If This Is Right, I Sure Don't Want To See Wrong

By: Michael Ashton | Fri, Dec 3, 2010
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Well, it isn't the first time but I was wrong. It turns out there was a big miss in the Employment report.

Payrolls rose by only 39,000 employees in November, versus +150,000 that had been expected. There were net upward revisions of 38,000 to prior months, so that the net increase in jobs was 77,000. Moreover, the Unemployment Rate wasn't steady. It didn't go up 0.1%. It went up 0.2%, to 9.8%; it was actually 9.817%, so it wasn't even that it was rounded up...the Rate legitimately rose. The labor force participation rate held at a 24-year-low of 64.5%; note that when the labor force participation rate rises, it tends to increase the Unemployment Rate at first since at first the new people in the labor force are merely looking. Believe it or not, there is a possibility that we haven't seen the cyclical high in Unemployment yet. The 2009 high was 10.1%. Whether we get there or not, however, the simple fact is that over the last year or two, despite a massively higher stock market, enormous federal expenditures, and a couple of quantitative easings, the Unemployment Rate is roughly unchanged from a year ago and 0.4% higher than eighteen months ago.

One lesson that would-be economists should learn from today's data, by the way, is that if you want to know whether the job market is doing well, simply asking the guy on the street is a pretty decent way to find out. The guy in the flashy suit and the bow tie, sitting in a fancy office on Wall Street and showing up on CNBC from time to time, may have some neat models, but the employment situation is something that the average Joe is more attuned to (unlike he is with inflation, where as I have pointed out before cognitive biases limit his ability to correctly perceive changes in the aggregate price level). The Consumer Confidence "Jobs Hard To Get" subindex is currently at 46.5, not far away from the cyclical high of 49.4 hit last October (when the cyclical peak in Unemployment was also hit). Until that indicator begins to decline in earnest, it will be hard to be too sanguine about job market opportunities.

Where I was also wrong, more poignantly, is in the market reaction to such a number. Although this was a perfectly awful number, stocks traded as if they hadn't noticed the data, and finished with a gain, only 1 point from the year's high close! Volumes were the lightest of the week (instead of being the heaviest, as is more the norm for an Employment Friday). It almost seems as if investors are trying to convince themselves that bad news is actually good news because it implies more quantitative easing (but does it?) and increases the chance of a deal on taxes (but does it?). The buck fell, which makes sense, and commodities rallied as a result. However, inflation markets fell, which is odd given the rally in commodities but at least is the right direction given weak growth data.

This latter point is worth mentioning, incidentally. The sharper-penciled economists have long been basing their forecasts for 2011, and in particular Q1 and Q2, on their assumptions of whether the Bush tax cuts would be extended (and for whom), whether extended unemployment benefits would be granted, whether the AMT fix would be implemented, and a few other matters of less cosmic importance. It seems that the assumptions generally have been that extended unemployment benefits would be extended further/again, that the AMT would be fixed as usual, and that the current tax regime would be extended for at least most taxpayers. To date, none of this has happened, and although there is much smoke about the issue I don't see any fire.

This really matters, because failing to extend those tax rates would mean a huge fiscal hit to the economy. Now, remember that I am pretty skeptical about the ability of fiscal policy to be stimulative or anti-stimulative in the long run. This is less true when we are dealing with taxation than with spending, but it is still mostly true in my view. If tax rates jump up, this means that consumers will take a huge hit to their earnings. But it will also mean that the federal deficit will improve, which means the government will have to sell fewer bonds, which means that people who would otherwise buy those bonds will have more money than they otherwise would. The short run fiscal effect happens because the extra investable money those investors have only filters back into the economy slowly (for example, when they fund a startup enterprise, or pay a smart inflation guy to consult on what to do with all that extra money when Treasury rates are near zero) while the money the consumers lose is money they would have spent a large proportion of right away.

In other words, it is the opposite of spending money on inefficient and useless "shovel ready" projects that put money in people's pockets to be spent today but costs the taxpayers decades to pay off. If we could trust the Congress not to spend this "windfall," then it wouldn't be a total long-term disaster (although lower spending is better than higher taxes as a deficit palliative, since government spending tends to be inefficient relative to the private sector).

But, in the short-term, it would be a disaster. In an article back in September, Goldman stated that "letting all of these provisions expire would subtract nearly 10 percentage points from annualized disposable income growth in Q1 2011, which could translate into a nearly 2 percentage point decline in final demand and nearly that large a drag on GDP in the first half of 2011." Frankly, if we got a 10% annualized decline in disposable income growth from the already-stressed levels we are at following the recession, I would expect a larger pass-through than 2% to final demand...but it's hard to argue with the Goldman economists.

This is now a pretty real-and-present danger. The lame duck Congress really has no reason to act and provide cover for the incoming GOP House. While one would expect the incoming Congressmen to retroactively "fix" the rates, that isn't entirely clear either since many of them were elected on a platform of fiscal conservatism and having your first vote be one that increases the deficit by $300bln is not exactly an easy call (this, of course, is why the party who is leaving power is more than happy to leave that Hobson's choice to the incoming party). But even if they did retroactively restore the Bush rates, fix the AMT, and extend unemployment benefits, is there any guarantee that the President would sign all of those bills? And even in the best of cases, the mess it would create (and the additional withholding that would be taken in the early weeks of the year) would itself be disruptive.

QE2 was, in my view, partly implemented because the Fed (whose Chairman is making yet another appearance on "60 Minutes" this weekend. The guy is as overexposed as Jessica Simpson) was aware that such a train wreck was a non-negligible possibility, and needed to "do something" as the only ones who weren't paralyzed heading into the elections. They deserve some credit for seeing the train wreck, although I'm not sure their actions were very helpful.

There is no economic data due on Monday. We will increasingly be trading, anyway, on political developments over the next few weeks: tax policy here, and machinations in the EU around the Irish bailout (e.g., will the Irish accept the terms?). Also, as we get closer to the end of the year, we will get spastic moves that have nothing to do with anything but illiquidity. I do intend to keep an eye on funding markets heading into year-end. I doubt that there will be any big problems in funding over the turn, and I am sure the Fed will be ready to smooth any rough sailing (after all, as the recent document dump shows they'll help almost anyone). But this isn't Monday's trade.

Over the next week or so my "to-do" list includes breaking out a long-term yield chart to see where we are in the Big Picture and to detail a new inflation model of mine that incorporates housing separately from ex-housing drivers. So stay tuned!

 


 

Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA
E-Piphany

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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