen 3.7% (±18.5%) in January, meaning that we can bE 90% certain that the true change was between -14.8% and +22.2%. One wonders why they even bother. Data typically take some time to be assembled. Preliminary estimates are subject to revision.

Data uncertainty can create some problems for investors. One should always look skeptically at any single piece of data and consider the broader array of information. Stock market participants often react to surprises in the data (if sufficiently far from the median forecast) even though the surprise may not be meaningful. In setting short-term interest rates, Fed officials look at a wide range of indicators, also paying attention to as much anecdotal information as they can assemble.

The government’s collection of economic data picked up following the Great Recession, with an eye toward understanding and preventing serious downturns. Many of the figures are geared to the old-style economy (plenty of figures on manufacturing, for example). However, despite long-standing budget constraints, the government has adapted to a changing economy over time and its data methodology has evolved. Note that in contrast to Canada, which has one statistical agency, U.S. data are spread all over the place (the Bureau of Census, the Bureau of Labor Statistics, the Federal Reserve, etc.). As an aside, this makes it more difficult to cook the books.

Candidate Trump said that the unemployment rate, officially reported at 4.8% in January, was really more like 42%. That might be true if one counted four-year olds and grandma as being part of the labor force, but it’s unclear why you would want to do that. It’s well known that labor force participation has declined significantly since before recession (from 66% to 63% more recently) and the employment/population ratio has fallen (to 59.8% in January, vs. about 63% just before the recession). Bringing the participation rate back up to 66% would allow the economy to grow faster. However, most of the decline in participation has been related to the aging of the population and some is due to a greater tendency for teenagers and young adults to remain in school.

The employment report is made up of two separate surveys. The establishment survey yields estimates of payrolls, hours, and wages. The household survey generates estimates of labor force participation and the unemployment rate. Note that some undocumented workers are captured in both surveys, but the Bureau of Labor Statistics cannot determine how many. In the household survey, the BLS does ask whether one is foreign born or native born. In January, foreign-born individuals accounted for 17.0% of workers. It’s well known that undocumented workers will often apply for a job using an assumed Social Security number. Hence, they pay into both the Medicare and Social Security trust funds without receiving benefits.

Last week saw two proposals regarding the economic data. One was to not count re-exports (goods that are imported then exported someplace else) as exports. This might make sense of you also don’t count the imported re-exported goods as imported. Otherwise, the change simply expands the reported trade deficit (some say this is the goal), without anything really changing. Needless to say, things get complicated when you consider that U.S. manufacturing relies on supplies, parts, and materials from around the world. Some items are shipped back and forth across borders a number of times throughout the production process. The proposed Border Adjustment Tax has generated a lot of pushback in Washington (in addition to threats of retaliation overseas).

The other proposal was related to budget forecasting. The impact of fiscal policy changes are calculated using static scoring. That is, the economy is assumed to perform the same regardless of any changes in taxing and spending. Depending on how far we are from full employment, tax cuts would normally be expected to boost growth. Dynamic scoring, which takes the expected growth impact into account, should give a more accurate assessment of the loss in tax revenue from cutting tax rates. The reason the government doesn’t do that is because it leads to abuse. One can always claim that growth will be so strong that tax cuts don’t reduce tax receipts. The Wall Street Journal reported last week that the Office of Management and Budget has been ordered to assume that long-term growth in real GDP will be 3.5% per year. That makes it easier to cut tax rates. In contrast, the nonpartisan Congressional Budget Office projects that real GDP growth will be a bit under 2% per year over the next decade, reflecting slower growth in the labor force (it’s also worth noting that about 40% of the labor force growth over the next decade is expected to come from immigration).

Investors need to make informed decisions. While the government’s economic figures are far from perfect, they provide a fairly reliable picture. Undermining the quality of those statistics is something no one should tolerate.



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