Morning Report: Will the US economy have a Wile E Coyote moment in 2019?

Vital Statistics:

Last Change
S&P futures 2765.5 -19
Eurostoxx index 385 -3.9
Oil (WTI) 65.16 0.1
10 Year Government Bond Yield 2.91%
30 Year fixed rate mortgage 4.57%

Stocks are lower this morning on trade fears. Bonds and MBS are up.

We will get a lot of housing-related data this week, but nothing should be market-moving. We will get housing starts and building permits tomorrow, existing home sales on Wednesday, and house prices on Thursday. Otherwise, should be a relatively quiet week.

The NAHB Housing Market Index (a sentiment indicator for the homebuilders) fell to 68 last month from 70. Rental markets are softening in some of the more pricy MSAs.

OMB official Kathy Kraninger is supposedly the front-runner to replace Mick Mulvaney as the permanent director of the CFPB. The confirmation process will probably take at least through the end of the year. She is not viewed as any sort of financial regulatory expert, so expect to see a lot of objections from Democrats over the nomination.

Ben Bernanke thinks the US economy will have a Wile E Coyote moment in 2019 or 2020 when the tax cut stimulus wears off. His point is that we are enacting fiscal stimulus at “exactly the wrong time” when the economy is already at full employment. Of course the statement about full employment is debatable. The unemployment numbers indicate we are, but the employment-population ratio does not. The employment-population ratio currently stands at 60.4%, and pre-crisis, we were around 63%. That 2.6% difference works out to be about 8.5 million people. We are getting some modest real wage growth (average hourly earnings are up 2.7% YOY and the core PCE index is growing at 2%) however broad-based wage growth probably isn’t going to happen until the EP ratio gets back up around 63%. Yes, there is a demographic element to this with the baby boomers retiring, but that is overplayed. Many people who are retiring in their 60s would rather work. You can see just how bad the Great Recession was. Most of the gains that started in the 60s with women entering the workforce were given back. The “retiring boomers” narrative has a kernel of truth in it, but it isn’t driving it.

employment population ratio

The FAANG stocks are now worth more than the entire UK stock market. While people talk about short Treasuries as being the most crowded trade on the Street, it doesn’t hold a candle to the FAANGs

FAANG

Goldman’s model now suggests the US economy grew at 4% in the second quarter. Friday’s Empire State Manufacturing Survey was the catalyst for the upgrade.

The government is trying to clarify the Volcker Rule, which prohibits banks from proprietary trading. So far, it seems to be clouding the issue as opposed to clarifying it. Ultimately trades held for less than 60 days are considered proprietary trades although there is a carve-out for hedging and market-making. Given the drop in commissions over the past 20 years, and sub-penny bid ask spreads, the economics of market-making are terrible to begin with, but the regulatory uncertainty probably seals the deal. The next crash is not going to be pretty.

Morning Report: Why we haven’t seen much wage growth (yet) and what the left gets wrong about labor markets

Vital Statistics:

Last Change
S&P futures 2743 9.7
Eurostoxx index 388.45 1.55
Oil (WTI) 65.49 -0.32
10 Year Government Bond Yield 2.91%
30 Year fixed rate mortgage 4.54%

Stocks are higher this morning on no real news. Bonds and MBS are flattish.

We should have a relatively quiet week coming up, with not much in the way of data and no Fed-speak.

Friday’s jobs report was pretty much a Goldilocks report as far as the markets are concerned. Strong job growth, with respectable (but controlled) wage growth is exactly what the Fed wants to see. Tomorrow, we will get the JOLTS job openings report, which should show job openings of around 6.5 million.

Academics are scratching their heads trying to figure out why wage growth is so slow with unemployment below 4%. With the economy at “full employment” at least according to the unemployment numbers, how can so many jobs still be created? And if unemployment is below 4% and we are at a record number of job openings, where is the wage growth?

First of all, the jobs report had wage growth at 2.7%, and the core PCE inflation rate is 2%. So, we do have inflation-adjusted (i.e. real) wage growth. Second, productivity is a puzzle. It has been low for a decade, and part of the issue is that productivity is notoriously hard to measure, especially when valuable goods are “free” or hard to measure. Think of social media, which has all sorts of entertainment value and productivity enhancing value, yet is supposedly free. Yes, you are paying with your data, but what is your data worth? Productivity calculations need a dollar value. Productivity has been low, but there is a huge uncertainty range around that number.

I think a huge part of the issue is the fact that the unemployment rate excludes anyone who has been unemployed over 6 months, and there is a huge reservoir of workers on the sidelines who want to return to the labor force. Companies know this, and all they have to do is relax their standards (i.e. hire people who have been out of the labor force for a while) and they will fill their positions. At the end of the day, this is a numbers game. The employment-population ratio has been steadily increasing since 1970 as women have entered the workforce. It peaked in 2000, bottomed after the Great Recession, and has been steadily working its way upward. The demographic factor (retiring baby boomers) is probably getting overplayed here, as most people no longer can retire at 65 (and there really is no reason why most can’t continue to work).

Leftist economics are arguing that employers are somehow colluding to keep wages low, and therefore are suggesting a panoply of policy levers designed to artificially force up wages and increase unionization. Aside from non-competes in the rarefied air of Silicon Valley engineers, generally this doesn’t happen – cartels are almost impossible to make work (witness OPEC) and there are simply too many employers who don’t compete with each other to coordinate it, even if they wanted to.

Instead of jumping to the “market failure” conclusion, the answer is that there is more slack in the labor market than the numbers suggest. There may be a mismatch of skills, where there is high demand in areas where there aren’t a lot of available workers (skilled trades, data scientists) but overall the employment population ratio doesn’t lie. The last time we saw decent wage growth was the 90s, where the employment-population ratio was around 63%. The latest number was 60.4%. That difference in a population of 326 million is about 8.5 million jobs. That is about 3 year’s worth of job growth, without population growth which is still measurable at 0.7% a year. Even if you take into account the 6.5 million job openings, you still have probably 2 million extra workers on the sidelines. IMO, that is your answer about wage growth, not monopsony of collusion, which is just a specious argument for more government intervention in the labor markets.

Chart: Employment-population ratio.

employment population ratio

House price appreciation continues apace, and between rising price and interest rates, the monthly house payment on the median house with 20% down has increased by $150 a month, according to Black Knight Financial Services. Income growth at 2.7% is not going to keep up with home price appreciation, which is running at around 6% a year. When rates were falling, we were able to paper over that issue with lower mortgage payments, but that game is over. Housing starts are still way too low, and that question is even more perplexing than wage growth.

Note that private equity is now building homes for rent, which should alleviate some of the supply problem. It was only a matter of time until new entrants saw the opportunity that the big builders have been sitting on. Politicians are getting sick and tired of the lack of housing supply (especially at the lower price points).

Friday’s jobs report reversed the Euro-driven drop in the June Fed Funds futures. At one point, they were predicting a 81% chance of a hike. Now it is back up to a near certainty. The December futures are predicting a 40% chance of 4 or more hikes this year and a 60% chance of 3 or less.