Relevant and even prescient commentary on news, politics and the economy.

Global PMIs and Fed Policy: they’re linked

Today a host of global purchasing managers indices (PMIs) reiterated that the global economy is slowing….quickly.

Within 24 hours, China, the US, and the euro area all reported July PMIs falling toward the feared 50 (below which the manufacturing industry is contracting) – 50.7, 50.9, and 50.4, respectively. The UK PMI fell below 50 to 49.1 in July.

I would posit (and I believe that others have, too, like Edward Hugh) that this is directly related to Fed policy, specifically that of quantitative easing (QE).


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The chart above illustrates the stated PMIs alongside the dates of a shift in the Federal Reserve’s QE policy. The shorter bars indicate those dates when the Fed ended QE and announced that it would reinvest maturing proceeds. On the other hand, the full bars illustrate the outset of QE.

Falling PMIs correlate with the end of QE. New QE correlates with a rebound in global PMIs. Given this correlation and the latest GDP release, I expect that talk of QE anew to surface.

Rebecca Wilder

Wilder on ‘Real retail sales in Europe: will German consumers save the day? Maybe, perhaps’

After the US report on Q2… Angry Bear and credit market weakness in the eurozone, Rebecca takes a look at the retail side of the economy:

Retail sales in Germany and Spain were reported last week for the month of June. On a working-day and not-seasonally adjusted basis, real retail sales fell 7.0% on the year in Spain. In contrast, working-day and seasonally adjusted real retail sales surged over the month in Germany, 6.3%, and posted a 2.6% annual gain.
But the Spanish data is better than the non-seasonal numbers would suggest. In fact, accounting for seasonal factors as in the manner done by the Federal Statistical Office of Germany, Spanish real retail sales posted a monthly gain, 1.2% in June. Don’t get too giddy on me – the Spanish data looks awful in a small panel (time series and cross section).

The rest of the post is here: Real retail sales in Europe: will German consumers save the day? Maybe, perhaps

The Q2 US GDP report – just terrible

Bureau of Economic Analysis today reported that real gross domestic product in the US increased at an annual rate of 1.3% in the second quarter of 2011. This (newly revised – see below) acceleration in real GDP was driven primarily by a slowdown in import demand, stronger federal spending, and a pickup in non-residential fixed investment. Real gross domestic purchases – GDP minus net exports – was weaker than the headline, increasing 0.7% on the quarter, reflecting the positive contribution from external demand. Domestic demand is barely growing – remember these are annualized rates, not q.q rates.


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Below the hood, the pace of personal consumption expenditures slowed markedly, +0.1% in the second quarter compared to +2.1% in the first. Some of the drag to consumption will bounce back in the third quarter, as auto sales and the supply chain disruptions dissipate – durable goods decreased 4.4% over the quarter. On the bright side, real nonresidential fixed investment picked up 6.3% in the second quarter and tripling the pace seen in the first. Real net exports contributed a large 0.58% to the headline growth number, as real exports maintained a healthy pace and imports decelerated over the quarter.

Overall, I think that the story is pretty consistent with the details of the labor market: the economy is improving, but domestic demand is very weak.The US economy is increasingly likely to enter a ‘growth recession’ – sub-potential growth – in 2011. And as David Altig highlights, a growth recession is generally associated with an economic contraction.

On the revisions

The drop in Q1 2011 growth to 0.4% was certainly not expected. Much of it was due to a reclassification of domestic inventory build (adds to GDP) to imports (subtracts from GDP). But there’s a lot more.

Today’s estimates reflect the annual revisions of the US national accounts. The revisions date back to 2003, which show a deeper recession and a quicker rebound. We now know that GDP bottomed in the second quarter of 2009, after having fallen 5.1% since the fourth quarter of 2007. Previously, the cumulative drop in GDP was 4.1%. The recovery through Q1 2011 was slightly faster, 4.9% in the pre-revised data compared to 4.64% in the revised series. (Rdan….4.9% is correct figure)


(Rdan: revised chart to correct calculation error…8/1)

Broadly speaking, though, the revisions show that economic momentum is petering out on a 6-month/6-month annualized basis. In sum, nominal spending on consumption goods and services was revised downward by 307.8 billion dollars spanning the years 2008-2010, and nominal fixed investment spending dropped by 83.9 billion dollars compared to previous estimates. Government spending is proving to be less of a drag than previously thought (in nominal terms), having been revised 5 billion dollars higher compared to previous estimates over the same period.

On balance, the expected 2011 growth trajectory will struggle to top 2%, as a rather positive 2H 2011 of 3.0% and 3.5% in Q3 and Q4, respectively, would imply a 1.9% Y/Y pace for 2011 as a while. I seriously doubt we’ll get that trajectory in H2 2011 – we’ll have to see what economists now forecast – but the downside risk to the economy is pervasive. It’s not just Japan.

Rebecca Wilder

The US economy: July’s not looking any better

Next week the Bureau of Economic Analysis will release its estimate of Q2 US GDP growth. Of 69 economists polled, the bloomberg consensus is that the US economy grew at a 1.8% annualized rate spanning the months of April to June over January to March. In all, this quarterly growth rate implies just 1.9% annualized growth during the first half of 2011. Not much of an expansion.

Economists have put their ‘hope’ into the second half of 2011. But high frequency data show that the third quarter is setting up to be a doozy as well. This is too bad because we’re talking about jobs and the welfare of American families here.

I like to follow two weekly indicators to get a feel for the labor market and the corporate trucking business. The message is clear: the economy is not improving.
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First, the bellwether of the state of the US labor market – weekly initial unemployment claims – continues to disappoint. In the week ending July 16, seasonally adjusted initial claims increased 10,000 to 408,000. The 4-week moving average was 421,250, which is just 19,000 below its May peak of 440,250. This week’s report fell on the BLS’ survey week, so the July employment report is likely to be another weak one (weak is of course a euphemism for the June report).

The chart below illustrates the annual growth rate of the non-seasonally adjusted 4-week moving average of initial unemployment claims. I use this for comparison to the second series, diesel consumption, which is not seasonally adjusted. I include the recession bars for association with the business cycle. Claims really are more of a coincident indicator – but the frequency is helpful for gauging the state of the real economy.

The weekly claims are not indicating a recession – they are contracting on an annual basis. However, the contraction in claims is slowing, -8.4% Y/Y, which is much slower than the average -13% annual drop in claims during the first quarter of 2011. Unless claims start to fall more precipitously, the labor market will continue to be stuck in neutral – not good.

Second, the US Energy Information Administration releases weekly estimates of distillate fuel oil supplied to the end user in thousands of barrels per day (real). This is important because roughly 90% of this number is comprised of diesel fuel.

Given that diesel fuel is a primary input to construction and commercial
and industrial trucking, the weekly series serves as a high-frequency
indicator of domestic demand for goods that are transported across the
country. There are seasonalities to this data , but the message is clear:
demand for diesel fuel suggests that wholesale demand is inherently weakening.

Unlike diesel prices, which can be impacted by number of factors including taxes, refining capacity, and most recently by IEA’s petroleum release, consumption measures absolute demand.

The chart below illustrates the same representation of demand for distillate fuel (primarily diesel) as the annual growth rate of the 4-week moving average. The latest data point is July 15. The annual decline was a bit less severe in the week of July 15 – but this series is quite a bit more volatile, and the downward trend in fuel consumption has been established.


As of last week, these two high frequency indicators demonstrate no marked improvement in domestic demand through July.

Rebecca Wilder

Wilder’s News on Europe

Rebecca Wilder has shifted to publishing her insightful articles on Europe back to her Newsneconomics platform, but will continue to publish on US topics and US/Europe connections on Angry Bear.

I think that the shift is smart…the audience for Angry Bear is focused more on the US and as the election cycle is already quite heated probably will remain so. The material on Europe tends to get lost.

The Financial Times, for instance, picks up her material rather quickly through the Newsneconomics name. Therefore, for now Rebecca has chosen to write for Angry Bear and to keep us abreast of the Eurozone through Newsneconomics.

Such an arrangement allows for a different audience to communicate with each other in comments, many who are economists and readers who live in the Eurozone and whose primary interest is in their own news.

But Eurozone news remains quite pertinent to Angry Bear readers, hence I will post excerpts and a link to her posts through Angry Bear.

Ireland’s Bank run by Rebecca Wilder

I knew that the Irish deposit base was shrinking – I just didn’t realize the severity of the situation. In sum, €21.4 bn in household and non-financial business deposits have been drawn down since their respective peaks.

Irish businesses in aggregate have been in a silent bank run since 2007, households since 2010. So how big is €21.4 bn? Roughly 14% of Irish GDP.

The current labor market expansion: third poorest performer 24 months after the recession’s end since 1948

It’s now two years after the end of the Great Recession, and the unemployment rate has ticked downward just 9 pps (percentage points) since its 10.1% peak. Pundits call this an expansion since GDP has fully retraced its recession losses; but the unemployment rate tells a very different story.

(click to enlarge)


The chart illustrates the unemployment rate after 24 months since each recession’s end spanning 1948 to June 2011. The business cycle dates are set by the National Bureau of Economic Research. The rates are indexed to the first month of each cyclical recovery for comparison, and the raw data are referenced in the table at the end of this post.

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Spanning the business cycles since 1948, the average decline in the unemployment rate is 20 pps from its peak to 24 months after the recession’s end. In the ’07-’09 ‘expansion’, the unemployment rate has fallen by less than half the average, -9 pps since the first month of recovery, July 2009.

In terms of relative labor market performance 24 months into the recovery/expansion, this cycle is the fourth worst – really the third worst since 24 months into the 1980 recovery is the 1981-1982 recession.

Technically, we’re not seeing a jobless recovery, since the unemployment rate peaked early on in the recovery (month 4); but it might as well be. Sticking with the household survey, employment (as opposed to the nonfarm payroll) is down by near 7 million since the economic peak and down 644 thousand since the recession’s trough. Yes, employment is net down since the recession ended. These numbers are affected by the annual population controls, but the trend (or lack thereof) is loud and clear.

The labor market is festering – we need a real policy response now.

Rebecca Wilder

Chart data (before index construction)

The US unemployment rate: European levels without the European safety net

Jobs growth is a lagging indicator of economic activity, so the June report confirms that the US economy has been in a deep rut (Marshall Auerback calls it a ‘fully-fledged New York City style pot hole’). Yes, the US economy is growing; but sub-2% really ‘feels’ like stagnation, if not recession for many. As always, Spencer provides a fantastic summary of the employment report here on AB: ‘bad news’, he says.

I call it abysmal, both relative to history and on a cross section. The chart below illustrates the unemployment rates across the G7 spanning 1995 to 2011.

Across the G7 economies, the level of the US unemployment rate is second only to France. This is true on a harmonized basis as well.
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The speed at which the US unemployment rate reached European levels was abrupt. Only the UK has seen such a swift deterioration in labor market conditions.

The chart above illustrates the same time series as in the first unemployment chart, but the rates are indexed to 2005 for comparability. France’s high level of unemployment is structural. In contrast, the US level of unemployment is NOT, not even close.

The chart above illustrates the components of the OECD’s indicators of employment protection. Also, see a short note by the Dallas Fed highlighting the differences between the French and US labor markets (and the 1994 OECD jobs study).

The French labor market is quite rigid, which leads to a structurally elevated unemployment rate and expansive unemployment compensation (see this follow up to the OECD 1994 jobs strategy report). The US Labor markets is much more fluid, which is why the unemployment rate has surged relative to comparable economies in Europe (see second chart).

European levels of unemployment without the European safety net.

The chart illustrates the maximum number of months that a worker can claim unemployment insurance for the year 2007. In normal times, French workers can collect benefits for up to 23 months by law, where the US worker collects for just 6 months. The tax and benefit policies data are updated infrequently, and listed on the OECD’s website (excel file link).

Seriously, shouldn’t Congress be focused on the depressed state of the US labor market, rather than a ‘scaled back’ version of deficit cutting? Addressing one will clearly impact the other – it goes both ways. Unfortunately, the government’s pushing in the wrong direction (cutting deficits brings further unemployment rather reducing unemployment drops the deficits).

Rebecca Wilder

US labor market: wage and salary growth vs. payroll growth

I’ll make this quick, since I’m going to get in trouble for writing on a national holiday. But the pace of annual jobs growth is too slow to generate strong wage and salary income. Much empirical research has been dedicated to the estimation of consumption functions, generally finding that labor income is the primary driver of consumption (here’s a primer at the Federal Reserve Board). However, by extension jobs growth is highly correlated with wage and salary growth, roughly 50% of personal income – this is the relationship I analyze here.

Roughly half of the BEA’s measure of personal income comes in the form of wage and salary, so called labor income and simply referred to as ‘wages’ from here on out. This is highly correlated with nonfarm payroll growth, both in nominal and real terms (92% and 79%, respectively, since 1996). The chart below illustrates the correlation between real wage growth and nonfarm payroll since 1982 (I use real wage so as to account for the effects of inflation).


The annual pace of real wage gains and jobs growth have declined over time (jobs growth is measured using the nonfarm payroll). Simply eyeballing the data, there’s a structural shift roughly around 1996, as listed in the table below.

Using these two time periods, 1982-1995 and 1996-05/2011, I estimate a simple model of real wage growth on nonfarm payroll growth. The chart for the 1996-2011 model is illustrated below; and for reference, the regression results across both time periods are copied at the end of this post.

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Note: I do not have time for a full blown econometric analysis. I did, however, perform statistical tests for serial correlation in the errors, unit roots in the transformed data (none), and general modeling tests.

I come to two general conclusions regarding the relationship between real wage growth and jobs growth over time:

(1) Real wage growth has become more persistent over time. In the first period, 1982-1995, just one lag was required to expunge the errors of autocorrelation. Spanning the second period, 1996-2011, three lags were required. The sum of the coefficients on the three lags is 0.87 in the later sample, or current wage growth is highly dependent on previous periods – sticky if you will.

(2) Nonfarm payroll growth has become less significant over time. Spanning the years 1982-1995, the coefficient on annual payroll growth was 0.27 – for each 1pps increase in the annual payroll growth, the trajectory of annual real wage growth increased by 0.27pps. The coefficient dropped to 0.17 in the sample spanning 1996-2011. This is probably a consequence of service sector jobs growing as a share of the labor market. I’d like your ideas in comments as well.

Clearly this is a very simple model but it does highlight that wages are likely stuck in the mud for some time. In May, annual real wages fell 0.6% over the year, having decelerated for 5 of the 7 months since November 2010. Real wages can pick up, but it takes time AND jobs growth faster than the 0.67% annual pace in May 2011.

Ultimately, what this analysis tells me is with wealth effects slowing markedly – the trajectory of the S&P decelerated and house prices continue to fall – it’s going to take a burst of payroll growth to get real wage and salary growth back on track enough to finance US domestic consumption. One caveat to all of this negativity is that oil prices are coming off – this will boost real wage and salary growth directly.

Rebecca Wilder
P.S. I guess this turned out somewhat less ‘quick’ than I had anticipated – not in trouble yet! Gotta go.

Results:

State and local governments should be listed as a primary risk to the US outlook

I don’t see why the aggregate state funding gap is not numero uno on the ‘risks’ to the US outlook (I usually hear oil, Europe, China, etc., in my line of work). According to the Center on Budget and Policy Priorities, the State budget gap is not expected to clear at least through 2013. From the CBPP report “States Continue to Feel Recession’s Impact“:

Three years into states’ most severe fiscal crisis since the Great Depression, their finances are showing the clearest signs of recovery to date. States in recent months have seen stronger-than-expected revenue growth.

This is encouraging news, but very large state fiscal problems remain. The recession brought about the largest collapse in state revenues on record, and states are just beginning to recover from that collapse. As of the first quarter of 2011, revenues remained roughly 9 percent below pre-recession levels.

Consequently, even though the revenue outlook is better than it was, states still are addressing very large budget shortfalls.

Better put: state revenues are rising more quickly than expected from a low base following the most precipitous drop ‘on record’. Not feeling too confident here.

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Whether or not this ‘surge’ will continue depends on the labor market, corporate profits, and retail sales – heck, aggregate demand. There’s an obvious connection between retail sales and state sales tax revenue, and retail sales are weakening. In May, the pace of the 3-month moving average of retail sales slowed to 0.27% (from a peak of 1.09% in October 2010), while that of real retail sales fell 0.11% over the month (raw data here). Lower gas prices will help; but without significant relief in the labor market (from the private sector), the pace of revenue growth is unlikely to be maintained.

It’s not just the states – the health of state and local government’s (or lack of) matters A Lot for the US economy.

On average, state and local governments jointly are the largest single contributor to aggregate compensation in the 1990’s and 2000’s (roughly), according to the Bureau of Economic Analysis.

Since 1987, State and Local governments have accounted for an average 13% of total compensation of the US economy. So the outlook for 13% of aggregate compensation essentially depends on jobs growth in these sectors.

The trend for job growth has been decidedly negative for state and local governments. State and local governments have net-fired workers every single month since November 2010.

State and local governments are doing something they’ve not or rarely done before: hinder nonfarm payroll growth. In May 2011 (the latest data point), state and local governments dragged annual total payroll growth by 2% and 20%, respectively. Local government payroll was 11% of the total in May. This is not good.

Federal government support to state and local governments is set to decline significantly next year (see figure 2 on html of CPBB report). So it’s up to the private sector to provide sufficient income growth to offset the likely decline (latest data is 2009) by the giant of aggregate compensation, state and local governments, for years to come. I’m skeptical.

Rebecca Wilder

Consumption and compensation: explicit and implicit wealth effects in finance

Readers of this blog know that I am in finance, specifically global fixed income. This blog post covers wealth effects in the financial industry, which is a relatively dominant share of total US compensation, 7.3% in 2009 and likely higher now (data are truncated at 2009). My view is that economists underestimate the wealth effects on consumption in the financial industry, given that financial wealth affects not only portfolio net worth but also the present value of labor income. Therefore, the sell-off in global risk assets may hit consumption more than expected in coming quarters, given that finance is the fifth largest industry, as measured by total compensation, on average spanning the years 1989-2009.

Why US consumption matters. The outlook for the US economy is of utmost importance to that for the world, given that the US will hold an average 22.1% of World GDP through 2016 (measured in $US), according to the IMF April 2011 World Economic Outlook. And the outlook for the US consumer is of utmost importance to that of the US economy, given that personal consumption expenditures hold a large 71% share of 2010 US GDP. Therefore, holding the US consumer share constant, US consumption is expected to be 15% of the global economy on average through 2016.

How wealth usually matters for US consumption. In economics, one of the drivers of consumption patterns ‘now’ is the wealth effect, usually defined as the shift in consumption due to changes in tangible (home values) and intangible (paper assets, like stocks and bonds) net assets.

(click to enlarge)

(Read more after the jump!)
The chart above illustrates the ‘wealth effect’ on consumption as the ratio of net worth to disposable income (blue dotted line) as it’s correlated to the consumption share (outlays really, see table 1 for the breakdown) of disposable income (green line). The consumption (outlay) share is is 100 less the saving rate.

A large part of the Fed’s quantitative easing program (QE) was targeted at stimulating the positive wealth effects on consumption via higher risk asset prices. I would argue that this has been largely successful to date. The two year moving average of the consumption share (green solid line) fell precipitously following the financial crisis, only to generally stabilize since Q1 2009; this is largely coincident with the outset of QE1.

Back to why I brought up finance. There’s another effect in play here, more specifically related to the compensation structure in the financial industry. See, along with the tangible and intangible net asset values, total wealth includes the present value of labor income, i.e., the present value of lifetime compensation.

For all industries except finance, lifetime income is generally not associated with financial markets and risk assets, except via interest payments on fixed income. However, in finance total compensation is directly impacted by asset values via the bonus structure, often a large part of total compensation. Therefore, when asset markets are challenged, this likely affects the present-value of labor income adversely.

There’s an outsized wealth effect of net asset values in the financial industry: the direct wealth channel (net asset worth) plus the indirect channel (present value of labor income) on consumption.

Why is the financial industry important? It’s pretty simple: financial compensation is a large part of total US compensation, 7.3% in 2009, which has grown an average of 6% annually since 1988 in nominal terms. (Note: you can get this data from the BEA’s industry tables).

As financial markets take a turn for the worse – the S&P grew 5.4% December 31, 2010 through March 31, 2011 and is now down 4.1% since March 31, 2011 – the adverse wealth effect is likely to be stronger in the financial industry than in any other industry. For north of 7% of total US compensation, labor income is challenged in expectation, which is likely to drag consumption.

Purely anecdotal evidence. This strong wealth effect exists in my household. Both my husband (equities) and I (fixed income) are in finance; and when markets are challenged, we tend to save more. And it’s not because our stock portfolio is showing holes – actually, we don’t have much of a stock portfolio – it’s because our household income falls in expectation via the ‘bonus’ component of financial salaries.

I haven’t seen any work done on this wealth effect channel – but it does beg the question of whether there will be further downgrades to the US economic forecast if risk assets continue to sell off.

Rebecca Wilder