Tuesday, August 21, 2012

Key Indicator of Prior Quantitative Easings

There continues to be talk as to whether the Fed will implement another round of quantitative easing in the coming months (QE3).  What indicator should one watch to determine if QE3 is on the way?  Here's a chart of the break-even inflation rate on five-year treasuries:

Break-even inflation is the difference between the yield on the five-year US Treasury bond and the five-year TIPS (Treasury inflation protected security).  The yield on TIPS represent the interest earned apart from inflation, to which enough interest to cover inflation is added to one's return.  The difference between traditional Treasuries and TIPS is the amount of inflation necessary to result in an equal yield between the two securities (break-even inflation).  It gets a little complicated, but expected inflation is less than break-even inflation since an inflation risk premium is implicitly part of break-even inflation.

Back to the main point.  one of the Fed's main goals is to keep inflation at about 2% (that's it's inflation target).  You'll notice two periods during which break-even inflation declined significantly.  Of course the first time was at the depths of the financial crisis in late 2008, when break-even inflation collapsed to -2%.  The collapse in inflationary expectations was one reason the Fed engaged in the first round of quantitative easing.  The second instance was not as dramatic, but took place in the summer of 2010.  After reaching a short-term peak of about 2% earlier in 2010 (2.16% in January, 2.01% on April 30), break-even inflation experienced a significant decline to 1.22% in late August.  What stopped the decline?  Break-even inflation bottomed out and began to rise when Ben Bernanke laid the groundwork for QE2 at a speech in Jackson Hole, Wyoming.  Thus, both QE1 and QE2 were preceded by market perceptions of deflation or that inflation would be exceedingly low.  Does that exist today?  As the chart shows, break-even inflation is relatively stable (about 1.9%), indicating that QE3 is unlikely at this time according to this indicator.

Monkeys and unequal pay

How do monkeys react to unequal pay?  Here's a link that I found on Greg Mankiw's blog.

Friday, August 17, 2012

July Job Report for Florida

The Florida job market worsened in July as the state lost 3300 jobs and the unemployment rate rose to 8.8%.  Job losses were spread across various industries, led by wholesale trade and local government, both down 3100 for the month (seasonally adjusted).   Industries that added jobs included employment agencies (temps) and amusement parks.  In fact, employment agencies have experienced an increase of 27,200 jobs over the last year (an 18% increase), which represents nearly 40% of the net increase in overall jobs statewide.  Number two in terms of adding jobs over the last year was food and accomodation places, with an increase of 11,500 while the industry shedding the most jobs was state government, down 6300 since July 2011.  Overall, the private sector has added 7800 jobs thus far in 2012, while the public sector lost 9600, resulting in a net loss of 1800 jobs so far this year.  Meanwhile, the labor force declined slightly, reducing the labor force participation rate to 60%.  The decline in the participation rate is responsible for about a third of the decline in the unemployment rate this year.

The unemployment rate for metro Orlando rose to 9.1% from 8.7% in June.  About half of the increase was due to seasonal factors.  The government releases its estimate of the seasonally adjusted unemployment rate for metropolitan areas several weeks after the main job report.  It's likely that the seasonally-adjusted rate rose from 8.5% to 8.7%.  Orlando lost 5500 jobs in July and now reports a one percent increase over the past year, the same as Florida with both lagging the country, which posted an increase of 1.4%. 

What's the takeaway from this report?  Both the state and local economy continue to struggle to recover from the Great Recession, with job markets that continues to be quite weak.

Friday, August 3, 2012

July Employment Report

This morning's job report surprised many people on the upside.  Though it was an OK report given the recent performance of the economy and labor market, there's still evidence of some distortions due to seasonal adjustments.  When the January employment report was released, I delved into the details and noticed an upward bias due to seasonal adjustments (see commentary).  Since then, I've been looking forward to the July report to provide further evidence of the effect of new seasonal adjustments.  Basically, seasonal adjustments are designed to remove the impact of employment patterns that typically occur at certain points in the year and are determined by prior trends (i.e., employment patterns from July 2011, July 2010, etc., are used to estimate the seasonal adjustments used for July 2012.  The Great Recession distorted the seasonal adjustments resulting in the economy appearing stronger in the Winter months followed by slowdowns in the Spring and rebounds in the summer.  For July 2012, if the average seasonal adjustment for 2002-2009 was used, this morning's report would have shown an increase of 122,000 jobs, 41,000 less than officially reported.  In fact, the seasonal adjustment for July was the most generous in the past decade (I only checked the data post-2000).  While seasonal adjustments are necessary to understand what's going on in the economy, unfortunately, seasonal adjustments in recent years have actually been somewhat misleading.

Moving on, the report shows a sluggish economy that is still growing.  Negatives tended to be seen from the household survey including the increase in the unemployment rate to 8.3%; increase in the "real" unemployment rate (U6) to 15%, decline in the employment-population ratio to 58.4%, and the decline in the labor force participation rate to 63.7%.  Given the sluggish job market, average hourly earnings have increased by 1.7% in the past year, resulting in almost no increase after inflation (PCE inflation is running at about 1.5%).

The main takeaway from this report is that the economy continues its weak recovery from the Great Recession.  With economic growth of under 2%, it's hard to imagine employment growth picking up or unemployment declining any time soon.  Still, it signals a weak recovery rather than a slip back into recession.

Wednesday, August 1, 2012

Brief Look at Income and Spending in June

Yesterday, the government released its estimate of consumer spending and income for June.  The bad news is that consumer spending has been flat recently, but the good news is that incomes adjusted for inflation are rising somewhat, which should help sustain consumer spending down the road (reversal of earlier this year).  The savings rate rose to 4.4%, reflecting in part revisions to previous data (the government made revisions for the past 3 years based on more up-to-date information).  What do we learn from this?  It's more of the same.  No recession barring another shock, but consumer spending should be able to plod along during the rest of the year.  As mentioned in several previous posts, other factors will impact consumer spending including the fiscal cliff and the global economic slowdown.

In addition to income and spending, the report provides what's considered by most to be the best measures of consumer inflation.  Inflation based on the PCE index is now running at 1.5% over the last year, while core inflation (exlcuding food & energy) is 1.8%.  Inflation has slowed from a moderate pace to almost nonexistent in recent months.  In fact, in the second quarter of 2012, PCE inflation was -0.3% (annualized rate) while core inflation was more stable at a 1.8% annualized rate.  Economists tend to be criticized for discussing core inflation; many consider it a way of ignoring higher inflation.  The recent behavior of inflation is one reason that most economists think that it's a better gauge of short-term inflation trends than overall inflation as overall inflation bounces around due to significant fluctuations in food and energy prices while core inflation better reflects underlying trends.  Given that, inflation seems to be running a little low (less than the Fed's target of 2%), but there are no signs of deflation any time soon.  That will probably make the Fed hesitant to engage in QE3 at this time.