Tuesday, February 21, 2012

Should we be concerned about oil prices?

Economic reports from late 2011 and early 2012 indicate a recovery that is solidifying.  While many were concerned about a possible double dip late last summer, increasing optimism seems to be taking hold as more jobs are created and the unemployment rate declines.  As discussed elsewhere, some of these reports are probably a little misleading.  Nevertheless, the economy is on more solid footing than it was six months ago.  What could go wrong?  One concern mentioned in the post regarding the outlook for the new year was rising oil prices.  Less than two months later and more people are becoming concerned that we can see a repear of last year or worse.  Recall that the economy appeared to be strengthening as 2010 ended and 2011 began, but than a series of shocks hit the economy including a spike in oil prices.  As a result, economic growth was anemic in the first half of 2011.  Could it happen again?  Unfortunately yes.  The average price of gas is at a record high for the month of February and some forecasts suggest it could hit $5 by summer.  Barring a blow up in the Middle East, this seems unlikely (note that the record high average price is $4.13 reached in the summer of 2008 while it rose to $3.97 in May 2011).

Why are oil and gas prices rising?  There are many reasons that are beyond control in the short term.  One reason not discussed much is the "risk-on" trade.  Investors were quite nervous in Fall 2011, depressing prices of many assets including stocks and oil.  As investors became more confident and were willing to take on more risk, asset prices rose, including both stocks and oil.  Since reaching a low in October, the S&P has risen by almost 24%.  Over the same time, gas wholesale gas prices have risen by about 25% while Brent North Sea crude prices have risen by about 20%  thus, part of the reason for the recent run-up in oil prices is renewed willingness by investors to take on risk.  Of course there have been reasons for the willingness of investors to take on more risk including perceptions of a stronger US economy and less fear of a European meltdown, both of which led to rising stock and oil prices.  In addition, speculation has played a significant role in the behavior of oil prices in the last decade, driving it up to $157 per barrel in 2008 and back down later that year as the global economy collapsed.  Events in the Middle East, including the after effects of the Arab Spring and concerns about rising tensions over Iran's nuclear program are beginning to have an impact.

Though not much can be done about it in the short term, I suspect oil price may become a critical issue as the presidential campaign heats up this summer.  The Obama administrations "delay" of the Keystone oil pipeline  will be at the center of the debate.  For details about the merits of the pipeline, I'll defer to a respected economist that specializes in energy, Jim Hamilton, who tends to be objective without an ideological agenda.  Here are some of his recent posts in favor of the pipeline:

Friday, February 3, 2012

Did seasonal adjustments distort the January Job Report?

This post is not designed to be cynical or pessimistic, but to explore possible reasons that the report overestimated the strength of the job market.  Most economic data, including employment data, are seasonally adjusted.  As part of a recent analysis of the job market relative to GDP, Mark Vitner of Wells Fargo examined how seasonal adjustments may be misleading.  It should be noted that this was not written as a way to explain away this morning's job report, but was released on January 31.  Here are a few of his key points:

"The 2007-2009 recession was the deepest recession since the Great Depression, when considering peak-to-trough declines in real GDP. Moreover, some of the largest declines in employment, as well as the largest increases in the unemployment rate, occurred during the fall and early winter months of 2009-2010, with nonfarm payrolls reaching a bottom in February 2010...  This occurrence has likely set the bar very low for employment gains during the winter months in such a way that even normal hiring gains related to the holiday shopping season are showing up as seasonally adjusted employment gains, leading to exaggerated estimates of employment growth.

The seasonal factors used to adjust the unemployment rate were also impacted by the severity of the 2007-2009 recession. The result of this amplitude change is that the seasonal adjustment process has tended to exacerbate downward movements in the unemployment rate during the fall and winter months, while exerting upward pressure on the unemployment rate in the spring and summer months."

In essence, hiring patterns in recent years are used to estimate seasonal adjustments.  Given that some of the worst job losses during the Great Recession took place in the winter (Dec 2008-March 2009), the seasonal adjustments for those months may be biased, resulting in an overestimate of seasonally-adjusted employment growth for those months.  How much of a difference did this make?  If one seasonally adjusts last month's data using the average seasonal adjustment for January for the five years prior to the Great Recession, there would have been 40,000 fewer jobs reported (resulting in an increase of 203,000 jobs as opposed to 243,000).  Thus, a significant portion of the upward surprise appears to be linked to seasonal adjustments that may be biased.

Update (Saturday):

Here’s the math underlying the analysis. The average seasonal adjustment for January data between Jan 2002 and Jan 2009 was about 1.583% (these adjustments were not affected by the financial crisis).  That is, non-seasonally adjusted data are adjusted upward by 1.58% to get the seasonally-adjusted numbers).  Meanwhile, the January 2012 was adjusted upward by about 1.65%.  What difference does that make?
Non-seasonally adjusted employment for January 2012 was 130.263 million and the seasonally-adjusted number was 132.409 million. If one applies the average adjustment from 200522009 (1.58%), the seasonally-adjusted number for January 2012 is 132.321 million, 40,000 less than the official figures.  Thus, it's still a strong report, but probably reflects some bias from the new seasonal adjustment factors (note: this does not account for issues related to warmer than normal temperatures in Jan 2012, etc.).

January Jobs Report

This morning's job report far exceeded expectations, indicating that the economy added 243,000 jobs in January (257,000 in the private sector) and the unemployment rate declined to 8.3%.  Jobs gains were widespread, evidence of a strengthening economy.  Does this mean that the economic recovery is beginning to shift into high gear?  Though this was a good report, there are some reasons to think that it overestimated the strength of the economy (to be discussed in another post).  Let's take a quick look at some of the key numbers:
  • The participation rate was 63.7%, setting a new low for this period and is the lowest since March 1983.  If it declines a little more (63.5%), it'll reach a rate not seen since the late 1970s.
  • The employment-population ratio remained at 58.5%, slightly above the recent low of 58.2% (last time it was this low was 1983).
  • The broad measure of unemployment (U6) declined to 15.1% (from 15.2%).
  • The household survey showed a surge in jobs, most of which were part time.  Full-time employment rose by 80,000 while part time rose by about 700,000.
Add it up and it's a good report, the best since last Spring, but before assuming that the economy is ready for take-off, one should examine it further and compare it to other reports about the economy.