Fed Watch: Still in the Game

Tim Duy with a Fed Watch after today's jobs report:

Still in the Game, by Tim Duy: The title could refer to the Fed or myself, considering my long hiatus from Mark’s blog. In this case, however, it is the Fed I am referring to. The jobs report was mixed, but tilted enough to the “strong” side to keep the more hawkish FOMC members fidgeting nervously. Yes, the headline reading of 121,000 net new hires in May argues for a pause at the next meeting. But the rest of the report argues for another 25bp. And, given last month’s wave of hawkish rhetoric, caution suggests following the latter bet.

First, note that the Fed was perfectly happy to raise rates after the last employment report, which posted a 75k gain in employment (since revised up to a 92k gain) and a measly one cent gain in hourly earnings. Did I say “perfectly happy?” Note the John Berry would not agree with me on this point. He claims that:

Some officials, convinced that economic growth is slowing and that inflation will settle down again soon, would really rather not raise the target this week for the 17th time in a row.

Even those officials feel they have no choice because investors, shaken by recent inflation reports, fully expect them to do so.

True, I think that some officials, such as the nonvoting Kansas City Fed President Thomas Hoenig and the voting San Francisco President Janet Yellen (whose bank did not put in a request for a discount rate increase) did not want to hike rates again. But to blame the rate hike on investors “shaken by recent inflation reports” misses half the story – the policy half. Berry forgets that most of the Fed finally found a consistent voice in the weeks prior to the meeting. And that voiced screamed “inflation.” No, the markets did not lead the Fed. In my opinion, the Fed decided to lead. Berry’s contacts (whoever they might be) shouldn’t blame the markets. They should blame their colleagues. And Berry shouldn’t help them shift the blame.

Given that a weak May report did not deter the Fed, why would a better June report argue for a pause? Employment gains accelerated, hours worked expanded, and both the duration of unemployment and the percentage of long term employed dropped. And then there is that wages jump – a “whopping” eight cents! Yes, yes, eight cents aggregated over millions of workers and hours does add up to real money, so it is significant. Moreover, average wages stand 3.9% higher than year ago levels. This will suggest to some FOMC members that the tepid employment growth remains strong enough to generate inflationary pressures. Recall arch-hawk Chicago Fed President Michael Moskow’s speech last month:

With overall population growth continuing to slow and labor force participation not expected to rise, we probably need to adjust our benchmarks for what level of employment growth is consistent with economic growth near potential and a steady unemployment rate. It used to be that increases in payroll employment that averaged 150,000 per month were consistent with flat unemployment. Now that number may be closer to 100,000. These developments also imply that, in the absence of changes in productivity growth, our estimates of potential GDP growth should be revised down 2 or 3 tenths of a percentage point to a range of 3 to 3-1/4 percent.

I am sure that Moskow will note that 121k is higher than his 100k estimate for a steady unemployment rate. For like minded FOMC members, this report suggests the economy is uncomfortable close to potential, and not slowing enough to stave off inflationary pressures. Instead, rising wages implies that workers have the gall to demand higher wages to compensate for accelerating inflation.

Of course, there is another side to this story – that these wages gains will be offset by productivity growth, and thus are not inherently inflationary. And while wages are up 3.9%, CPI headline inflation will post a greater y-o-y increase in June (the May number was 4.2%). In other words, real wages are down. Should we expect the Fed to hike rates when real wages are falling, or whenever they threaten to edge up? Is the goal to hold real wages constant? See Angry Bear for more on this criticism of Fed policy.

The Fed, I suspect, will not cozy up to these arguments. On the first point, policymakers will note the possibility that, given the “tight” labor market – 4.6% unemployment – this is only the first round of wage gains that will start to push up unit labor costs. On the second point, they will note that the wage section of the employment report covers only 80% or so of the workforce – the 80% FOMC members do not encounter unless they work late enough for the janitorial staff to make the rounds. Just kidding, sort of. They will note that real disposable personal income is 1.4% higher than a year ago. Real incomes are rising, not falling! Naturally, the rise is attributable to gains at the top of the economic heap. But the distribution of gains is not within the purview of monetary policy. Fed officials will argue that topic is in the realm of the legislative and executive branches of government (the Fed didn’t give tax cuts to the wealthy). The Fed addresses policy to the nation as a whole, not to individual subgroups or sectors. And more importantly, households still appear willing to spend, albeit at a slower pace and at the expense of savings.

Bottom line: I want to believe that the Fed will pause as they assess the magnitude of economic slowing. But I have been led down that road before, and am not ready to make that trip again. Instead, I suspect they will read this report as a sign that while the economy is slowing, the pace of activity remains strong enough to heighten inflationary pressures. True, we will get another employment report before the next FOMC meeting, as well as multiple reports on inflation, not to mention Q2 GDP as well as the minutes from the last FOMC meeting. And Fed officials may suddenly back away en masse from last month’s inflation worries. But this employment report goes to the hawks.

Update: The Wall Street Journal's Greg Ip explains the difference between the payroll and household survey of unemployment using the latest employment numbers to illustrate the difference:

Jobs Surveys Send Divergent Signals, by Greg Ip, WSJ: While Friday's employment report showed a disappointing increase of just 121,000 in nonfarm payrolls in June, optimists noted that the separate survey of households showed employment had jumped 387,000.

But the picture would be different if the two surveys defined employment the same way. If they did, then the household survey would have shown a decline in jobs of 92,000, the Bureau of Labor Statistics estimates.

The two surveys often send different signals, but the differences have been especially large lately. Since December, payroll jobs are up 854,000 while household employment is up 1,584,000. Since both surveys estimate total employment from a sample, neither is a perfect tally but economists generally prefer the payroll survey because its sample is far larger -- about 400,000 establishments, compared to the household survey's 60,000 households.

In theory, the two could be completely accurate yet come up with widely different job counts, because they define employment differently. In June, these definitional differences accounted for more than the entire difference in the two results.

Of the many definitional differences, the largest, in terms of magnitude, are that the household survey counts the self-employed while the payroll survey does not; and that the payroll survey counts someone with two jobs twice, whereas the household survey counts that person once.

Each month, the BLS comes up with a household estimate of employment as using the payroll survey's definition of employment. In June, that total showed a decline in jobs of 92,000 from May. (You can see the estimates and a technical note on their web site here: http://www.bls.gov/web/ces_cps_trends.pdf1)

Is this positive or negative news for the job market? The answer depends on the reason for the divergence. If it's because the ranks of the self-employed are growing, the job market is stronger than the payroll survey suggests. If it's because the number of people with multiple jobs is shrinking, the market is weaker than the household survey shows -- all else equal.

In June, the message appears to be negative. The number of the self-employed rose 20,000. But the number of multiple job-holders fell 320,000, which means at least that many fewer paychecks from this group. (It may not mean less income: The worker may have gone from two part time jobs to one full time job.) But these two categories swing widely from month to month. In the last six months, the number of the self-employed has risen 346,000 while the number of multiple-job holders has fallen just 75,000.

Even using the payroll definition, the household data are still highly volatile; it showed a huge gain of 606,000 jobs in May from April, far more than the payroll survey's increase of 92,000.

Yet since last August, the two have told almost the same story: Jobs are up by 1.4 million according to the payroll survey, and 1.3 million using the household survey but the payroll definition. The household survey using the broader household definition is up by 1.9 million, which means about 600,000 extra jobs that can't be explained by definitional differences. It may be a sign, albeit an inconclusive one, that job creation is stronger than the payroll survey suggests.

Comments

[Winslow R.]

I expect a shift in fiscal and/or monetary policy because I don't believe Bernanke/Bush want a recession. Rates have inverted and now loan growth is faltering. The switch has unintentionally been flipped.

[anne]

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

Vanguard Fund Returns
12/31/05 to 7/7/06

S&P Index is 2.3
Large Cap Growth Index is -2.1
Large Cap Value Index is 6.8

Mid Cap Index is 3.1

Small Cap Index is 5.0
Small Cap Value Index is 6.9

Europe Index is 13.8
Pacific Index is 2.7
Emerging Markets Index is 5.8

Energy is 16.0
Health Care is 2.9
Precious Metals is 28.3
REIT Index is 14.4

High Yield Corporate Bond Fund is 1.4
Long Term Corporate Bond Fund is -5.1

[anne]

Look to the bond market :) Federal Funds futures are suggesting still another 25 basis point rate increase, while the long term bond market is suggesting a slowing economy with little inflation threat. So, the end of the Fed cycle would seem near but not quite there.

[anne]

Interestingly, there has been no recession in any developed country since the energy price increases began. Nor has housing weakness in any developed country led to a recession even with energy price increases. There seems to be an increased flexibility in these economies, that is allowing for continually easier adjustment. Also, there are ways in which we personally should have been and evidently have been insulating ourselves against rising energy prices. The sense I have is that we are faring reasonably well through what 15 and 25 years ago would have been a considerably more difficult period.

[Winslow R.]

I'm watching slowing credit growth, it is turning into a trend in the month of June. See Line 1.

http://www.federalreserve.gov/releases/h8/Current/

[anne]

Winslow, you are right, we are slowing. The hope is that we can slow from the terrific first quarter but not slow enough to seriously limit employment growth. The negative possibility is that Federal Reserve policy works slowly and there are already a number of rate increases yet to be experienced. Positively, we bottom at about 2% growth because of the economic flexibility we now have.

[dWj]

I severely don't get this suggestion that the fed is supposed to respond to real wages. If nominal wages were rising at a 15% clip, and negative wages were real, would anyone doubt that the Fed should pull a Volcker and get some sort of handle on inflation? To the extent that wages are the only source of inflation, real wages are outside the reach of monetary policy anyway. High nominal wages increases, whether from an economy growing faster than potential or from high inflation, should trigger a hawkish response.

I'm not saying I do or don't support such a response now. 3.9% doesn't frankly overwhelm me; with productivity in the 2 to 2.5% range, it seems close to happy, and a bit on the weak side if anything. My real point is that people use "real" measures of particular prices when they're looking for inflation, and that's just stupid, unless you're looking at lags or accelerations or attribution or something.

[spencer]

Growth is slowing, but maybe not as much as some think.

But also note that productivity may also be slowing.
Hours worked rose at a 2.3% rate in the second quarter --versus a 2.4% year over year gain -- while the consensus forecast is for second quarter real gdp growth to be under 3%. This implies that second quarter productivity growth should slow to under 1% as compared to a year over year gain of 2.5% in the first quarter. If compensation is running at a 3% rate this implies unit labor costs would jump to about 2% -- a significant jump from the 0.3% trailing number.

Also note that a much of the slower growth is autos. But Detroit just reinstituted very strong price incentitives so the next change in auto sales should be a significant rebound.

Aside from housing and autos it is hard to find significant weakness and the correction in commodity prices appears to be over as copper, oil and even agricultural prices are starting to move up again.

[jalrin]

The Fed has lost its mind. If they really were concerned about commodity price inflation, they would jack up futures margin requirements until the speculators were forced out of the markets. However, they prefer to bankrupt the working men and women of this country while protecting Wall Street from the consequences of their speculative frenzies.

[groucho]

"they prefer to bankrupt the working men and women of this country while protecting Wall Street from the consequences of their speculative frenzies"

jalrin

FED is following their charter, in exquisite detail. Keep people employed and keep the prices of goods somewhat in check. Of course the end results of this nonsense are workers at walmart purchasing bicycles to travel to their job and then stopping at the Dollar Store on the way home from work to purchase these low priced goods and bring them back to their room/apt for a wonderful night of hamburger helper(which is tasty even without the hamburger).

The end of the cold war was the perfect opportunity to rewrite the mandates and create a rational prosperity driven system. Instead we've gotten an asset scam system where the masses get taken to the cleaners on every new bubble scheme. This system is sick. The only good thing is that it is unsustainable and will be brought down in the not too distant future.

Hopefully, a more equitable system will rise up in it's place. The current system is toast.

[manatee]

We are still in the middle of excess liquidity, strong demand and relatively strong supply position (though varied, depending on supply movability). This is a positive self-reinforcing trend, where we continue to see a relatively rising price and rising output. With inflation on the uptrend (whether due to rising energy price or overall narrowing output gap), wealth disparity is rising. With FED responding to inflation so far, we start to experience a mixed economic signal. This is because the high safety net (i.e. wealthy people) continues to show insensitivity to FED tightening (and likely to spend even more), while the low safety net (i.e. less wealthy people) starts to be exhausted from the rising energy and financing cost. However, probably overall output continues to be strong.

A pause by FED in aug will allow the low safety net group to adjust and thus supporting the overall output growth. This will guarantee the come-back of FED's rate increase in late Q4 or Q1/07. Another rise by FED in aug (and in subsequent FED meeting) will further exhaust the low safety net group.

I think that FED should prefer the continued positive self-reinforcing economic trend rather than the negative one. But it will make sure that the low safety net group will not be exhausted too much and be allowed time to adjust to the subsequent higher rate (i.e some rate pause and rate rise later).

Inflation is like oil price, if it rises slowly and in an anticipated way, where people adjust to it, the benign situation can be maintained. Oil at USD70 per barrel has not wrecked the global economy, as people expected one or two years ago. This is due to the gradually rising oil price, which allow people to adjust. People may start to price in oil at USD80 and 90.

This is the situation I expect in the major economies. However, in most of the past FED tightening, some emerging economies cannot withstand the increasing tightening and start to crack. I don't know who will be the victims this time. But if it is a major one, FED will start to cut rate, quite certainly.

Nevertheless, most emerging economies do know the rising chance of financial crisis in the tightening phase and probably have adjusted to be in line with FED rate tightening. In such case, the positive self-reinforcing economic trend will continue.....

But every system has weakness and bottleneck does exist in every case, which could be high current account deficit countries (excluding US), US housing market, etc. you can make your own favorite choice.

So key point in my opinion will be velocity of rise in oil price. if the speed is slow enough, then FED might pause in one or two meetings and raise it again later.

[dryfly]

Of course the end results of this nonsense are workers at walmart purchasing bicycles to travel to their job and then stopping at the Dollar Store on the way home from work to purchase these low priced goods and bring them back to their room/apt for a wonderful night of hamburger helper(which is tasty even without the hamburger).

LOL. I been there. If beer is cheap life's still okay.

[dryfly]

Mark - the Economist had an interesting bit on employment numbers.

HERE

I realize the Economist isn't a 'serious' eonomics source... sorta what 'Scientific American' is to real science (a little fact a lotta eye candy). Could you comment on the issue? This (believe it or not) comes up quite a lot among us foolish know nothings... is the comparison between US & EU apples to apples or appples to oranges or apples to chuck roast? None of us have a clue.

Working out who's out of work

Jul 7th 2006
From The Economist Global Agenda

Unemployment rates are what you make of them

AMERICA said on Friday July 7th that its unemployment rate for June held steady at 4.6%. On the face of it, this would suggest a pretty healthy labour market, one where the supply and the take-up of jobs were both strong. A decade ago it was common to hear that America’s “natural” unemployment rate—the lowest unemployment rate the nation could sustain without triggering excess inflation—was 5-6%.

But by some other measures, the labour market is weak. Real wages for the median worker in America have been stagnant during this business cycle, although economic growth was running at an annualised pace of 5.6% in the first quarter. Corporate demand for labour has not been growing fast enough, apparently, to drive up wages.

Views on the market differ, partly because a labour force is intrinsically hard to define and measure, as is a level of unemployment. For the latter, you count the people who want to work but cannot find jobs. But who are those people, exactly?

[...]

The problem of counting workers and would-be workers increases the value of proxies for the strength of the labour market, such as wages and employment rates. But these, too, raise questions. In France only 62% of the working-age population was employed in 2005, compared to 84% in Iceland. But should that leave us worrying about a dysfunctional labour market in France, or worrying more that so few adults in Iceland are able to choose lives of study and leisure?

The ageing of the rich world makes these questions all the more pressing. As the number of would-be retirees rises, the politicians running the welfare states of the West will need new ways to re-stock and motivate the workforce. They will need more and better labour market statistics to do that well.

[Mark Thoma]

Thanks. Fortunately, the OECD worries about this. The have standardized unemployment rates available here.

They aren't perfect, and Dean Baker has more qualifications here. (the link to un-rates is from the comments to this post).