Short
Term Interest Rates, Unemployment, the CPI and ANIMAL SPIRITS
by Victor Sperandeo with the Curmudgeon
Fed Rate Hikes vs Fed
Mandate:
As widely expected, the
Fed raised short term interest rates by 25bps at its FOMC meeting which
concluded on December 14th. Fed
Chairwoman Yellen said on Wednesday that three rates hikes were likely in
2017. Earlier this year she said that
a rate hike is a live possibility at the next Fed meeting and that the case
for a rate rise has strengthened. Yet rates werent raised for 12 full months
since December 2015.
That begs the question
of "why" has the Fed lagged in raising rates - even 25 bps
earlier this year?
Curmudgeon Notes:
1. Recall that Fed
Vice Chair Stanley Fisher said in January that four rate hikes were likely
in 2016.
2. The Fed has dual
mandates of price stability (keeping a lid on inflation/guarding against
deflation) and achieving full employment/decreasing unemployment.
·
CPI
"Core Rates" have been above the "2.0%" Fed target
inflation rate since November 2015 or for 13 months! The high being 2.36% (year
over year) and the average 2.21% over that period.
·
The
US unemployment rate is now 4.6% and has been < or = 5% over the last 13
months as per this bar chart:
3. Heres a longer-term chart of the US
Unemployment Rate which peaked in 2009 at ~10%:
->Yet despite core
inflation above its 2% target and unemployment at or below 5%, the Fed has only
raised rates twice in the last decade and only once in the last 12 months!
...
Why the Fed Hasnt
Been More Aggressive in Raising Rates:
The answer of why the
Fed has not raised rates more comes from Eric Pomboy
founder of Meridian Macro Research,
a very sophisticated analytical firm. His conclusion is based on the
80 CPI component sub-indexes, three of which are weighted to Health
Care. The bulk of the increases in the
CPI are from the ACA (Obamacare), which are effectively a redistribution of
income ("TAX INCREASES " on those earning more than $64,000 and
subsidizing lower earning people). Thereby, raising rates would have NO effect
on the lowering of price increases, or inflation, since the ACA mandates health
insurance at set prices with no real competition. Effectively, raising rates means nothing, as
we all must buy mandated health insurance plans.
In my opinion, this is
why the Fed has lagged in raising rates.
It puts them in a box (or a coffin) in that they will be behind the
interest rate/inflation curve until Health Care mandates are gone. Not only must US residents purchase health
care insurance, but they must purchase plans that the government dictates. Which
part of the ACA is more wicked? You can be the judge.
More Fed Rate Hikes
Not Likely Anytime Soon:
The US economy will not
noticeably change by the Fed's tiny 25 bps increase in rates on December 14th.
Meanwhile, you don't
hear the FOMC members talking about raising rates again soon. The strong US dollar is at 14 year highs and
is literally killing emerging markets. The strong dollar will also decrease US
company exports which will result in lower GDP and lower corporate earnings for
most companies. Raising rates increases
the differential between US and foreign interest rates, which then attracts
foreign money to US fixed income securities and thereby strengthens the US
dollar. At this time the Fed doesnt
want a stronger dollar!
Financial Repression
Hurts Savers and Retired Folks:
What should also be
understood is the extent of the Fed's nihilistic attack on savers (and all the
people living off interest income) by keeping short term interest rates so low
for so long. By my calculations, based on the historic ratio of CPI TO T-Bills,
the 30 day T-bill rate should currently be 1.95% vs the actual 0.5% [Source: WSJ]
. If T-bill rates were higher, so would
high yield savings accounts (which currently yield <1 bps) and Certificate
of Deposits (which yield about 1% in a one year CD). Current savings and CD rates are hardly enough
to live on for retired folks, let alone pay even a small bill.
->That huge cost of
financial repression is entirely due to the Feds zero to low Fed Funds rate
policy.
Analysis of
Unemployment Rate:
The November 2016 BLS Employment Situation Report (published December 2,
2016) showed the unemployment rate declined to 4.6% from 4.9% the previous
month. That was mostly due to a
declining worker participation rate of 62.7% (the low was 62.4% in September
2015). You have to go back 40 years for
a lower labor participation rate. The number of workers counted as not in the
labor force surged by 446,000 to 95.06 million. Also, of 178,000 new non-farm jobs created,
118,000 were part time. From the report
(bold font added for emphasis):
The civilian labor
force participation rate, at 62.7 percent, changed little in November, and the
employment-population ratio held at 59.7 percent. These measures have shown
little movement in recent months.
The number of persons
employed part time for economic reasons (sometimes referred to as involuntary
part-time workers), at 5.7 million, changed little in November but was down by
416,000 over the year. These individuals, who would have preferred full-time
employment, were working part time because their hours had been cut back
or because they were unable to find a full-time job.
There are also seasonal
adjustments and the Birth Death Model which make the employment
situation look better than it really is.
Weve discussed these in many past Curmudgeon posts, notably this one under the
subhead Phantom Jobs Created by "New Companies" Which Don't Really
Exist.
For perspective, the US
population is currently between 243 and 251 million vs. 156 million in the
labor force, and 95 million not in the work force. Again, from the BLS report:
In November, 1.9
million persons were marginally attached to the labor force, up by 215,000 from
a year earlier. (The data are not seasonally adjusted.) These individuals were
not in the labor force, wanted and were available for work, and had looked for
a job sometime in the prior 12 months. They were not counted as unemployed
because they had not searched for work in the 4 weeks preceding the
survey.
Victors Conclusions:
1. In my opinion, the Fed is now a minor-league
player compared to the potential of the end of the EU, as shown by Brexit and
the Italian vote against constitutional reform strengthening the position of
European political parties that want their country to leave the EU (e.g. National
Front in France).
The consequence of the
failed Italian referendum is that many Italian banks are about to go bust,
unless someone steps up with the cash to save them. The ECB may be a back-stop in the short run. Lets watch this attentively as it should be a
key focus for traders and investors.
2. The markets are
likely to continue their current direction and trajectory: US stocks up, bonds
down, dollar up, gold down. However, in
the near to intermediate term, a correction in equities seems like a
very high likelihood. I will be revising
my forecasts at year end so stay tuned.
Curmudgeon Note -
BoAML Report Excerpts:
In a December 15th
research note titled: Flow Show-Melt Up and Rally On, BoAML stated:
1. Forced buying: Meantime we see
"forced buying" as "secular stagnation" portfolios unwind
and business incentive for active managers to chase can push risk assets
sharply higher until a.] gold rally signals dollar has rallied too far, b.]
High Yield spread widening signals bond yields up too far, c.] bank stocks are
sold on stronger macro data (buyer fatigue).
2. The rally ends (correction likely
Feb-April 2017) with a bullish Positioning (BB index = 8, cash around 4%,
Overweight's in stocks, Japan & banks >2 Standard Deviations), bullish
Profits (global PMI's >55, US wage growth >3%), Policy hawkishness
(Fed/macro jacks up short end of yield curve).
...
3. The mainstream
financial media is attributing the Trump stock and dollar rally to "Animal
Spirits." John Maynard Keynes
first used the term in his 1936 book "The General Theory of Employment,
Interest and Money" to describe the instincts, proclivities and
emotions that ostensibly influence and guide human behavior and which can be
measured in terms of consumer confidence. It has since been argued that trust
is also included in or produced by "animal spirits."
Keynes said something profound, which
is certainly the case today:
"The markets are
moved by animal spirits, and not by reason."
Good luck and till next time...
The
Curmudgeon
ajwdct@sbumail.com
Follow the
Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has been
involved in financial markets since 1968 (yes, he cut his teeth on the
1968-1974 bear market), became an SEC Registered Investment Advisor in 1995,
and received the Chartered Financial Analyst designation from AIMR (now CFA
Institute) in 1996. He managed hedged equity and alternative
(non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a
historian, economist and financial innovator who has re-invented himself and
the companies he's owned (since 1971) to profit in the ever changing and arcane
world of markets, economies and government policies. Victor started his Wall Street career in 1966
and began trading for a living in 1968. As President and CEO of Alpha Financial
Technologies LLC, Sperandeo oversees the firm's research and development
platform, which is used to create innovative solutions for different futures
markets, risk parameters and other factors.
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