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?
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.
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...
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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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