Monday Morning Notes, 10/26/20

The U.S. housing market continues to steam along on the back of demographic trends and low interest rates. Single family starts rose in September, compensating for a decline in multi-family:

The primary support for this market is Millennials aging into their home buying years; the pandemic and low rates are just pushing the marginal buyers over the edge. Existing home sales also moved sharply higher:

Remember that even existing home sales create a downstream impact on durable goods consumption and residential investment (remodeling). With inventory tight (just 2.7 months of supply), prices continue to climb, up 14.8% over last year:

Household wealth will continue to rise. Speaking of tight markets, the Wall Street Journal has a fun story on the crazy contingencies in housing contracts now occurring:

In central Oregon, real-estate agent Chris Sperry has also played peacemaker. Ms. Sperry represented a buyer and seller in a transaction where the buyer insisted she wanted the seller’s cat along with the house. The seller balked.

“It really got into a heated argument on both sides,” she says. The seller finally agreed to leave her cat, and Ms. Sperry bought her a replacement kitten.

This week we get the third quarter GDP report. Expectations are high with Wall Street expecting a 31.9% gain and the Atlanta Fed expecting 35.2%. I am not inclined to agonize over the exact number as it is all too easy to lose sight of the forest for the trees. The wild swing in the data tell us that U.S. economy shut down in the second quarter and reopened in the third. This isn’t new information. The rebound in activity will still leave the economy operating below pre-pandemic levels. Part of this can’t be helped due to the nature of the pandemic, another part is self-inflicted due to lack of preparation on issues like opening schools. Presumably the latter could still be addressed but won’t be until (hopefully) after the election. We know this story at this point.

We have already turned the page on the third quarter. What we really care about is the pattern of recovery going forward as the after-effects of the start-stop dynamics play themselves out. Can the economy sustain upward momentum? Is the recovery self-sustaining even without additional fiscal stimulus? To get at those questions we need to start thinking about the October data.

One metric that has traditionally tracked year-over-year trends in GDP growth fairly well is the New York Fed’s Weekly Economic Index (WEI):

I tend to care about the year-over-year GDP trends more than the quarterly growth rates; the latter are subject to excessive noise that can overwhelm the underlying signal. The WEI regained its momentum in October. This is important for two reasons. First, it indicates that the general upward trend in the economy continues into the fourth quarter. Second, note that the index accelerated in October despite now going on the third full month since the end of enhanced unemployment benefits in July. This suggests that the expansion remains resilient to the reduction in fiscal support.

Similarly, the IHS/Markit PMI flash report for October indicates that the fourth quarter is getting off to a solid start:

U.S. output growth regained growth momentum in October, as business activity rose at the fastest rate for 20 months and business optimism improved markedly. The upturn was largely driven by service providers, though manufacturing firms also reported a further solid increase in production.

That said, watch for another trend: Slower job growth:

Reflecting softer pressure on capacity, firms increased their workforce numbers at a slower pace in October. The rate of employment growth was faster than the series average, but dipped to a three-month low…

… manufacturers registered a slower rise in employment in October. Some firms, however, stated that difficulties finding suitable candidates weighed on their ability to hire.

I am not going to start in on the lack of suitable candidates; from such random comments I can’t tell you what is firm specific, industry specific, a broader structural issue, or just a firm looking for a “unicorn” employee. I need more information. The slower job growth though is relevant and matches this from Ernie Tedeschi:

The September job growth number was 661k overall, 877k private. The slowdown in job growth would be consistent with a baseline expectation that this recovery follows the patterns of recent cycles in which job growth settles into a pace that closer to 200k/monthly until the economy can be freed from the pandemic.

I find this particular interesting in light of the fiscal support to households this year. I am still in shock by the magnitude of the support:

My prior was that a fiscal shock of that magnitude would have had much longer legs; I would not have anticipated the dramatic accumulation of savings given the initial severity of the downturn. Seems like that prior was just wrong. This suggests to me that the support was not particularly well targeted (I would prefer state and local aid over tax rebates). That’s fine, we were faced with a unique event deserving of the kitchen sink. But the lack of effective targeting would explain why the economy seems to have weathered the July fiscal cliff.

And then there is the next big question. How well we weather the surge in Covid-19 cases?  There is no national leadership at this point. A new cluster of cases has been reported in the orbit of Vice President Mike Pence, the supposed head of the coronavirus task force. White House Chief of Staff Mark Meadows admitted the administration is no longer trying to contain the virus (my belief is the Trump administration is just hoping to leave Biden with as big a mess as possible). Cases are surging across the Midwest. Utah hospitals are close to rationing care. Europe is careening out of control. Remember when Europe was the model? Good times. Even China has a fresh outbreak.

In the U.S., the lack of national leadership suggests a national lockdown is unlikely; I anticipated rolling increases and decreases in the level of restrictions on a local level. I doubt indiscriminate lockdowns are politically feasible, especially for a population struggling with virus fatigue. My experience is that the fatigue cuts across political lines at this point.

We have a busy week ahead, even before the already mentioned GDP report on Thursday. Monday we get another reading on the housing market with new home sales for September; expectations are for 1,025k compared to 1,011k the previous month. Durable goods orders come on Tuesday; to date, core manufacturing orders have exceeded expectations and are expected to be up another 0.5% in September. Note that that the series has considerable monthly volatility; keep focused on the underlying trend. Friday we get some follow up to the GDP report with the September income and outlays report which also contains PCE inflation for the month. Also arriving is the employment cost index for the third quarter and the final Michigan consumer sentiment numbers. Blackout week for the Fed.

That’s it for this morning. Good luck and stay safe!

Consumer Spending, Brainard

Monday I promised some detail on the shift of spending from services to goods. Via Bloomberg:

In the world of investing, self-storage properties are about as bland as it gets. Then again, U.S. consumers are going to need a place to store the mountains of stuff they bought during the pandemic. Retail sales soared 1.9% in September, more than doubling analysts’ estimates of a 0.8% gain. The surge came despite the end of enhanced unemployment benefits at the end of July. Although concern is rising that the absence of a new fiscal aid package will cause retail sales to falter, such worries give too much importance to fiscal aid in supporting retail sales and not enough importance to the changing composition of household spending.

The point is to not confuse retail sales with overall spending. The services sector captured in overall spending is larger than the goods sector. Overall spending is down in line with incomes less transfer payments, but the shift from services to goods boosted retail sales. I wouldn’t be surprised by a blowout holiday season for retailers not because the economy is great but because you can’t travel.

Separately, Federal Reserve Governor Lael Brainard spoke Wednesday. The theme:

Further targeted fiscal support will be needed alongside accommodative monetary policy to turn this K-shaped recovery into a broad-based and inclusive recovery.

This is a good sentence that I think highlights a key split in the commentary. One segment, of which I am a member, tends to emphasize that the recovery is likely self-sustaining at this point. Moreover, I argue that there is substantial upside risk in 2021 given the large stock of accumulated savings and the possibility or even likelihood of a vaccine. I don’t think we suffer through another nationwide shutdown as occurred this past spring even in the event of a surge in Covid-19 cases; more targeted and rolling shutdowns will be more likely. Overall, the economy will continue to grow around the virus.

Another segment of the commentary emphasizes the need for additional fiscal stimulus. This often sounds as if the recovery will reverse in the absence of that stimulus, an increasingly difficult position to hold given that the enhanced unemployment benefits ended in July yet the economy has not nosedived. Brainard gets it right though. The real risk from a lack of fiscal stimulus is not so much that the economy can’t recover but that the recovery will more likely be neither broad-based nor inclusive and thus slower than optimal.

Brainard on the recovery:

Targeted interventions, along with adaptations in the behavior of households and businesses, have enabled economic activity to recover. All told, after an unprecedented contraction in the first half of the year, U.S. gross domestic product appears likely to have reversed more than one-half of that decline in the third quarter.

I don’t think this is entirely accurate. What enabled the economy to recovery was reopening the economy. Fiscal policy helped, but it helped because it could help, because the economy began to reopen. There is only so much fiscal policy can do if you can’t open the doors.

More Brainard:

Overall, total consumer expenditures in the United States have recovered about three-fourths of their spring decline through August.

Yes this. Don’t be fooled by retail sales into thinking that consumer spending has recovered. Brainard is correct. This though needs some clarity:

Interest-sensitive sectors such as residential real estate and autos have rebounded strongly—a welcome reminder of the power of monetary accommodation, especially when coupled with necessary fiscal support.

Interest rates on auto loans are down just a notch, just 47 bps since January. And lower rates in housing help, but fundamentally the demographics are driving the train there. I think this points to some fundamental tailwinds the economy has now that it didn’t have in 2009 and that those tailwinds are not widely appreciated.

Brainard acknowledges easy credit conditions for large firms while seeing the core of the problem in lending markets:

Small businesses tend to be concentrated in sectors that entail high direct contact, operate with relatively tight cash buffers, and rely on bank credit rather market-based finance.

The key is “high-direct contact.” With the pandemic, many of those firms simply can’t get customers and if you can’t get enough customers you can’t get a bank loan. Brainard also highlights the particular challenges for minority-owned small businesses. She then proceeds through a discussion of the unevenness of the labor market. This is I think the most important long-term problem:

The recent decline in prime-age labor force participation has been due primarily to women. September marks the third consecutive monthly decline in the prime-age female LFPR since it bounced back in May and June. The decline in September, when many schools moved to virtual instruction, was especially pronounced for women ages 35 to 44. Indeed, the fraction of prime-age respondents to the Current Population Survey in September with children ages 6 to 17 who reported being out of the labor force for caregiving reasons was about 14 percent, up nearly 2 percentage points from a year earlier.5 If not soon reversed, the decline in the participation rate for prime‑age women could have longer-term implications for household incomes and potential growth.

I think we probably need some aggressive government intervention to revive the child care market to sustain the labor force participation of women. Getting a vaccine and K-12 schools open next fall thought would help too obviously. Brainard harkens back to the good old days of really just 9 months ago:

In the years before the pandemic, I was encouraged to see prime-age individuals in all demographic groups drawn into the strong labor market, reversing the previous decline in participation and boosting the productive capacity of the economy.

And then lays out what will happen if we can’t reverse current trends:

Persistent spells out of employment risk harming not only the prospects of these individuals, but also the economy’s potential growth rate.

We are in an uncomfortable situation. The more we pump up the economy, the more we shift the structure of the economy away from the services we will want next year. Next year then we will have to restructure the economy again. We can use more targeted aid to support those services now, but the resulting spending will still pump up the wrong sector of the economy. Getting this right might not be as easy as it seems. The key is targeted support:

The recovery will be broader based, stronger, and faster if monetary policy and fiscal policy both provide continued support to the economy. While monetary policy has helped keep credit available and borrowing costs low, fiscal policy has replaced lost incomes among households experiencing layoffs and businesses and states and localities suffering temporary drops in revenue.

The first round of stimulus was fairly broad-based with the tax rebates and PPP lending. A more targeted approach would be preferable in the next round to minimize remaking the economy in a direction we would won’t demand next year.

Brainard discusses the Fed’s new policy framework and concludes rates will be near-zero for a long time, which isn’t exactly news. This though is interesting:

In conjunction with the forward guidance on the policy rate, the commitment to continue asset purchases at least at the current pace over coming months is also helping to achieve our goals by keeping borrowing costs low for households and businesses along the yield curve. As noted in the September FOMC minutes, in the months ahead, we will have the opportunity to deliberate and to clarify how the asset purchase program could best work in combination with forward guidance to support achievement of maximum employment and 2 percent average inflation.

The Fed has committed to holding rates at zero until actual inflation is sustainably at 2% but has made no such similar commitment with asset purchases. Here she suggests that such guidance will not be coming anytime soon.

Bottom Line: We can believe both that the economic recovery will continue and that the recovery would greatly benefit from targeted fiscal stimulus.

Monday Morning Notes, 10/19/20

September retail sales came in stronger than expected as the headline number pulled above pre-pandemic trend:

Core sales were down a notch but remain solidly above trend:

Food and drinking even gained although it still remains depressed:

Aggregate retail sales continued to gain in September despite now two months after the end of enhanced unemployment benefits at the end of July (otherwise known as the fiscal cliff that wasn’t; hey, I am as surprised as anyone else). I know this is going to be an unpopular opinion, but the fiscal stimulus may have been less important for retail sales than widely assumed. What we see inside the retail numbers – the shift in spending away from the services component – has happened in the economy overall. Spending on goods has remained strong largely because households were unable to spend on their typical basket of services and that extra money had to go somewhere. I will have more on that topic later this week.

The fiscal support was not unimportant, it was just important in different ways than expected. Consider this interesting story from the Wall Street Journal:

While the coronavirus was pummeling the U.S. economy, Americans’ credit scores—a metric used in nearly every consumer-lending decision—were rising. The average FICO credit score stood at 711 in July, up from 708 in April and 706 a year earlier, according to Fair Isaac Corp. , the score’s creator. Early estimates suggest the average score has held steady through mid-October at the July level, which is the highest since FICO began keeping track in 2005.

Surveys tells us the the vast majority of aid boosted household wealth via either direct savings or indirect savings (paying off debt). There is no question that this has bolstered the financial conditions of millions of Americans. Nor should there be any question that there exists a stockpile of spending power that will come into the economy when confidence improves.

Confidence is actually already improving, at least a little. The early October reading from the University of Michigan saw confidence edge up 80.4 to 81.2 as a gain in the expectations measure outweighed a loss in current conditions. Overall confidence remains well below its pre-pandemic levels but we should take comfort in the recent firming. We might haver expected by October confidence was collapsing due to the July fiscal cliff.

Disappointingly, industrial production edged down in September:

in part because auto production slowed a bit the strong post-lockdown rebound:

Still, even excluding autos manufacturing was flat on the month. I think a larger issue is that the recovery has been consumer-driven and on goods not services. Spending on consumer goods tends to be disproportionally off-shored to foreign producers. Hence we would expect the trade balance to widen, which is has (in stark contrast to the last recession):

The data highlights of this week will be housing starts and permits for September on Tuesday ad existing home sales on Thursday. Housing has been a supernova-sized bright spot in the economy; how much of the upward momentum can be sustained is an open question as builders will avoid overbuilding to maintain profit margins. Substantial retrenchment however is unlikely given the strong underlying demographic factors supporting housing demand. Also this week we get the Markit PMI numbers (Friday). There are a slew of Fed speakers this week. Most notable will be Federal Reserve Chair Jerome Powell on Monday (Cross-Border Payments and Digital Currencies), Vice Chair Richard Clarida also on Monday (U.S. Economic Outlook and Monetary Policy, which looks like a repeat from last week), and Governor Lael Brainard (Economic and Monetary Policy Outlook). From a macroeconomic perspective the Brainard speech seems the most likely to bring new information to the table. There are some presidents speaking (Williams, Mester, Harker) but the presidents speak a lot and often add little value but lots of color. That’s a little honesty to start your week.

Good luck and stay safe!

More Thoughts on Initial Unemployment Claims

Initial unemployment claims edged up last week. This is disappointing but the data is damaged by the failure of California to update its numbers. And as I have argued, the initial claims data appears to have overstated the severity of the recession. I want to explore that point a bit further.

To begin, I have a particular reason to be cautious about the initial claims data. At least in Oregon, following that data resulted in a fairly consequential forecast error. From the latest Oregon Revenue Forecast:

At the time of our previous forecast, the only data available was the tidal wave of initial claims for unemployment insurance. To date Oregon has received more than half a million initial claims. Now, these claims always overstate the level of job loss in the economy, and fail to capture any job gains occurring. However given the sudden stop nature of the pandemic and ensuing recession, our office believed the relationship between the increase in initial claims and job loss would be stronger than usual. This turned out to not be the case. In recent weeks the Oregon Employment Department found that 200-300,000 of the initial claims correspond to categories that are unlikely to result in job loss, at least as measured in the standard monthly employment reports. Such categories include those receiving Work Share, those filing incomplete, duplicate, or invalid claims including PUA claims filed in the regular program, or claims that ultimately resulted in zero or just one week of benefits claimed. The upshot is while our office forecasted job losses of around 20 percent, in reality Oregon lost 14 percent at the nadir in April, and 12 percent for the second quarter as a whole. As such, the initial severity of the recession was not nearly as bad as expected. The economy is tracking considerably above forecast today given the relative starting point for the recovery is higher

That’s Oregon. What about the U.S.? I find it surprising that I have seen no commentary regarding the fact that the U.S. recorded roughly 50 million initial claims in the four months between March and June yet that translated in a peak to trough drop of just 22 million jobs. The pace of rehiring was either remarkably rapid or it should be a red flag that something is broken.

Consider the scatterplot of claims versus job growth over the past three business cycles, 1990:1 – 2020:1:

Eyeballing the data you can see a kink in the relationship. At around 350,000 claims (average over the month), the level of claims is essentially irrelevant to job growth (measured as y-o-y change). It doesn’t make sense to fit a line through the entire data set, so instead I regressed only on periods where claims exceed 350,000, 152 observations out of 362 total. I think it passes the smell test (R-squared is 0.73):

Now let’s extend  the fit to the data since the pandemic recession began:

Using the pre-pandemic relationship, the April pace of claims of roughly 5 million a week should have translated into a year-over-year job loss of 150 million. That’s crazy and didn’t happen. The level of claims has persistently overstated the extent of the actual job losses; the degree of deviation from the past trend has lessened over time although still remained in September. The estimated job loss based on claims was 14.6 million compared to September 2019; the actual loss was 9.6 million.

I can largely eliminate the problem in September by using just data from recession months:

I get a better fit, R-squared is 0.87, but there are only 32 observations and probably isn’t an accurate projection for the last few months as the economy is no longer in recession. I know, I can hear the howls of protest already, but a recession is not all periods in which the economy is below potential but instead only periods where output is falling. Monthly indicators turned in May:

Bottom Line: I don’t know what happens going forward. Maybe when California fixes its data we learn that claims kept dropping in October. Or maybe the employment data is revised downward on a massive scale. Or maybe job growth just flattens. What I am fairly confident of is that the claims data resulted in a degree of pessimism about the economy that was clearly unwarranted. Is the pace of layoffs still elevated relative to last year? Almost certainly yes. But I am not confident layoffs are as high as the initial claims numbers suggest.

Clarida, Claims, CPI, Retail Sales

Federal Reserve Vice Chair Richard Clarida gave an interesting speech today. His take on the current situation sounds very optimistic:

…This recession was by far the deepest one in postwar history, but it also may go into the record books as the briefest recession in U.S. history. The flow of macrodata received since May has been surprisingly strong, and GDP growth in the third quarter is estimated by many forecasters to have rebounded at perhaps a 25 to 30 percent annual rate. This development is especially noteworthy when set in relief against the surge in new COVID-19 cases that were reported this summer in a number of U.S. states and the coincident flatlining in a number of high-frequency activity indicators that we follow to track the effect of the virus on economic activity.

Although spending on many services continues to lag, the rebound in the GDP data has been broad based across indicators of goods consumption, housing, and investment…

Notable points include that 1.) Clarida reasonably thinks the technical recession is over (it is), 2.) his reference to GDP forecasts sounds on the pessimistic side; Atlanta Fed is estimating 35.2%, 3.) rising Covid-19 cases are impacting the high-frequency indicators but not traditional measures, suggesting to me that we need to be careful with the former, and 4.) unsurprisingly, the weak spot is now in services, particular those impacted by the need for increased social distancing.

Possibly more importantly is the optimism in his longer-term outlook:

…the COVID-19 recession threw the economy into a very deep hole, and it will take some time, perhaps another year, for the level of GDP to fully recover to its previous 2019 peak. It will likely take even longer than that for the unemployment rate to return to a level consistent with our maximum-employment mandate. However, it is worth highlighting that the Committee’s baseline projections summarized in the most recent Summary of Economic Projections foresee a relatively rapid return to mandate-consistent levels of employment and inflation as compared with the recovery from the Global Financial Crisis (GFC).

Yes, this is not the same as the expansion that follow the GFC. This is a different expansion. What does the overall outlook mean for policy in the context of the new policy approach? Clarida provides a cryptic answer:

It will take some time to return to the levels of economic activity and employment that prevailed at the business cycle peak in February, and additional support from monetary—and likely fiscal—policy will be needed.

He clearly says “additional” support from monetary policy “will be needed.” I take this as a hint that the Fed is gearing up for something new in the coming months. Given that they have dismissed yield curve control, he might be thinking of shifting the composition of asset purchases further out the yield curve.

Also, note that Clarida says that additional support for fiscal policy is only “likely” needed, a downgrade from Federal Reserve Chair Jerome Powell’s consistent requests for more fiscal stimulus to support the economy. Why might Clarida be more cautious? First, his optimistic take on the data flow as noted above. Second, this via MarketWatch:

“We have a lot of accumulated saving and I think that will be a tail wind for the economy when we get to the other side of this,” he said.

It’s starting to sink in that not only is the economy on a sustainable upward path, much of the stimulus money was saved and is available to support demand when confidence rises.

Tomorrow we get the initial claims data. Last week I argued that the initial claims data likely overstated the weakness in the labor market. Today we received this via Bloomberg:

California’s numbers on unemployment claims are set to remain frozen at prior levels in Thursday’s national report and potentially longer, extending distortions that some economists were expecting to subside after the state ended a two-week pause on filings…

…But the state’s claims will continue to be estimated in national figures — using the numbers from the week before the pause in mid-September– until the figures normalize, which could take two to three weeks, the Labor Department said in response to questions from Bloomberg News.

Approach the claims data with caution.

From earlier this week, CPI inflation moderated further, falling to a more typical 0.2% month-over-month gain:

If it settles back into the pre-pandemic trend, the level won’t regain its previous trend:

It’s tough to see a substantial acceleration with shelter inflation still weak:

This is the kind of data that keeps the Fed committed to low rates for the foreseeable future even as the economy gains ground.

Finally, this week we get the retail sales report for September. Keep your expectations realistic. In aggregate, retail sales have already returned to trend:

Will retail sales push above trend? One risk here is the headlines scream “Retail Sales Slowing as Economy Falters.” The reality is that growth will slow if we regain the previous trend line and it has nothing to do with a faltering economy. An alternative risk is that you can tell a story of how retail sales rise to persistently above trend if the supply-side of the pandemic that still encumbers part of the economy pushes demand into the retail sales sector.

That’s it for today. Good luck and stay safe!

The Fiscal Cliff That Wasn’t?

There has been considerable drama over the fate of another stimulus package, including pleas from Federal Reserve officials that the recovery is at risk of reverting to recession absent another boost. This from Federal Reserve Chair Jerome Powell:

 In a typical recession, there is a downward spiral in which layoffs lead to still lower demand, and subsequent additional layoffs. This dynamic was disrupted by the infusion of funds to households and businesses…

…[a] risk is that a prolonged slowing in the pace of improvement over time could trigger typical recessionary dynamics, as weakness feeds on weakness.

There is a lot going on in those sentences. I think it is important to be careful with the term “spiral” as it implies a self-perpetuating process. The implication of a spiral is that it doesn’t end or, in other words, the economy can’t find a new equilibrium. Basically, an economy characterized by one stable equilibrium and once pushed off that equilibrium it spirals into oblivion (or, if pushed the other way, into a bubble). I don’t think this is an accurate characterization of the economy.

Intuitively, one job loss leads to less than one more job loss such that each subsequent round in the dynamic becomes smaller and smaller until a new equilibrium is reached. If this wasn’t the case, you would expect every negative shock to have a very large chance of yielding a very severe recession. That’s just not what we observe in the real world.

That said, policy would still minimize the extent of those subsequent job losses and thus limit the depth of the recession. In the particular turn of events faced this year, however, I would say it is still an open question as to how much that process was reversed by policy and how much was reversed by the subsequent positive shock that hit the economy.

What positive shock? Well, if shutting down the economy was a negative shock, then re-opening the economy was a positive shock which began to shift the dynamics in the reverse direction. This too will taper off over time (one job gain will not produce more than one additional job gain).  Eventually the economy will end up in a familiar kind of equilibrium in which it is growing at such a pace that produces say 200k jobs per month.

Powell posits a theory where that slowing in the pace of improvement yields a fresh recession. That implies some endogenous double-dip recession that seems unlikely absent a fresh negative shock. More likely is that the pace of recovery slows such that the time to full recovery is more protracted than desirable. Unfortunately, I suspect this is almost a certainty given that a substantial portion of the economy remains encumbered by the pandemic.

Will we see a new negative shock? The Fed has two leading candidates. The first is a surge of Covid-19 infections that lead to a fresh nationwide lockdown. I think this is very unlikely. More likely is more of what we have been seeing, rolling policy and behavioral shifts on a local level as cases rise and fall. I don’t think another mass lockdown is politically sustainable nor economically desirable.

What about the fiscal shock of not getting another stimulus package? It sure seems like fiscal policy went off a cliff more than two months ago and yet the economy has not yet followed. And while people like to refuse to believe that the stock market has any relationship with the overall economy, note that stock prices cratered as the economy went over the pandemic cliff in the spring yet have completely ignored the fiscal cliff.

This opens up the question of why has the economy so far not retrenched with the end of the enhanced unemployment benefits? The answer seems to be this from the New York Federal Reserve:

Next, we analyze how the respondents who were on unemployment insurance (UI) in June, at the time they took the survey, used these benefits. As indicated by the table above, the average share of funds saved (23 percent) out of UI checks is much lower compared to the reported saving rate out of the stimulus checks. This difference, of course, is most likely related to the fact that those who are on UI are more likely to be credit- and cash-constrained. Similarly, we observe that the average shares of funds used to pay down debt (48 percent) and spent on essential items out of UI checks (24 percent) are significantly higher than the respective shares reported from stimulus payments. The addition of spending on non-essential items and donations brings the total MPC out of UI checks to 29 percent.

Essential and non-essential spending accounted for just 29% of UI payments, the rest was saved or used to pay down debt (which increases net wealth so it is really just saving). Results for the tax rebates:

Our analysis shows that, while economic impact payments have been acting as a significant boost to the economy, households spent a relatively small share (29 percent) of these payments by June 2020 and allocated the remaining funds equally between saving (36 percent) and paying down debt (35 percent).

The conclusion is that that vast amounts of the fiscal support was not spent but instead saved I wrote about this back in August). Which would explain why spending has not collapsed with the end of the enhanced benefits. The past benefits still exist as savings to be drawn down or were not as important for spending as initially believed (see this here).

Bottom Line: What can we conclude from this analysis?

  • The Fed is probably overly pessimistic about the sustainability of the recovery. From a monetary policy perspective, I think it is appropriate to place additional emphasis on downside risks.
  • From a public policy perspective, the still likely extended period of high unemployment argues strongly for additional fiscal support, but if much of the rebates and UI payments are being saved, we should be considering more targeted support or aid that we know will be entirely spent (aid to state and local governments).
  • The observation that the economic recovery is both self-sustaining and the observation that more fiscal support would be optimal are not mutually exclusive. If you are a market participant, you can’t pretend that the recovery will falter simply because you believe more aid is appropriate.
  • The stock of savings accumulated during since March suggests substantial upside risk to the economy.
  • The possibility of a fiscal package after the election is another upside risk to the economy.
  • Even the upside risks to the economy may be insufficient to shift the Fed from its zero rate policy anytime soon given the stickiness of low inflation and its propensity to emphasize the downside risks. Asset purchases remain the open policy question (in either direction!).

The Fiscal Drama Continues

The fiscal drama continued over the weekend. Recall that last week President Donald Trump adamantly declared that spending talks were dead. Within hours though he was backtracking, soon claiming that he wanted an event bigger deal. It should be obvious as this point that Trump wants a deal, he doesn’t care how much it costs, and he isn’t getting his way. Senate Majority Leader Mitch McConnell just hasn’t been willing to expend the political capital on a deal, a reality that has been evident all summer long. Republicans appear to be positioning themselves for post-Trump world. This may have ramifications for the Fed.

The Wall Street Journal describes the current impasse:

Democrats criticized the nearly $1.9 trillion offer from Treasury Secretary Steven Mnuchin as insufficient, particularly in its funding and strategy for coronavirus testing and tracing. Senate Republicans, meanwhile, balked at the offer’s cost and its proposed expansion of the Affordable Care Act. The concerns from both sides of the Capitol lowered expectations that had risen Friday when President Trump approved the most generous GOP offer to date in the negotiations.

Trump claims that House Majority Leader Nancy Pelosi is the roadblock to a deal. The bigger roadblock though is McConnell who said that he thinks a deal is “unlikely” before the election. There is a contingent in the Senate that adamantly opposes a large package, especially one the includes expanded aid for the ACA. Via Politico:

Sen. John Barrasso (R-Wyo.) said that giving into Pelosi on anything seen as expansion of Obamacare in the next recovery bill will be seen as “an enormous betrayal by our supporters,” according to people familiar with the call.

The situation remains that McConnell has to be willing to twist arms on the far-right side of his caucus or accept a bill that has more Democratic support than Republican. I haven’t yet seen evidence that he is interested in either option. McConnell might rightfully sense that a fiscal package at this point won’t improve Trump’s chances in the election; realistically, they won’t get any checks out the door before November and people are already voting. He would rather retreat to conservative fiscal principles and, if his party holds the Senate, deny Democratic presidential candidate Joe Biden the economic boost from a big package.

If Trump had half the negotiating skills he claims to have, he would hold up the nomination of Amy Coney Barrett for the Supreme Court in return for a large stimulus package. But I don’t see that happening. What instead I see happening is lots of headlines about stimulus negotiations between Pelosi and Treasury Secretary Steve Mnuchin that amount to nothing while McConnell busies himself with filling the open spot on the Supreme Court.

Meanwhile, the Fed continues to push for more fiscal support. Last week, Federal Reserve Chair Jerome Powell again pleaded for more fiscal stimulus:

The expansion is still far from complete. At this early stage, I would argue that the risks of policy intervention are still asymmetric. Too little support would lead to a weak recovery, creating unnecessary hardship for households and businesses. Over time, household insolvencies and business bankruptcies would rise, harming the productive capacity of the economy, and holding back wage growth. By contrast, the risks of overdoing it seem, for now, to be smaller. Even if policy actions ultimately prove to be greater than needed, they will not go to waste. The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side to provide support to the economy until it is clearly out of the woods.

This weekend Minneapolis Federal Reserve President Neel Kashkari further ramped up the rhetoric. Via Bloomberg:

The U.S. economic recovery has “flattened out” and is in vital need additional support from fiscal policy, said Federal Reserve Bank of Minneapolis President Neel Kashkari.

“We’re going to continue to see a grinding, very slow recovery, with thousands of small businesses around the country going bankrupt,” Kashkari said in an interview Sunday on CBS’s Face the Nation. “That’s why it’s so vital that our elected leaders come together to take more action.”

I don’t think the recovery has “flattened out.” The pace will obviously slow relative to the third quarter but in the absence of a large shock (I think another nationwide shutdown is very unlikely) I do not expect the recovery will end spontaneously. At times it seems the Fed is working from an odd theory of the business cycle where endogenous double-dip recessions are the norm while at other times simply making the correct observation that mitigating the growing inequality caused by the recession requires additional fiscal policy. That’s though a topic for later this week. For now, I will leave it at that there is a very compelling case for additional fiscal aid to the economy but market participants should not be surprised if the economy continues to grow in the absence of that aid.

The Politico report referred to earlier contained this little gem:

Several Republicans also criticized Federal Reserve Board chairman Jay Powell, who has pushed for more stimulus.

Powell said nothing new this past week, but the politics are shifting under his feet. With Trump pushing for low interest rates and more fiscal stimulus, the Fed felt confident edging onto Congress’ turf. In a post-Trump world, Republicans are likely to revert to their typical tight fiscal, hard money stance (I am sure it is only a matter of time before Federal Reserve nominee Judy Shelton reverts to her gold standard roots). The Fed will return to being everyone’s favorite punching bag.

Bottom Line: I am skeptical that the fiscal stimulus talks dominating headlines will amount to any actual stimulus. Those talks, however, serve a purpose as they distract Democrats while McConnell pushes forward with the effort to fill the Supreme Court spot. I don’t expect the economy to go into reverse without more aid, but that more aid would certainly speed the recovery. The Fed will likely once again face hostility from conservatives in a post-Trump world.

Should We Trust The Initial Claims Data?

Another week with slow progress in the initial claims data. Via Bloomberg:

The number of Americans seeking unemployment benefits fell for a second week while remaining elevated, as the labor market makes scant progress amid risks of further weakness without additional federal stimulus.

The general reaction is like this via the Wall Street Journal:

“It’s more of the same, but it’s also still jaw-dropping that we have that many new claims even now as we’re six, seven months into this whole recession and recovery,” said Eliza Forsythe, an economics professor at the University of Illinois, Urbana-Champaign.

Yes, the claims data is jaw-dropping. But is it right? That’s an important question. A considerable amount of analysis is hanging on the initial claims data, including the prediction that these numbers prove the economy is heading for collapse now that the enhanced unemployment benefits have expired. If the claims data is just broken, those predictions are just wrong.

We should be more skeptical about the initial claims data. Notice that the economy went off the fiscal cliff more than two months ago and yet still seems to be recovering. We went off the fiscal cliff yet auto sales and housing are booming? Doesn’t that just seem wrong? And shouldn’t the data from California be more of a red flag than it has been? Via Bloomberg:

The report came with the same major caveat as last week: The figures from California, the most populous state, used numbers identical to the previous week because the state temporarily halted acceptance of new applications for two weeks to improve its systems and address a backlog of filings.

We know that the states were completely unprepared for the wave of claims that hit this spring. We don’t know however how deeply that damaged the data. The overwhelmed systems were likely more vulnerable to fraud as well.

What really struct me this week was this red flag from the JOLTS report:

How can layoffs and discharges have collapsed to pre-pandemic levels despite the persistently high level of initial claims? Let’s compare the two series. JOLTS is monthly while claims are weekly. To reconcile the two, I first took the average of claims over the month and multiplied by 4 and then compared it to the sum of weekly claims. The sum of weekly claims is noisier but the resulting two series are qualitatively identical:

For ease of exposition, I decided to use the smoother series.

Prior to the pandemic, the initial claims and layoffs/discharges were closely aligned:

Layoffs and discharges closely align with initial claims during recessions but deviate away from recessions (discharges not related to layoffs are a larger proportion of separations outside of recessions).  During the pandemic, however, claims have surged above layoffs and discharges:

For a different view, consider the pre-pandemic scatterplot:

versus the post-pandemic scatterplot:

Initial claims are just way too high relative to the level of JOLTS discharges and layoffs. Which series are you going to believe? True, the JOLTS data may have some pandemic-related challenges. Still on net, I think you have to give the benefit of the doubt to the BLS economists on this one as we have plenty of reasons to believe the claims data is corrupted.

Needless to say, the layoff and discharges series is telling a wildly different story than the claims data. It is a story that doesn’t match the conventional wisdom. For what it’s worth, I believe there is a strong institutional incentive for forecasters to not deviate from the conventional wisdom. A younger forecaster can more easily be outside the conventional wisdom relative to an older more experienced forecaster. If you are wrong, you are just young and inexperienced. If you are right, you just made your career. As forecasters age, they tend to drift toward the consensus for safety. Better to be wrong together than wrong alone. I also sense that in the current environment a forecaster might also be under social pressure to signal their political inclinations via their forecast.

One exception to this rule right now is Jan Hatzius at Goldman Sachs, whose 2020 and 2021 growth forecasts are decidedly above consensus:

Bottom Line: I think we should be much more skeptical of the initial unemployment claims data. If you switch your analysis to the the layoffs and discharges series, the world looks very different. A lot of the conventional wisdom is tied to the claims data. The claims data lets you view the current environment as a repeat of the last recovery. If the claims data is deeply corrupted, the conventional wisdom is just plain wrong. I keep saying the same thing: This isn’t the 2007-09 recession or the 2009-2020 recovery. It’s something different. 

Trump Kills Fiscal Stimulus Negotiations

In which I try to interpret today’s news; we will see how well this ages…

President Donald Trump killed negotiations over a fresh fiscal stimulus package just days after tweeting support for the effort. There has been a considerable amount of confusion over Trump’s actions. On face value, it seems like a foolish maneuver. Trump is losing ground quickly in the polls and now even has lost his lead against Biden on the economy. In killing a fiscal stimulus package, Trump is straight up taking on an unpopular position. Moreover, by leaving the Senate free to pursue the confirmation of Supreme Court nominee Amy Cohen Barrett, he is pushing another unpopular position. From a campaign perspective, it seems ludicrous.

What I think is happening is that Trump did not willingly kill the stimulus talks. Instead, he is yielding to Senate Majority Leader Mitch McConnell. McConnell has been repeatedly resisting a large package. He can’t deliver his caucus on a stimulus deal that is acceptable to Democrats. Any package acceptable to Democrats he would have to move without the support of a large portion of Senate Republicans. And some Democrats were probably unhappy with a smaller package.

Ultimately, I think McConnell just isn’t willing to get a deal done. Which I think is a point that has been lost in the discussion over the stimulus. McConnell has had plenty of opportunity to make a deal, but hasn’t. I suspect that he just isn’t falling in line with Trump. It’s Trump that has to fall in line with McConnell, and McConnell really only wants one more thing from Trump, and that’s the Supreme Court seat. It is possible that given the tight Senate races in too many “safe” states, McConnell realizes that Trump has outlived his usefulness.

It’s always risky to speculate on Trump’s motivations, but at this point he is probably counting on that Supreme Court seat to keep him in power in the event of a contest election and if McConnell said “do you want the stimulus or ACB?” Trump would choose that latter. But the way the polls are breaking a contested election seems less likely each day. Voting has already begun in some states and Trump’s repeated attempts to undermine the integrity of the elections is most likely backfiring by encouraging his opposition to focus on their voting strategy.

Why though would Senate Republicans be willing to risk losing those close races? Well, I think it is arguably the case that at this point another stimulus package won’t change the election. You probably can’t get the checks out the door fast enough. So maybe it just isn’t worth the fight anymore. More speculation, but I think they are fundamentally preparing for a post-Trump world in which they can either revert to ideological opposition to bigger government or just attempt to hamstring a Biden administration.

Interestingly, Trump’s abandonment of fiscal stimulus comes soon after the latest plea from Federal Reserve Chair Jerome Powell for additional support for what he sees as a still struggling economy. I think that Powell is pushing an overly bearish outlook which may be appropriate from a policy perspective but I suspect leads some market participants to underestimate the resiliency of the economy (evergreen observation really). That though is a topic for another time. For now, I suspect the end of fiscal support talks improves the odds of a Democratic sweep in the upcoming election. In that case, the stimulus is only delayed. There is maybe also still space in the near for some targeted aid, such as for airlines, just not a big deal.

Bottom Line: The next few months are going to be crazy. Buckle up.

Fiscal Support, Mester, Evans

A few items of note from today:

First, a contact sent me this quote from Jan Hatzius of Goldman Sachs:

Although we strongly agree with the macroeconomic case for additional fiscal support because the level of employment remains far below potential, we are not particularly concerned about an outright stall in the recovery even if this support doesn’t materialize.

I don’t have the rest of the report. As far as this part of the analysis is concerned, I agree. Most likely, net job growth will continue even if at a slower pace. That job growth will be sufficient to drive income growth, and income growth will support consumption. But what about the missing fiscal stimulus, you say? I know this will be widely hated, but the decline in spending in nominal and real terms at this point pretty much matches the decline in income excluding current transfer payments:

The fall in consumption exceeded the fall in incomes early in the cycle while, on net, transfer payments are ending up as forced saving. The virus is the key impediment to growth at this point; there are certain sectors of the economy, leisure and hospitality in particular, with limited prospects until the virus is under greater control. There isn’t really a debate on this point; there is simply a nontrivial supply-side constraint on the economy right now.

Next, via ForexLive, Cleveland Federal Reserve President Loretta Mester is reported to have voiced support for changing the composition of asset purchases to push buying out toward the longer end of the yield curve. This is interesting as it comes at the same time that the longest end of the curve is hitting a bit of a milestone:

It’s just sad what we get excited about these days, isn’t it? I am not confident conditions will change sufficiently anytime soon to create a substantial steepening of the yield curve (Cornerstone Macro had a nice note on that topic this morning) and Mester’s comment is a reminder that the Fed might choose to get in the way of any potential steepening as well.

Or will they? Buried in Chicago Federal Reserve President Charles Evans’ speech today is this line:

These challenges will be compounded by the fact that short-run r* today likely is depressed below its long-run value, but should move up to long-run r* as the economy recovers.  Describing the stance of policy against a moving and unobservable benchmark is another complicated communications challenge.

Evans at this point was discussing the litany of communications challenges surrounding the eventual (hah hah) lift off from the zero bound in the context of the Fed’s new strategy. One point he made is that even after lift-off policy will still be accommodative because r* will be rising back toward its long-run level. Which is a reminder that the Fed could just to view upward pressure on the long end of the yield curve as a signal that the economy is healing and just let it happen.

In any event, it is always good to remember that the Fed has in its back pocket an estimate of short run r*; the r* gleaned from the Summary of Economic projections is the long run version.

Evans presents this hypothetical application of the Fed’s new strategy:

Forget the many years of underrunning 2 percent since 2008, and let’s just start averaging beginning with the price level in the first quarter of 2020. Core PCE inflation in the SEP is projected to be 1-1/12 percent this year and then gradually rise to 2 percent in 2023. Suppose it hits 2-1/4 percent in 2024 and then stays there. In this scenario, cumulative average core inflation starting from the first quarter of 2020 does not reach 2 percent until mid-2026. That is a long time. If you can produce 2-1/2 percent inflation in 2024, you can get there about a year quicker. Some, though, might view 2-1/2 percent inflation as an excessive overshoot. And don’t forget, that is under a positive economic outlook such as in the SEP, which in my submission depends on strong fiscal and public health support.

That’s the kind of story bound to raise questions about why the Fed isn’t doing more now.

If you want more background on r*, listen to this Bloomberg Odd Lots podcast with IMF economist Peter Williams.

That’s it for tonight. Good luck tomorrow and stay safe.