Fed Watch: Placing Bets on Bernanke’s First Move

Tim Duy's Fed Watch:

The Greenspan era ended peacefully. I somehow expected that colors would look a bit dull, or the chirping of birds would become melancholy. Things instead seemed pretty much unchanged – we slid into the Bernanke era with an FOMC statement that contained little new information. We need to assume policy continuity until the new top dog says otherwise. In my mind, I think Fed policy is running on two competing planks:

1. With a full 350bp of tightening in the pipeline, and some indications of softening in housing, Fed officials would like the opportunity to pause to assess their handiwork.


2. Increases in resource utilization and the omnipresent threat of higher energy price leave policymaker’s uneasy about pausing at this point.

The term “conundrum” comes to mind. My bet is that plank number 2 will be the winner – the solid economic data with the continuous threat of inflation suggests the Fed will still draw another arrow from its quiver.

Last week I said the Fed would not take such a dim view of the Q4 GDP report in light of anecdotal evidence and the higher frequency data. The statement of last week’s FOMC meeting conforms to this view:

Although recent economic data have been uneven, the expansion in economic activity appears solid.

The “uneven” data is likely a reference to the weak GDP report. Still, the Fed did not seem as concerned about the uptick in core-PCE as I thought:

Core inflation has stayed relatively low in recent months and longer-term inflation expectations remain contained.

Regarding future policy:

Nevertheless, possible increases in resource utilization as well as elevated energy prices have the potential to add to inflation pressures.

The Committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance.

As others have noted, the shift in language was expected and provides maximum flexibility for Bernanke & Co. to maneuver. The identification of resource utilization rates (see my Fed watch two weeks ago) and energy costs indicates the bias is to tighten further, in my view. The “may be needed” phrases indicates, however, that no tightening is guaranteed. The Fed did not send up an all’s clear signal. Instead, we need to shift through two months of data to determine the degree of resource utilization. And the tone of recent data suggests the Fed will tighten yet again when Bernanke presides over his first FOMC meeting as chairman and the end of March.

The January employment report adds another piece of evidence in favor of additional tightening. True, it was not a blockbuster report. Instead, it suggested a certain continuity – the slow gradual tightening of the labor market. Employers added just under 200k workers to the payrolls with gains well spread throughout the economy. The weak spot was retailing, and construction was an unexpected strong point considering evidence of softening in that sector. Recent months were revised higher as well.

The unemployment rate fell to 4.7%, a low enough number that some FOMC members will be getting increasingly nervous about “resource utilization.” Some will point to the slight uptick in the employment to population and low labor force participation rates as evidence that the labor market is weak. I think that is a difficult argument to make – see also David Altig’s thoughts on this point. There are likely secular trends in the labor markets that are not fully accounted for yet. Another potential weak spot in the report was the flat work week.

Overall, however, my take on the data suggests a relatively strong labor market. In addition to steady job growth and low unemployment, wages gains are accelerating, with January’s 7 cent gain pushing wages up 3.3% compared to last year (and 2 consecutive 0.4% monthly gains, or an annualized 5.3% gain in January). And buried within the data are further bright spots, such as a solid decline in long term unemployment (more than 27 weeks):

Also, the unemployment rate including marginally attached persons and those employed part time for economic reasons continued its steady march down as well:

Now, one does have to be careful with unemployment rates as they are lagging indicators. But initial jobless claims – a leading indicator – remain low (in Oregon claims have dropped to the lowest level in over 10 years). Moreover, I am picking up anecdotal evidence that employers are sensing a change as well. Paraphrasing one employer, “My employees are asking for higher wages, and actually expecting they will get them. And they do.”

When employers complain about lack of potential workers, I tell them they need to raise wages. This doesn’t make them happy, either.

Note that I am not attributing a stronger labor market to any specific economic policies. And it is true that the labor market remained lackluster for an extended period of time. But it does look like conditions have significantly improved over the past year, and the Fed will take note. For a different view, and another potential measurement problem, changes in the rates of non-responders, see Dean Baker at MaxSpeak.

In addition to the employment report, the bulk of this week’s data has also been supportive of another rate hike. Productivity growth stumbled (see David Altig) and unit labor costs gained. I would be somewhat careful about overreacting to this report. The Q4 GDP report looked weak due to a number of factors that all came together at once, but are probably not indicative of the underlying economic trend. This would of course also apply to the productivity numbers. Still, the best days of high productivity growth look behind us. The Fed will be wary that firms are having an increasingly difficult time improving productivity, providing additional incentive to push higher costs down the line.

The Institute of Supply Management also provided its snapshot of manufacturing and non manufacturing activity. In both cases, the outcome was slightly weaker than expectations, but still suggestive that the economy remains on solid footing. The details of the manufacturing report suggested the “resource utilization” in growing – inventories were contracting, customer’s inventories were too low, prices paid edged up, and the backlog of orders continued to grow. More meat to feed the inflation hawks at the FOMC. But perhaps they will be softened somewhat by the non manufacturing report, which indicated that inventories were too high. Calculated Risk provides his thoughts and points out the discontinuity of reports of a contracting construction industry with the expansion in employment in that industry.

Two weeks ago I said that barring any significant shifts in the bond markets, the Fed was ready to pull the trigger on a complete inversion of the yield curve when policymaker’s pushed the overnight rate to 4.5%. Since then, bonds have fallen substantially, with the 10 year rate currently hovering around 4.55% (the curve is inverted at the 10 year – 2 year horizon). A slim margin, to be sure, but a margin nonetheless.

Will longer term interest rates move up again? Or will the negative factors waiting on the sidelines – the lagged impact of previous rate hikes, a softening housing market, low saving rates, and possible consumer fatigue – turn against us and put the FOMC firmly into pause mode? Many, I think would prefer to see the Fed wait it out a meeting or two – see Jim Hamilton, for instance. But the steady, mostly supportive flow of data suggests not just yet, with the odds still on the Fed will raise rates to 4.75% on March 28^th.

Still, two months of data is a lot to chew on, and it is likely we will all be scratching our heads between now and then.  [All Fed Watch posts.]

Comments

[save_the_rustbelt]

How many $9-an-hour jobs are in that strong labor market?

Manufacturing employment methinks is still deteriorating and the replacement jobs are seriously inferior.

"Paint brushes are in aisle 15. Have a nice day."

[Bruce Webb]

"Still, the best days of high productivity growth look behind us. The Fed will be wary that firms are having an increasingly difficult time improving productivity,"

Two notes on the productivity front. First we are in the dawn of the integration of the Internet and office productivity and customer service. "Just in time" delivery for anything used to take careful planning, now we have 200 people sharing a bare bones supply room because for anything but 8 1/2 by 11 copy paper and ball point pens we rely on the Corporate Express guy delivering the next day. You need a new stapler? Order it and get it tomorrow. More profoundly my office is engaged in transforming a traditional make an appointment or drop in, take a number and wait for hours customer service operation and moving it wholesale to the web. Depending on the location of your shop and the job site in relation to the County permit center, pulling a simple plumbing permit and getting it to the site could easily be a four hour task, with three plus hours of that getting to my office, waiting to be helped, and then returning to the shop or job site. Since last March you can now get that permit online, total elapsed time less than fifteen minutes. Simple concept yet it required a hefty investment in staff time to implement. We are now seeing small, but significant savings in staff time, but our customers cumulatively are seeing literally thousands of hours of productivity freed up. We are extending this across our entire business line over the next two years and in so doing will be freeing up literally millions of dollars annually in economic friction and wasted productivity. And my jurisdiction is way ahead of the curve.

Billions of dollars of potential productivity are tied up by personal interaction with government employees that really doesn't need to happen. (Much of the loss is simply transiting back and forth to the office itself.) Properly designed web-based government services are a universe away from phone tree hell (if you want X press #). And the same is true for any service based organization. You get people off the phone and out of the lobby and on the web and the savings are tremendous, not necessarily for the organization but certainly for the customer. Over the last twenty years office automation has largely been internal, now the convergence of low-cost high speed connectivity and dirt cheap storage (I have 128megs in my watch) means I can take most of my operation and dump it into your web browser. And governments copy other governments, a process for online plumbing permits can be replicated over and over. Waiting in line in person for simple government services may soon seem as quaint as a rotary phone.

So I would not write off massive productivity increases just yet. There is a lot of economic friction built into current business and government systems that can be lubricated away by web and other technology implementations.

And on the second point. Fourth quarter productivity flatlined, in fact went negative. We can talk about the reasons, we can predict that first quarter will go better, but me? For my purposes here I don't care. Economists that actually know things see -0.6% fourth quarter and calculate and speculate. As for me I am seeing 2.7% annual productivity growth and comparing it to a model that only requires 2.1%. What is the Low Cost Alternative I freely confess that I don't really understand productivity, I don't have to. I can see the impact over time of a number that comes in ahead of projections on the end result decades out.

I was expecting a productivity number above 3.0% for the year, I don't think anyone was anticipating the weakness of the fourth quarter. Yet I still got a productivity number .6 points above Low Cost and an unemployment number .4 points below. Mark and other smart people can figure out what the numbers actually mean, me I am just at war with Table V.B1 and Figure II.D7 in the Social Security Reports. I may not know what these numbers represent but I sure know what they imply.

Social Security is not Broke: By the Numbers

[Yartrebo]

As a user of these web applications, I must say I don't like them. They're okay when they work, but half the time they don't work (IE only, or require proprietary software like Flash), and when they do work they tend to be very picky and offer no slack for slight errors on the application (which is often enough an error in their database).

This is nothing that better software couldn't fix, but I'm not holding my breath for AI to be added to form processing, and for these websites to be written in a clean and lowest-common-denominator format.

[Bruce Webb]

Yartrebo, absolutely. It is the very crapiness of current e-government sites that gives us hope of huge savings.

Our customers are giving us a consistent message: we love the content when we get to it. Your design doesn't facilitate that. Well know we are getting our Customer Service people (that's me) together with our Tech people to actually deliver the services people need right up front instead of burying it ten layers down. We think we understand what we have been doing wrong, nobody on the team is defending what we have out there and we are spending real dollars to fix it. My County has 730,000 inhabitants and we are working with a consortium of King County (Seattle) jurisdictions with substantial resources of their own to produce some pretty impressive product. This is not like some small town hiring the mayor's nephew to put together a website.

People who use e-government services might be interested in visiting http://www.mybuildingpermit.com/home/default.asp where you can in a single session and with a single credit card payment pull permits from 10 different jurisdictions. Moreover all 10 jurisdictions have agreed to the same standards for inspections. (And if you don't understand how big this is, ask your nearest plumber what it is like to work with different hot tank strapping requirements for every separate town.)
Or visit King County's GIS (Geographic Information Services) Viewer http://www.metrokc.gov/gis/mapportal/PViewer_main.htm
Or sign your kids up for soccer camps from nine different cities at http://www.myparksandrecreation.com/home/default.asp

None of this existed two years ago. Which is my point. All of this is happening within 20 miles of Microsoft's Main Campus, Northwest Washington is heavily and increasingly wired for speed and innovations built here can spread with the speed on the Internet. eGovernment is in its infancy. All of the early buzz of the previous wave was in e-commerce and missed a fundamental fact - people like going to the mall. Well you don't find a lot of people just dying to go to the County Courthouse to pull a permit or do property research, you can trust me on this one.

Government is all about paper and red tape, we are slicing through both. Time will tell if we got it mostly right but the upside is tremendous. I am seeing more movement on this in the last two years than I have ever seen, and a lot of that has to do with the fact that more and more people have access to ever bigger pipelines to and from the Internet. Moving a 6 meg map over the Internet meant a substantial hit to both the com line and the disk drive a few years back, now a file that size is not even a hiccup to either.

I am typing in a bar, with a broadband wireless (not WiFi) connection to the Internet on a laptop with a 100 gigabyte hard drive and 1.5 gigs of main memory. Which cost me the same amount as my Mac 128 in 1985 which sported an impressive 128 kilobytes of main memory and a 400k floppy drive. Oh and don't forget that zippy 300 baud modem.

We could have pushed out a lot of these features five years ago, but relatively tiny fractions of our customers could have accessed them. That is all changing with lightning speed.

I don't blame Yartrebo for being skeptical, but watch our smoke. There is an amazing amount of economic friction up and down the real estate industry, from initial construction to resale of existing housing, it is a huge component of national productivity, and much of that friction is governmental in origin. Well the web gives us a big oil can and we are not afraid to use it.

[Mike Shedlock / Mish]

Dr. Tim Duy I supsect that as long there there is froth and speculation in IPOs, junk bonds, mergers, stock buybacks etc that he may be inclined to keep hiking.

I simply do not buy this argument: "the omnipresent threat of higher energy price leave policymaker’s uneasy about pausing at this point". Now perhaps that is how Bernanke thinks, its just I think it is a very poor argument.

Furthermore I do not think Greenspan or Bernanke even really understand inflation or Bernanke the real cause of the great depression. In general I think price targeting or watching oil or anything else is prone to all sorts of failures.

I would appreciate your comments on this article I wrote:
Inflation: What the heck is it?
http://globaleconomicanalysis.blogspot.com/2006/02/inflation-what-heck-is-it.html

Thanks
Mike Shedlock / Mish

[Mike Shedlock / Mish]

Well it looks like there was truncation
Inflation: What the heck is it?
Can be put together from these pieces

http://globaleconomicanalysis.blogspot.com
/2006/02/inflation-what-heck-is-it.html

[anne]

http://flagship2.vanguard.com/VGApp/hnw/FundsByName

Vanguard Fund Returns
12/31/05 to 2/3/06

S&P Index is 1.4
Large Cap Growth Index is 1.1
Large Cap Value Index is 1.9

Mid Cap Index is 4.0

Small Cap Index is 6.6
Small Cap Value Index is 5.7

Europe Index is 5.4
Pacific Index is 3.3
Emerging Markets Index is 8.6

Energy is 11.7
Health Care is 2.0
Precious Metals is 14.8
REIT Index is 6.6

High Yield Corporate Bond Fund is 1.0
Long Term Corporate Bond Fund is -0.5

[anne]

http://flagship2.vanguard.com/VGApp/hnw/FundsVIPERByName

Sector Stock Indexes
12/31/05 - 2/3/06

Energy 10.0
Financials 0.5
Health Care 1.3
Info Tech 2.1
Materials 4.1
REITs 6.1
Telecoms 5.9
Utilities 3.2

[anne]

http://www.nytimes.com/2006/02/04/politics/04budget.html?ex=1296709200&en=9fbd70da596bb628&ei=5090&partner=rssuserland&emc=rss

February 4, 2006

Bush to Propose Curbing Growth in Medicare Cost
By ROBERT PEAR

WASHINGTON — In his budget next week, President Bush will propose substantial savings in Medicare, stepping up his efforts to rein in the growing costs of social insurance programs, administration officials and health care lobbyists said Friday.

For the first time since taking office five years ago, they said, Mr. Bush will try to reduce projected Medicare payments to hospitals and other health care providers by billions of dollars over the next five years. In addition, they said, Mr. Bush intends to seek further increases in Medicare premiums for high-income people, beyond those already scheduled to take effect next year.

Despite the failure of his plan to overhaul Social Security last year, Mr. Bush has signaled that he intends to curb rapid increases in federal spending linked to the aging of the population. "The retirement of the baby boom generation will put unprecedented strains on the federal government," Mr. Bush said in his State of the Union address on Tuesday.

Administration officials, Congressional aides and lobbyists said the president was contemplating a package of proposals that would cut the projected growth in Medicare spending by $30 billion to $35 billion in the next five years. That represents less than 1.5 percent of total Medicare spending in those years. But whether Congress has the appetite to trim popular benefit programs in an election year is unclear.

The House passed another deficit-reduction bill this week by just two votes, underscoring the qualms among moderate Republicans about how far to go in limiting the growth of domestic programs at a time when the administration continues to push tax cuts....

[anne]

Having happily failed to slash Social Security benefits, the Administration is evidently going to try to slash Medicare. At least, there will be a feint in the direction because this is an election year and I cannot imagine any Democrat will support such an effort and Republicans like being elected. Still, there is enough lunacy around that finds war never a problem to pay for but resents allowing for our parents to care for themselves.

[Bruce Webb]

Mark on Bernancke: "I somehow expected that colors would look a bit dull, or the chirping of birds would become melancholy."

Anne! Less Vanguard! More chirping birds!!

But seriously your point is right on. The Republicans somehow are counting on people just not noticing that they are asking for a $40 billion cut in Medicaire, Medicaid and Student Loans while asking for $60 billion for tax cuts and another $60 billion supplemental for Iraq, all within a couple of week span.

I am the bleeding heart, Kumbayah liberal in the room, but if asked from a standing start whether I would invest $350,000,000,000 and counting to liberate a country of 26,000,000 from a murderous dictator I would have to sadly decline. Not that I would have been uncaring about the plight of the Iraqi people but because it is almost unimaginable what we would have done with that kind of money if invested worldwide.

I suspect that certain people with colder hearts than mine, who would not even think of investing roughly $15,000 per individual in any social program whatsover, are beginning to whip out their calculaters and wonder why we are investing that same amount of money on Iraqis (largely spending it on bombs and bullets to blow those same Iraqis up).

In the very earliest days of the occupation I had a joke that even made wingnuts smile: "I have good news and bad news. 'What's the good news?' Bush has come out for Universal Health Care. 'What's the bad news?' It is for Iraq." I suspect those smiles are becoming grimmer and more strained over time.

Saddam: very, very BAD. Democracy: very, very GOOD. But neither pole makes Cost/Benefit analysis just vanish into thin air.

[anne]

Bruce :) I always look to Vanguard and MSCI market and market segment indexes to add to any thoughts on economic analysis. When analysts tell us that there are concerns about an increase in the labor cost index over the last 12 months, but I find long term bond prices rising on the news, I trust the bond market. I have been hearing warnings about a housing slowing for quite quite a while, but I find no market effect from any such slowing abroad and wonder at the least :)

[anne]

http://www.msci.com/equity/index2.html

National Index Returns [Dollars]
12/30/05 - 2/3/06

Australia 4.9
Canada 8.2
Denmark 3.7
France 6.5
Germany 6.9
Hong Kong 3.2
Japan 3.0
Netherlands 4.6
Norway 9.0
Sweden 4.3
Switzerland 5.2
UK 5.0

[anne]

http://www.msci.com/equity/index2.html

National Index Returns [Domestic Currency]
12/30/05 - 2/3/06

Australia 2.9
Canada 6.2
Denmark 2.1
France 4.7
Germany 5.1
Hong Kong 3.3
Japan 4.0
Netherlands 2.8
Norway 7.7
Sweden 1.3
Switzerland 3.5
UK 2.4

[Bruce Webb]

But Anne, can't you give us some birds? I know you can.

[calmo]

Bruce, has arisen (it could be arousen, just be patient forchrisake) to the bait. (You can tell his bird net is ready.) He knows there is something behind this double catalog of stats. (2 birds?) He's counting on something rustling in the bushes, you?
From that furnace heart:
I suspect that certain people with colder hearts than mine, who would not even think of investing roughly $15,000 per individual in any social program whatsover, are beginning to whip out their calculaters and wonder why we are investing that same amount of money on Iraqis (largely spending it on bombs and bullets to blow those same Iraqis up).
-people whipping out their calculators and wondering?...I have a ways to go before I warm up to your standards, sir.