Employment and Participation rates are falling.
Wage rate growth is slowing.
Slowing wage rate growth and inflation confirm that the economy is faltering.
The RBA, with one eye on the housing bubble, has indicated its reluctance to cut rates further. Increased infrastructure spending by Federal and State governments seems the only viable alternative.
With the motor industry winding down and apartment construction headed for a cliff, this is becoming increasingly urgent.
Payrolls jumped by a seasonally adjusted 235,000 jobs in February, setting the Fed on track for another rate rise next week.
GDP growth is projected to lift in line with employment, wage rates and hours worked. At this stage, the Fed is still attempting to normalize interest rates rather than slow the economy to cool inflationary pressures.
Wage rate growth remains muted, at close to 2.5 percent, so rate hikes are likely to proceed at a gradual pace.
The need to tighten monetary policy is only likely to be seriously considered when wage rate growth [light green] exceeds 3.0 percent [dark green line]. Then you are likely to witness a dip in money supply growth [blue], as in 2000 and 2006, with bearish consequences for stocks.
*The dip in 2010 was a mistake by the Fed, taking its foot off the gas pedal too soon after the 2008 crash.
From the Trading Diary:
I received a message from a US reader suggesting I should “stay out of politics”.
I would love to stay out of politics. Frankly, I find it tiresome. Unfortunately, politics and the economy are so intertwined as to make the study of one meaningless without consideration of the other. I say “unfortunately” because a lot of the damage done to the economy is caused by the political system.
As for Donald Trump, I am a conservative but do not support him. He is not another Reagan who can lead from the center and inspire his country. If anything he is a polarizing force, more ego-driven than Nixon and just as unpredictable.
I hope I am wrong. Trump has many sound policies and has made some solid appointments to his team. Don’t believe everything you read from a hostile media. They could do a lot of good. Provided they are able to manage the elephant in the lifeboat — the destabilizing side of Trump’s nature.
Now that I have offended at least half of all US readers — slightly less than half if you listen to bleating about the majority vote — let me explain why politics and economics are so intertwined.
Apart from trade wars, which I will discuss at a later date, I see the main threat to the US economy as inflation.
Before I start, let me say that these dangers are not immediate and the present boom is likely to continue for the next 12 to 18 months. But they could quickly materialize, bringing the boom to a premature end, so it is best to keep a weather eye on them.
Earlier this week I discussed why the inflation outlook is so important to stock market performance:
From Tim Wallace at The Sydney Morning Herald:
Nine years on from the start of the financial crisis, the US recovery may be overheating, Legal & General Investment Management economist James Carrick has warned.
He has predicted a series of interest rate hikes will tip the US into a 2018 recession.”Every recession in the US has been caused by a tightening of credit conditions,” he said, noting inflation is on the rise and the US Federal Reserve is discussing plans for higher interest rates.
Officials at the Fed have only raised interest rates cautiously, because inflation has not taken off, so they do not believe the Fed needs to take the heat out of the economy.
But economists fear the strong dollar and low global commodity prices have restricted inflation and disguised domestic price rises. Underneath this, they fear the economy is already overheating.
As a result, they expect inflation to pick up sharply this year, forcing more rapid interest rate hikes.
That could cause a recession next year, they say. In their models, the signals are that this could take place in mid-2018.
Harvard scholar Paul Schmelzing points out that inflation is starting to rear its head in both China and Germany, with producer prices rising. This may in part be a result of the falling value of the Yuan and Euro against the Dollar, resulting in higher domestic commodity prices.
The opposite, however, is true for the US, with a rising Dollar lowering import prices and acting as a headwind against inflation.
The consumer price index (CPI) is rising because of higher crude oil prices but core CPI (excluding food & energy) has remained fairly constant, around the 2.0 percent target, over the last five years.
So why the concern?
Well the Fed is more concerned about underlying inflation, best reflected by hourly wage rates, than the headline CPI figure.
A sharp rise in hourly earnings rates would force the Fed to respond with tighter monetary policy to take the heat out of the economy.
The chart below shows how the Fed slams on the brakes whenever average hourly earning rates grow above 3.0 percent. Each surge in hourly earnings is matched by a dip in the currency growth rate as the Fed tightens the supply of money to slow the economy and reduce inflationary pressure. And tighter monetary normally leads to recession.
Two anomalies on the above chart warrant explanation. First, is the sharp upward spike in currency growth in 1999/2000 when the Fed reacted to the LTCM crisis with monetary stimulus despite high inflationary pressures. Second, is the sharp dip in 2010 when the Fed took its foot off the gas pedal too soon after the financial crisis of 2008/2009, mistaking it for a regular recession.
Hourly earnings growth is currently at 2.5 percent, so the Fed has some wiggle room and is only likely to react with tighter monetary policy when the figure reaches 3.0 percent.
Recent rate rises are more about normalizing interest rates — not taming inflation — and are not cause for alarm.
But Paul Schmelzing warns that the combination of a tight labor market and fiscal stimulus could fuel inflation and lead to a bear market in bonds similar to the 1960s.
That is exactly where Donald Trump is headed with a major infrastructure program likely to hit the ground next year. In a tightening labor market, the Fed would be forced to tighten monetary policy, slowing the economy and leading to another bear market in stocks as well as bonds.
Politics is tricky; it cuts both ways. Every time you make a choice, it has unintended consequences.
~ Stone Gossard
Interest rates are climbing steeply as the market anticipates more inflationary policies under a Trump presidency. 10-Year Treasury yields broke through 2.0 percent and are testing resistance at 2.50. Penetration of the descending trendline would warn that the long-term primary down-trend is weakening, signaling a test of 3.0 percent. Breakout above 3.0 is still some way off but would signal the end of the almost 30-year secular down-trend in Treasury and bond yields.
The Chinese Yuan has fallen sharply in response to rising interest rates, with the Dollar headed for a test of resistance at 7.0 Yuan (USDCNY).
Gold responded to rising interest rate expectations with a test of primary support at $1200. Narrow consolidation is a bearish sign, as is reversal of 13-week Momentum below zero. Breach of primary support would signal a primary down-trend with an immediate target of $1050/ounce.
In the long-term, higher inflation and a weakening Yuan could both fuel demand for gold as a store of value. But the medium-term outlook is bearish.
The consumer price index (CPI) ticked up 1.14% (year-on-year) for April 2016, on the back of higher oil prices. Core CPI (excluding energy and food) eased slightly to 2.15%.
Inflation is muted, but a sharp rise in hourly manufacturing (production and nonsupervisory employees) earnings growth (2.98% for 12 months to April 2016) points to further increases.
Despite this, long-term interest rates remain weak, with 10-year Treasury yields testing support at 1.65 percent. Breach would signal another test of the record low at 1.50% in 2012. The dovish Fed is a contributing factor, but so could safe-haven demand from investors wary of stocks….
The US Dollar Index rallied off long-term support at 93 but this looks more a pause in the primary down-trend (signaled by decline of 13-week Momentum below zero) than a reversal.
Explanation for the Dollar rally is evident on the chart of China’s foreign reserves: a pause in the sharp decline of the last 2 years. China has embarked on another massive stimulus program in an attempt to shock their economy out of its present slump.
But this hair of the dog remedy is unlikely to solve their problems, merely postpone the inevitable reckoning. The Yuan is once again weakening against the Dollar. Decline in China’s reserves — and the US Dollar as a consequence — is likely to continue.
From Justin Smirk at Westpac:
The headline CPI surprised in Q1 falling 0.2% compared to Westpac’s forecast for +0.4%….. The annual rate is now just 1.3%yr compared to 1.7%yr in Q4.
The core measures, which are seasonally adjusted and exclude extreme moves, rose 0.2% compared to the market’s expectation of 0.5% rise…. The annual pace of the average of the core inflation measures is now 1.5% from 2.0% in Q4 (Q4 was unrevised) and is the lowest print we have yet seen from this measure.
From Jens Meyer at The Age:
Today’s weak inflation numbers are a game changer for the Reserve Bank that will trigger a rate cut, says JPMorgan head of fixed income and foreign exchange strategy Sally Auld.
The investment bank now expects the RBA to cut by 0.25 percentage points next week and to follow this up with a further 25 basis points cut in August, taking the cash rate to 1.50 per cent.
Smirk disagrees:
…..But low inflation, on its own, is not a trigger for a rate cut. Sure, it unlocks the interest rate door for the RBA should it decide it needs to walk through that door as the Bank would not have to wait for another CPI update before doing so. However, it does not mean that the RBA will cut rates! A rate cut is dependent on local economic conditions demanding a rate cut. With unemployment on a new downtrend this is not so at the moment and we suggest that the RBA is waiting to see a new weaker trend in domestic activity and employment before it would embark on such a strategy.
Source: Australian 14 CPI 2016 | Westpac
Source: Three reasons for the Reserve Bank of Australia to cut official interest rates in May
Gold fell to $1070/ounce, breaching the band of primary support between $1080 and $1100 per ounce. 13-Week Twiggs Momentum peaks below zero indicate a strong primary down-trend. The next level of support is $1000/ounce*.
* Target calculation: 1100 – ( 1200 – 1100 ) = 1000
Core CPI is close to the Fed target of 2.0 percent but inflation expectations continue to fall, with the 5-year breakeven rate (5-year Treasury minus 5-year TIPS yield) as low as 1.2 percent.
Long-term interest rates are rising, anticipating a Fed rate hike. 10-Year Treasury yields retraced to test the new support level after breaking through 2.25 percent. Respect of support is likely and will signal an advance to 2.50 percent. Recovery of 13-week Twiggs Momentum above zero suggests an up-trend. Breakout above 2.50 percent would confirm.
Low inflation and a stronger Dollar are weakening demand for gold. The Dollar Index is testing resistance at 100. Respect of zero by 13-week Twiggs Momentum indicates long-term buying pressure. Breakout above 100 is likely and would signal an advance to 107*.
* Target calculation: 100 + ( 100 – 93 ) = 107
Lucia Mutikani at Reuters writes:
U.S. retail sales barely rose in September and producer prices recorded their biggest decline in eight months, raising further doubts about whether the Federal Reserve will raise interest rates this year. The weak reports on Wednesday were the latest suggestion that the economy was losing momentum in the face of slowing global growth, a strong dollar, an inventory correction and lower oil prices that are hampering capital spending in the energy sector. Job growth braked sharply in the past two months.
Readers of the headline Weak U.S. retail sales, inflation data cloud rate hike outlook could be forgiven for believing the US economy is headed for recession. After all, retail sales growth has slowed to a crawl.
And the producer price index is declining.
But if we strip out food and energy prices, PPI remains close to the Fed’s 2% inflation target. And low energy prices will eventually feed through as a stimulus.
Hourly earnings in the manufacturing sector are starting to grow.
“The overall message is that consumer spending has remained extremely strong. If sentiment had indeed shifted, it would be hard to explain why sales of cars, certainly among the more expensive items, jumped in September to their highest level since July 2005,” said Harm Bandholz, chief economist at UniCredit Research in New York.
Light vehicle sales continue their upward trajectory.
And construction spending is decidedly bullish.
Not much here to keep Janet Yellen up at nights. When it comes to rate rises, the sooner we get the economy back on a sound footing the better, I say. Otherwise we encourage further capital misallocation and dependency on Fed stimulus. There are no free lunches from central bankers. Everything comes at a price.
US inflation. Core CPI is hovering below 2.0 percent but the 5-year inflation breakeven (5-year Treasury yield minus TIPS yield) suggests that inflation will fall. The recent slow-down in average hourly manufacturing earnings growth (production and non-supervisory employees) may just be statistical noise, but decline of either of these signals below 1.0% p.a. would be cause for concern.
Treasury yields remain weak, with the 10-year yield testing support between 1.85 and 2.0 percent.
The Dollar Index continues to range between 93 and 98. Falling inflation would favor an upward breakout. But flight to safety could drive the Dollar up (and yields downward). The biggest factor that may the Dollar down (and yields up), however, would be a Chinese sell-off of foreign reserves (largely Treasury investments) — to support the Yuan and/or stimulate their economy.
Spot gold is likely to test primary support between $1080 and $1100 per ounce. Declining 13-week Twiggs Momentum, with peaks below zero, signals a strong down-trend. Breach of primary support would offer a target of $1000/ounce*.
* Target calculation: 1200 – ( 1400 – 1200 ) = 1000
This is just plain wrong.
The Australian economy is sitting atop an enormous housing bubble caused by credit expansion from 1995 to 2007. To counter the end of the mining boom, the RBA lowered interest rates to stimulate the economy. While this may be necessary to relieve pressure on borrowers, what we don’t need is another credit expansion. That would simply make the economy more unstable and increase the risk of a crash. Banks are moving to curb lending to speculators, with lower LVRs, but not fast enough in my view. We can’t afford a credit contraction, but the RBA needs to impose sufficient discipline to keep credit growth at/below the inflation rate — so that it gradually declines in real terms as the economy grows.
