Paulo's Econ Watch

Showing all posts tagged #monetary-sector:

US wages: going up

Posted on April 29th, 2016

Main takeaways:

ECI is Fed's preferred measure of wage growth.
So is is worth looking beyond the headlines...
...and they suggest wage growth is firming.
Wages are growing at 2.5% pace, higher than the headline 2.1% would suggest, and...
...the pace of wage growth in increasing -- as one would expect.

The employment cost index (ECI) measures the change in the cost of labor, free from the influence of employment shifts among occupations and industries -- and therefore is often Fed's preferred measure of labor costs. Total compensation costs for civilian workers is the measure that makes the headlines. It includes wages and salaries (around 70% of compensation costs) and benefits. Civilian workers includes private industry and state and local government establishments.

I will focus only on wages and salaries for private industries of the ECI report.

The chart below shows that wages and salaries for private industry workers rose 2.1% yoy in the first quarter of 2016, unchanged from the number reported in 4Q 2015. However, there is clearly a base effect (1Q 2015 seems to have been an outlier) and wages increased 2.6% annualized in the last three quarters (2.9% ar in 1Q 2016).

The ECI report breaks down wages by industry. The chart belows shows a surprising result: wages in the goods-producing industries (and manufacturing) -- a sector which is currently struggling -- is rising faster than wages in services and the growth rate is increasing.

But the above-mentioned discrepancy is also only due to base effect. When looking at the last two or three quarters, wage growth in both goods and services producing industries were close to 2.5% annualized.

One can also look at the detailed industry breakdown (looking into goods and services sectors). There is a lot of noise in the breakdown, but the black line in the chart below shows a simple average of annual wage growth for the main industries.

The chart below plots only the average for the main industries in order to highlight the recent trend.

Another way to understand the base effect is to look at wages by occupational group. We can see that sales & office spiked in the first quarter of 2015 and therefore the annual growth rate collapsed in 1Q 2016.

The chart below highlights the spike in wages for sales & office occupational group that happened in early 2015. There is an interesting paper explaining the volatility in the ECI indexes due to rates of pay that are defined wholly or in part on the results of worker efforts and the BLS reports an index of wages excluding incentive paid occupations. The chart also shows that the spike was related to performance incentives / bonus.

The chart below reproduces wages by occupational groups excluding incentive paid occupations (except for natural resources and construction). One gets a very different picture of wages by looking at this chart.

Now back to all wages. It shows that wages for private industry workers ex. incentive pay is growing at 2.5% yoy (vs. 2.1% when incentive pay is considered) and in the last two quarters wage growth has been 2.6% annualized (vs. 2.3% annualized when incentive pay is considered).

US outlook: dovish and confused (Apr/16)

Posted on April 12th, 2016

Link para a apresentação de US: http://bit.ly/us-outlook-apr16

Main takeaways:

* Global risks the main reason behind FOMC's dovish stance (China, strong dollar).

* I think the odds are for an improving global backdrop in the coming months.

* Global (and US) manufacturing showing some tentative signs of improvement...

* ...but consumption softens in the US. It is likely temporary, but will keep Fed on hold.

* Improving labor force participation and lack of wage growth helps Fed's narrative (but recall ULC is increasing at the same pace as 2004!).

* Yellen has questioned the recent firming of core inflation. She was right once (recall "inflation is noisy" comment in 2014). But not likely to be right this time - a myriad of inflation indicators suggest the pickup in core inflation may be sticky.

* FOMC focus on global risks, asymmetry, and inflation expectations opens room for inflation swaps / TIPS to move higher.

Conclusions:

* As anticipated in our last outlook report the Fed decided to pause to watch: impact of tightening financial conditions, dollar and oil/commodity prices, drop in inflation expectations, path of actual inflation, ISM and manufacturing data, credit data, inventory adjustment.

* But the Fed also opted to emphasize risks to the global economy and the asymmetric risks facing the normalization of policy rates.

* Fed stopped short of supporting a period of inflation overshoot to offset the below target prints.

* Soft-patch in consumption in 1Q (despite incipient manufacturing rebound) keeps pushing forward the next rate increase.

* Risks abound, but my guess is that the economy will remain in the current path, global worries would not escalate and, by mid 2016, the Fed would be ready to signal rate hikes would resume. Two hikes in the second half of 2016 continues to be a reasonable base case (July or Sept for the next one).

Trading views: inflation swaps embedds a lot of downside risks

* Intermediary inflation swaps (5-year swap, 2 years forward) appear too low.

* Inflation in the last five years was 1.4%/year, even after the large drop in energy prices !!

* If oil prices stabilize, inflation would increase to 2.0%-2.5%.

* Recall the Fed story of asymmetric risks favor a pickup in inflation.

* But wasn't this pick-up in inflation the story of 2015? Yes, but China and oil changed the picture. Would it happen again?

* Recall that, a year later, the economy is even closer to NAIRU. Is the Phillips curve really dead?

US inflation up in January, but soft patch likely in the near term in tandem with oil prices

Posted on February 19th, 2016

Main takeaways:

Headline and core inflation both up in January.
Sticky-price CPI (a sign of anchored expectations) is at 2.5%.
Inflation momentum has been around 2.2% for one year.
If oil prices continue to move lower, inflation (headline and core) will likely soften in the near term, mimicking the path observed in late 2014 / early 2015; if this does not happen it could signal strong underlying price pressures.
Some measures of inflation expectations are catching down with inflation compensation -- this was a key concern in the last FOMC meeting.

Headline and core inflation ticked up again...

(headline is a base effect since overall prices are almost flat... but core prices are trending up)

...and inflation momentum hovering around 2.2% for one year now

The chart below shows CPI in the last 6 years. Headline CPI was growing close to the underlying core CPI in a period where oil prices were roughly flat, but the gap opened from mid-2014 onwards with the sharp drop in oil prices. It is interesting also to note that the strong US dollar has, so far, barely dented the trend in core inflation (except for the 2H 2014 period, when core CPI softened a bit in tandem with the sharp drop in energy).

Headline and core inflation could soften again reflecting lower oil prices, repeating what happened in late 2014 early 2015.

(if it doesn't, it could imply stronger underlying price pressures...)

Core goods are almost flat, but core services inflation is rising and reached 3.0% yoy.

Sticky-Price CPI (a sign of anchored expectations) is high

The Atlanta Fed produces a breakdown between 'sticky' vs 'flexible' prices and they argue 'sticky' prices (which is a weighted basket of items that change prices relatively slowly) "appear to incorporate expectations about future inflation to a greater degree than flexible prices".

Market-based inflation expectations and compensation: this is key for the FOMC!

Some survey measures are moving down -- doves will worry.

US: inflation soft patch likely in the near term as oil prices move lower

Posted on January 20th, 2016

Main takeaways:

Headline and core inflation both ticked up in December, but were a bit below market consensus.
Sticky-price CPI (a sign of anchored expectations) ticked down but is still at 2.5%.
Inflation momentum softened from 2.4% to 1.9%.
If oil prices continue to move lower, inflation (headline and core) will likely soften in the near term, mimicking the path observed in late 2014 / early 2015.

Headline and core inflation ticked up...

...but inflation momentum softened back to 2%

Headline and core inflation could soften again reflecting lower oil prices, repeating what happened in late 2014 early 2015

But behind slight increase in YoY core inflation there's a growing divergence. Core goods are 0.4% lower than a year ago while core services are 2.9% higher.

Sticky-Price CPI (a sign of anchored expectations) is high

Market-based inflation expectations and compensation: this is key for the FOMC!

US FOMC Minutes digest: concerned about inflation; risk management was behind decision to raise rates

Posted on January 6th, 2016

Main takeaways:

Minutes confirmed risk management was key to the decision to increase rates (see US FOMC digest: risk management):
- monetary policy has lags;
- for FOMC members, an 'early' and gradual hike, therefore, reduces the risk "it might need to tighten policy abruptly" later on;
- the asymmetric risks posed by rates still close to zero was dealt with by promising to keep a large balance sheet "until normalization" of interest rates is "well under way."
FOMC minutes stressed a couple of times the dichotomy between domestic and foreign developments:
- participants took the view that domestic demand would only be partially offset by weakness in net exports, and
- acknowledged downside risks from global and financial developments had receded.
Inflation outlook was debated at length by FOMC:
- members noted the decline in oil prices "was likely to exert some additional transitory downward pressure on inflation in the near term.
- members also noted that "some survey-based measures" of inflation expectations moved down, and several members expressed unease with that.
- for some members, risks to their inflation forecasts remained considerable (further shocks to oil and commodities; a sustained rise in US dollar).
- a couple worried global disinflationary forces could be more important than improving labor market for the inflation outlook.
- some members said the decision to raise rates was a close call, given uncertainty about inflation dynamics.
Above mentioned concern with inflation was reflected in the statement saying that the Committee "would carefully monitor actual and expected progress toward its inflation goal."
However, the hurdle for inflation is not very tough -- underlying PCE momentum is running in the 1.2%-1.5% range, and the Fed central tendency forecasts for 2016 is 1.2%-1.7%.

US FOMC digest: risk management

Posted on December 17th, 2015

Main takeaways:

Dovish hike delivered; the gradual base case is 100bp/year, but market is not convinced; Fed emphasizes policy remains accommodative.
Key reason for moving (when inflation is still low): monetary policy has lags; a delay increases risk of abruptly tightening later.
Reference to actual inflation and that inflation expectations have to be well anchored probably helped to bring the doves on board.
However, the hurdle for inflation is not very demanding -- underlying PCE momentum is running in the 1.2%-1.5% range and the Fed central tendency forecasts for 2016 is 1.2%-1.7%.
Fed expects neutral fed funds (r*) to raise only gradually; markets, on the other hand, are betting on a secular stagnation type of story -- r* remains zero for the next two years and monetary policy stance remains even more accommodative than today.

FOMC	Comments
Policy decision	Raise the target range for the federal funds rate to 1/4 to 1/2 percent. Monetary policy remains accommodative. Reinvestment policy will continue until "normalization of the level of the federal funds rate is well under way" -- this should "reduce the risk that fed funds rate might return to the effective lower bound in the event of future adverse shocks".
Why?	"Considerable progress that has been made toward restoring jobs, raising incomes, and easing the economic hardship of millions of Americans", and reflects "confidence that the economy will continue to strengthen". The recovery, however "is not yet complete": there's room for labor market to improve further and inflation continues to run below 2%. So why increase rates? a) softness in inflation is due to transitory factors that should abate over time; b) diminishing slack should put upward pressure on inflation as well; c) it takes time for monetary policy actions to affect future economic outcomes; d) a delay of normalization (for too long) increases risk of abruptly tightening policy at some point to avoid overshooting the goals.
Risks	Risks are balanced.
Policy outlook	In "determining the timing and size of future adjustments", FOMC "will carefully monitor actual and expected progress toward our inflation goal". Also, FOMC confidence in the inflation outlook rests importantly on its judgment that longer-run inflation expectations remain well anchored. Normalization process likely to proceed gradually. This is consistent with the view that neutral nominal fed funds rate (r*) is currently low by historical standards. FOMC expects that with "gradual adjustments in the stance of monetary policy" economic activity will continue to expand at a moderate pace and labor market indicators will continue to strenghten -- by how much? look at forecasts.

Discussion on equilibrium / neutral fed funds rate (r*)

The FOMC expects federal funds rate to remain, for some time, below levels that are consistent with its longer run assessment. The key rational behind this idea is that for that is the neutral rate (r*) is currently low and will only move gradually towards its long term level.

Why is r* low?

Because of the headwinds: tighter underwriting standards, limited access to credit, deleveraging, contractionary fiscal policy, weak growth abroad, significant appreciation of the dollar, slower productivity and labor force growth, elevated uncertainty about economic outlook.

These have declined noticeably over the past few years, but some have remained significant. As these abate, r* should gradually move higher over time -- this can be seen in the SEP.

How do you know for sure that r* is low?

One indication is that growth has been only moderate despite very low level of funds rate and the large balance sheet. Had r* been higher, economic expansion would have been much more rapid.

How low?

During the October FOMC meeting the staff briefed participants about the topic and the conclusion leaned towards:

r* was negative in the aftermath of the 2008-09 financial crisis and is currently close to zero.
Equilibrium level of r* would likely remain low relative to estimates before the financial crisis (due to productivity and demographic factors). This is reflected in SEP's forecast of 1.5% real rate in the long run (below the 2% used in the past).

According to the Taylor rule mentioned by Yellen (Yellen's preferred Taylor rule) on her remarks earlier this year (Normalizing Monetary Policy), even considering r*=0 (the green line in the chart below) the Fed would already be behind the schedule. An r*=0 (and current readings on PCE inflation and unemployment rate) would imply fed funds approximately 50bp higher -- this is why the Fed calls the monetary policy stance accommodative (below the neutral).

The fact that the slope of the 'dots' curve is higher than the green line reflects the idea of r* gradually moving higher over time. Market forecasts, on the other hand, are betting on a secular stagnation type of story -- r* remains zero for the next two years and monetary policy stance remains a bit more accommodative as it is today (a bit more than 50bp below the r*=0 line).

Emphasis on actual inflation

The newly introduced actual in the sentence "the Committee will carefully monitor actual and expected progress toward our inflation goal" was probably key to bring the doves on board (the other was the reference to the reinvestment policy, which would continue until "normalization of the level of the federal funds rate is well under way" -- this probably helped to please Brainard).

However, the Committee was smart enough to leave this comment flexible enough to avoid tyeing the Fed to a given path of inflation. Chair Yellen ably avoided giving any hard target when questioned by reporters. They avoided the historical mistake of the 6.5% unemployment target...

"Now, I've tried to explain in many of my -- and many of my colleagues have as well why we have reasonable confidence that inflation will move up over time, and the committee declared it had reasonable confidence. Nevertheless, that is a forecast. We really need to monitor over time actual inflation performance to make sure that it is conforming, it is evolving, in the manner that we expect. So it doesn't mean that we need to see inflation reach 2 percent before moving again, but we have expectations for how inflation will behave, and were we to find that the underlying theory is not bearing out, that it is not behaving in the manner that we expect, and that it doesn't look like the shortfall is transitory and disappearing with tighter labor markets, that would certainly give us pause. And we have indicated that we are reasonably close, not quite there, but reasonably close to achieving our maximum employment objective. But we have a significant shortfall on inflation. So we are calling attention to the importance of verifying that things evolve in line with our forecasts."

"I'm not going to give you a simple formula for what we need to see on the inflation front, in order to raise rates again. We will also be looking at the path of employment as well as the path for inflation. But if incoming data were, led us to call into question the inflation forecast that we have set out, and that could be a variety of different kinds of evidence, that would certainly give the committee pause. But I don't want to say there is a simple benchmark. The committee expects inflation over the next year at the median expectation is for inflation to be running about 1.6 percent. And both core and headline, so we do expects it to be moving up, but we don't expect it to reach 2 percent."

The chart below gives a good picture of recent inflation performance. Both headline and core inflation were increasing at the same pace (about 1.5%) from late 2011 to mid 2014, when oil prices were roughly flat. From October 2014 to January headline inflation dropped 0.8% (-3.4% annualized) reflecting the drop in energy prices, and has increased 1.1% until last October (about 1.4% annualized). This late rebound is headline prices is roughly in tandem with the pace of core inflation.

Core CPI inflation momentum is already running 2.4% (details here) but the gap with PCE inflation has opened and core PCE momentum is in the 1.2%-1.5% range. The Fed expects PCE inflation in the 1.2% to 1.7% range in 2016 (central tendency) so the bar is not very high.

However, further decline in oil prices and/or strengthening of the dollar could easily delay Fed action.

FOMC reference scenario

The table below is a reference to the FOMC base case, which is compatible with "gradual adjustments in the stance of monetary policy" -- i.e., 100bp/year.

The evolution of the actual economic variables and the evolution of Fed's forecasts will tell whether the economy is ahead or behind the base case.

Chart 1) Evolution of Fed forecasts for unemployment and inflation

Unemployment rate	PCE inflation

Chart 2) Dots and the implied Taylor rule

	Taylor rule
Fed funds in 2015 below the r*=0 Taylor rule -- meaning monetary policy stance is accommodative
Dots for 2016 still imply a accommodative policy stance -- even assuming r* remains at zero!
Dots for 2017 moved down, suggesting the Fed sees headwinds taking longer to abate.

US financial conditions and commodity prices ahead of the historical FOMC tomorrow

Posted on December 15th, 2015

Main takeaways:

Commodities (including oil) breaking new lows.
Strong USD.
Equities off the highs with increasing vol.
Baa - Aaa spreads widening. High yield mkt close to panic.
But overall financial conditions are off the highs observed earlier in the year.

Charts

US trade-weighted dollar is higher than earlier in the year, when Fed warned about its negative consequences to the economy.

Oil prices are also at the lows.

Retail gasoline prices are close to the lows.

Commodity prices also at the lows.

US equities recovered part of its Aug/Sep losses, but face renewed uncertainty.

Equity vol is high again.

US 10y Treasuries

Baa spreads widened

Market-based inflation compensation sharply down, but this could just be oil prices

Financial conditions, as measured by GS, are tighter than in the last few years.

...but broadening the definition to include oil prices show a more benign picture

Financial conditions, as measured by the Chicago Fed, also show a tightening, but overall levels remain in the accommodative range

Adjusting for the business cycle, Chicago Fed index suggest that financial conditions moved to tight earlier in 2015 and are now back to easy.

Below, some additional financial conditions and financial stress indices

Longer history of financial conditions and the relevant episodes.

US Inflation: enough to remain confident? (Nov/2015)

Posted on December 15th, 2015

Main takeaway:

Core CPI inflation momentum rose to 2.4% (annualized).
Core services inflation increased from 2.5% yoy in June to 2.9% yoy in November. Core goods are down 0.6% yoy.
Sticky-price CPI (a sign of anchored expectations) is trending up.
Interestingly, core inflation is unabated despite the strong dollar.
Headline inflation will likely move up in the next couple of months due to base effect.

Fed's criteria for raising rates:

"The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term."

Given the expected hike tomorrow, the Fed is reasonably confident inflation will move back to 2%.

The focus, then, is likely to move toward the criteria the Fed will use to justify the second rate hike.

The chart below shows CPI in the last 6 years. Headline CPI was growing close to the underlying core CPI in a period where oil prices were roughly flat, butMarket forecasts, on the other hand, are betting on a secular stagnation type of story -- r* remains zero for the next two years and monetary policy stance remai

the gap opened from mid-2014 onwards with the sharp drop in oil prices. It is interesting also to note that the strong US dollar has barely dented the trend in core inflation.

The chart also shows that headline yoy inflation is likely to increase in the next couple -- unless the drop in oil prices is big enough to offset the drop in inflation observed in Nov/14-Jan/15 period. Even if headline inflation remains flat in the next couple of months, the yoy figure will increase from the current 0.4% to 1.4% in January.

Today's CPI print showed another increase in core inflation momentum (3-month annualized inflation). Core inflation momentum moved from 2.2% to 2.4%:

Average YoY measure of core inflation is currently at 2.1% -- the most recent low was 1.8% in May, but overall core inflation has been stable at around 2% since mid-2012.

But behind slight increase in YoY core inflation there's a growing divergence. Core goods are 0.6% lower than a year ago while core services are 2.9% higher.

Note how the pace of increase in core services prices increased in the last few months! It is very close to the average 3% inflation observed during 2002-2008 period.