Corporate stuff

I thought I would take a break from making fun of MMT, Trump and the human nature bulls to do some economics, which is probably too strong a term.

But here are a couple pictures based on the profits data included in last week’s revisions to the Q1 GDP figures.  In my view, bean counting the GDP add-up is mainly a waste of time, but there is some interesting stuff in the National Accounts.  How could there not be?

Here is the first thing to catch my eye, in part because I am inclined to look for it.   Early this cycle, real output from the domestic operations of nonfinancial corporations was booming, far outpacing the tepid recovery in overall GDP.  The GDP figures distracted a lot of equity types from the fact that the fundamental cyclical driver of profits was performing very strongly and was grounds for optimism.

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Margins went up too, which the bears were oddly inclined to dismiss as not really counting (WTF?), but margins are cyclical and responded to the output boom in the part of the economy that was not being held back by the aftermath of the housing bubble collapse.  I am still not sure if this simple historical point has been internalized, even by the bulls.

The thing is, though, that story is now very stale, as measured corporate sector output is now lagging the overall GDP.  I am not confident the lag will continue. But it does seem that the period of corporate outperformance is long past. Basically, we have already had the bounce in goods demand, driven by the renormalization (or partial renormalization) of all forms of investment, including in consumer durables.

Second and predictably related, profit margins have been coming down.  I am not a fan of margin mean reversion. To me it is more useful to look out the window at the cyclical drivers of margins and ask if they point up or down. Recently, they have pointed down, because we are past mid cycle, so I have looked for narrower margins.  But I would not have guessed – did not guess – that the compression would be this quick.

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Measurement is always an issue here. In particular, I would not be shocked if Brad Settler Setser – an expert in this area – were to point out that there is some goofy invoicing going on US corporate transfer pricing, which is holding down both measured exports and domestic profits.  One way to get around this would be to look at overall profits and not just domestic. But I am not sure what the denominator should be there.

Maybe I should do some simulations incorporating Setser’s estimates into the profit story. Sorry, too lazy. I don’t get paid for this. I doubt it would overturn the basic story. Maybe it would make these data look closer to what I would have guessed.  If you are getting paid to do actual work, get on it.

Separately, this has nothing to do with the cycle or market, but the fact that margins are back to the neighborhood of “average” gives me even greater skepticism that looking at the labor income share (which is supposedly depressed) tells us anything about anything, including income distribution.

The abstraction of “factors of production” may be a bit dated for the modern economy. If I wanted to be a dick, I would even say it is Marxist, but I am just your humble and objective analyst.

I may have more on this later. I am pretty sure the rich guys are rich because of aspects of their sitch that are not well described by “factors of production.”

Citi humblebrag about their silly surprise indicator

This post is not that relevant. It is largely a reflection of a bad habit of leaning into unimportant things pretending to be important. So you have been warned. Maybe equities will go down for another reason. No view.

Before I get around to making fun of Citi’s humblebrag about their economic surprise index, I just want to point out that the recent collapse of the Citi index has not been confirmed by a similar index produced by Goldman.  Indeed, the Goldman US “MAP” is in the top quartile of its range, although there is something going on in China and India, apparently.

I prefer the Goldman index to the Citi because it includes only real activity indicators and is not affected by inflation data, negative surprises around which are probably not even bearish equities, because they slow the Fed.

Separately, and secondarily, the GS index does not assign 90 different weights to each release and is available both as a 3-month rolling window and as the underlying daily results.  This latter advantage allows us to tell if recent moves in the 3-month aggregation reflect recent developments or just base effects. However, it is not relevant to the contrast I draw between the Citi and GS surpise indices, both of which are conventionally presented as a 3-month window.

I don’t want to show the GS series because it is provided to me by Goldman as a courtesy, presumably because I used to “work” “on” Wall Street in the distant past and because I happen to be a fan of their chief economist. Goldman may be the vampire squid, but their macro econ team is best of class.  It is high quality squid. Anyhow, if you are curious about this call your friendly Goldman sales rep – or just take my word for it.

Ok, now to making fun of Citi for their humblebrag.  I see in an FT Alphavile article, kindly brought to my attention by Joe Little (thanks, Joe) that Citi is leaning into the idea that weakness in their indicator is bearish.

The Citi Economic Surprise Index is a perfect example of unique proprietary design which has almost no bearing on those who discuss it. The models were built by quantitative analysts in Citi’s FX unit and were structured for currency trading. Thus, if the CESI wiggles one way or another, investors get signals to buy the yen or the euro or the loonie, etc. It was not meant to be used for stock prices or for Treasuries, but coincident rather than causal relationships are relied on even if they have no consistency whatsoever. For example, Figures 1 and 2 show the relationship between the S&P 500 and the 10-year yield versus the CESI over the past five years. If one looks at just nine months, the gap looks worrisome for stocks (see Figure 3) but not necessarily for 10-year Treasuries (shown in Figure 4). Unfortunately, we find that the narrative becomes the dominant feature, not the historical trading evidence.

That is great, if extremely belated, but the problem is that they leave a clear impression that the Citi index is designed to provide input into timing in currencies.  I have never seen evidence that that works, although this may be just a reflection of my own ignorance – and currently being out of it.

But I can tell you this.  The weights that Citi assigns to the data surprises are a function of fitting the magnitude of the surprise to roughly instantaneous reactions of dollar currency pairs.  The index, then, is inherently backward looking. If the fit were perfect, it would just look like roughly 3-month changes of the trade-weighted dollar index, which would be helpful – even in currencies – how?

For me, there is no compelling evidence that the Citi index is “wrong”, athough I prefer the GS series, which seems cleaner – as a measure of the backward looking question of how the activity data have been surprising.  But the way these series are abused and mischaracterized is a sight to behold.

As I mentioned in an earlier post, with pseudo-academic flare flair, * they appeal to our System I, not system II. That is a flaw, not a feature. If they are going to be pseudo-quant, I sure as hell give myself the freedom to be pseudo-academic in describing them.

* If you put pseudo-academic in front of a noun, prolly best to the spell the noun right.

Two paper rule and MMT

Update on May 25:  “Intellectual horror show”

Brian Romanchuk has taken me up on my request for confirmation that MMT actually holds the position I had assumed it does on an important and currently-relevant policy issue.  The position is that policy makers (and those seeking to influence them) should utterly ignore the path of the debt/GDP ratio when setting spending and taxation.

Here is Brian in his own words. For context, I had asked him — or really any other MMT advocate — if they could confirm they agreed with an assertion I was inclined to ascribe to them. Brian was very precise in his reply, scratching out bits he disagreed with and adding detail/correction as required.

Screen Shot 2017-05-25 at 10.29.57 AMI am pretty sure Brian’s response includes reckless policy advice, for which a public intellectual should be held responsible.  (I too am responsible for what I say, but just do not rise to the level of public intellectual.)

How you get to that advice, how many agreeable academics you can cite in getting to it, the width of the mud moat you put around it, and how you might mischaracterize the views of those who disagree are — practically speaking — almost irrelevant. What matters is the advice, particularly if taken.

Brian had earlier told me that he was not convinced that the MMT perspective offered any additional “policy space”, but that it was nevertheless analytically insightful.  That take seemed more benign.  The passage above implies that the policy space is itself The Vasty Deep.

MMT comprises many ideas *, and I have tried to be clear that I do not disagree with all of them.  Partly this is because they occasionally seem sensible if not unique to MMT (e.g. loans create deposits) or not worth arguing about (e.g. whether this or that idea can be traced to Keynes). Besides, my knowledge is very limited and this ain’t about me.

Moreover, MMT has been on the side of the angels recently, arguing during the teens that austerity was mistimed and misguided, particularly among “sovereigns” issuing their own currencies. To my mind, that was very constructive. And they get extra points for being so cocky! If you are right, cocky is a feature.

But to argue that spending and taxation decisions should be set utterly without regard to the path of the debt/GDP ratio seems reckless. And I would like to shine a light on that — most practically relevant — aspect of what MMT is currently pushing.  They have been very loud on the point and the first step to correcting them is to get clear they own it. (In fairness to them, maybe they have always been clear. I did not want to assume.)

As for Noah’s original point about not needing to read anything you think is probably stupid, I see that among the scholars and voracious readers from MMT residing over at Brian’s blog five** clicked on what I had actually written.  I am not even sure if those were among the guys who so loudly complained about my piece.  Please keep us up on the importance respecting others’ views, guys. You are a light unto the world.

On the other hand, maybe MMT is just more discerning than I realized.  It would be hypocritical to claim they need to read what they are already certain and agreed is stupid. Caring about the path of the public debt is stupid, apparently.

* Thanks to one of the less-hyperventilating commenters to Brian’s site for mentioning this paper by three prominent MMT advocates.  It seemed like a fine paper, but just didn’t happen to address the main policy issue, as I see it, at least directly.  My one quibble is that the authors complain, inevitably, about being misunderstood.  That goes to why I prefer the stark question over the vast literature or “sacred texts”, as I have called them. A direct answer can avoid misunderstanding.

Original post:

From Krugthulu, screenshot:

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That passage really reminds me of MMT, as did Noah’s original post.  I am not interested in the vast literature there and Noah has crystalized for me why I don’t need to be.  *

I read Warren Mosler’s Innocent Frauds, and pointed out some nonsense there, to which I got, that is not part of the formal vast literature, it is just his popular work.  But public intellectuals are responsible for what they try to convince the public of. And why would the content of the popular work vary from the formal? Opinions vary, but it is a red flag if they do so within one person.

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But this debate can be simplified by getting straight to the central point, at least as I see it. MMT advocate do you agree with the following statement, which is an attempt to summarize what I think I have heard your peeps saying?

The public sector budget constraint is either non-existent or a trivial accounting identity with no practical implication.  Accordingly, tax and spending policy should be set without  any regard to the deficit and long-run trajectory of the debt/GDP ratio.  Fiscal policy may occasionally need to be tightened, but the signal for that would be only an acceleration of inflation to an undesirable pace. Worrying about the trajectory of the debt itself is merely a reflection of a misunderstanding of how the payments system works, and is pointless.

Full disclosure: the question is meant to be a trap. But it is simple and pretty close to a yes / no.  Maybe I could complicate it a bit by asking, if not, then how not? And precisely, without deflection.  If not two papers, then one answer.

* Noah did not address MMT in his post, but reading it the school popped into my head and stuck.  Amusingly, the very first note in his comments went to MMT and drew Noah out on it. Agree. 

Business credit looks a bit less weak, with no implication

A month or two ago, some macro types were in a bit of a lather about weak business credit growth. They warned it meant the wheels might be coming off the economy.

I found the business credit slowdown striking, but not for the conventional / bearish reason. As Jason Benderly of Applied Global Macro Research has explained convincingly, at this stage of the cycle, with credit-financed spending (basically on all forms of durables) well off the lows, credit should again tend to outpace nominal GDP growth.  And yet recently it has not been doing so, at least by much.

The explanation of that, besides inevitable minor slippage in any macro perspective, would seem to be largely transitory weakness in inventories, the required stock adjustment in the energy patch, and perhaps some other noisy weakness in capex.  It is not something I would be inclined to extrapolate, because I buy what I assume is still Benderly’s view.[1]  But more to the point, there was no reason to believe that the credit side should lead.

In my view, the best way to monitor the link from spending to credit involves use of Flow of Funds data or what they now call the quarterly Financial Accounts.  Those data are comprehensive and do a good job of isolating who has the liabilities, rather than the assets, whose growth rate can be distorted by definitional changes and securitizations.  Benderly makes expert use of them. But they are reported with a long lag, so can’t help much with interpreting the little wiggles, such as we have seen recently.

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So take a look at this second- or third-best approach.   Regrettably, no correlations or real analysis, but just a picture, at a distance and up close. I show a rough proxy for short-term business credit, defined as C&I loans plus domestic nonfinancial CP outstanding. The data are monthly to April and then (conservative) “estimates” for May, comprising the first week for C&I loans and the second week for CP.

I make nothing of the recent hook higher, which is tentative, lagging and what we should have expected based on a thesis that really tells us little about the outlook for the economy per se.  In fact, the underlying tendency for credit not to stay weak is probably marginally negative the economy because it reflects that demand growth is now more dependent on credit growth. Minor point, but just not currently a positive.

[1] I have not actually seen an update of the AGMR work on this, but durables demand has not collapsed, so I assume the automatic releveraging thesis is still intact.

Low unemployment and “the curve”

A continued steep decline of the headline unemployment rate and corroborating evidence from alternative measures of labor market slack have convinced some analysts that the cautious Fed may be falling “behind the curve.”  You can see here and here for two very similar examples from Bloomberg. (In fairness to Tim Duy, he wrote his take first.)  But I am sure you are familiar with the idea.

There is a reasonable debate, I think, about what is meant by “full employment” and how that links to the inflation outlook and what the Fed should do. For whatever it is worth, I don’t hate the idea of full employment, and think it may be a relevant concept even if the Phillips Curve is flat or non-existent. That is a separate discussion.

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But for the sake of argument, let’s take it as a given that the Fed will want to ration demand growth down to (supply-side) potential once the economy has hit full employment.  For good or ill, the Fed leadership leaves every impression that they intend to do that.  Either way, at some point, the unemployment is going to (have to) stop falling. That is definitionally true, although we can quibble about where some point is.

To me, that simple point comprises the germ of truth in the idea that the lower unemployment will force the Fed speed up its tightening. But it is only a germ.  The idea that the appropriate level of the funds rate – and thus the speed of tightening – correlates reliably with the unemployment rate is not supported by the evidence or even logic.

Who knows? Maybe demand growth will cool on its own, as pent-up demands get exhausted or wealth effects eventually dissipate. I would not bet on this result in fixed income, because the forward curve is pretty flat  and does not spot you much.   But, again, that is a separate discussion.

The idea that the appropriate (real) funds rate correlates reliably negatively with the unemployment rate is a vestige of the Taylor Rule.  I explained here my take on why the Taylor Rule and similar reductionist approaches to monetary policy cannot work in the neighborhood of the zero bound.   In my view, the gist is:

Crucially, the Taylor Rule does not identify the level of the funds rate appropriate to the current position of the business cycle. It would be a bizarre coincidence, as Dudley emphasizes, if the funds rate exactly appropriate to today could be described as a linear combination of the unemployment rate (or output gap) and the inflation rate.  

… No, the key feature of the Taylor Rule is that it incorporates stabilizing feedback signals that allow it to perform well in most economic environments (at least as simulated by econometric studies) despite its failure to identify the appropriate level of the fund rate in real time (which would be impossible).

For example, if the Taylor Rule were to prescribe a funds rate of 4%, and if that turned out to be too restrictive, then the following sequence of largely-benign events would arise.   The economy would slow in an undesired way and either the unemployment rate would rise or the inflation rate would fall. This would be recognized by the Taylor Rule as a signal that easier policy was required.

… However, none of that (is operational) in the current environment, which is why following the Taylor Rule or allied approaches is ruled out.  Right now, the Fed needs to make a judgment call on how its rates policy path will affect the economic outlook and cannot rely on the central feature of the Taylor Rule, which is that mistakes are easily corrected. This is admittedly a sticky situation to be in. I do not envy them.

Unsurprisingly, then, the Fed has not been following a zero bound for the past decade, and not just because it has been technically difficult to deliver a negative funds rate.  The timing and pace of “liftoff” should also vary from Taylor Rule prescriptions when the zero bound is proximate, for reasons Ben Bernanke alludes to in his most recent blog post, although a bit elliptically.

Screen Shot 2017-05-11 at 4.41.16 PMTake a look at the chart above.  The top panel is from an earlier Bernanke post in which he argues that the Fed at least implicitly followed a “balanced” Taylor Rule during the 2000s. Bernanke’s point is not that the Taylor Rule is a godsend but that – demonstrably – following a version of it would not have prevented the bubble.  In that chart, Bernanke uses data that was available to the Fed in real time, as is appropriate to his purpose.

The lower panel of the chart just updates the same Taylor Rule to today, although using data available only now, and at a monthly rather than quarterly frequency. I use Bernanke’s strange green and try roughly to overlay the date ranges, which is why the chart at bottom is wider. That construction allows you to see the effects of the revisions, although that is incidental, as my use of current-vintage data is mostly about data constraints (on me) and laziness.

Anyhow, the Fed has not been following even a dovish parameterization of the Taylor Rule, even as the zero bound has not been strictly binding.   The issue with the zero bound is that it is proximate, not currently binding, as I explained in my original post.

Janet Yellen has argued, incredibly to me, that the Fed is following the logic of policy rules but is aware that the coefficient on the output gap may vary, along with the equilibrium real interest rate or even extent of “inertia” in the actual policy rate. I think I know why she chose to do this. She wants to ward off the threat Congress might impose  that the Fed make at least some reference to the Taylor Rule in setting policy.

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Her point to Congress is that the Fed of already are following Taylor or the like. But that is marketing BS. If you can tweak the variables and even add new terms, then you are following discretion and not Taylor.  Which is good, in the current circumstance. But that goodness is separate from the deception involved here.

When the zero bound is proximate, the Fed simply cannot follow the logic of the Taylor Rule. And I would say that as an extension of that there is no reliable negative correlation between the unemployment rate and the (real) fed funds rate that the Fed will or should deliver.  I mention this not to be dovish.  The forward curve spots you so little.  Rather, this is just leaning into a quite conventional take that seems wrong.

Effective full employment has probably drawn a bit closer

Friday’s jobs report showed a continued decline of the “employment gap”, as measured by my simulation of Blanchflower and Levin.  The official unemployment rate is now actually below the CBO’s estimate of the natural rate, while the spread between the participation rate and its presumed natural level continues to edge lower.  The number of people working part time for economic reasons has also been declining and is now near what B&L have somewhat-arbitrarily defined as normal.

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If the gap continues to close at the pace of the past four months, it will be eliminated by early summer. That is obviously false precision as these things are measured very loosely and the whole idea of an employment gap is itself controversial.

San Francisco  Fed President John Williams may be jumping the gun when he says flatly that the economy is already “operating above potential.” But on this metric at least, things have moved a bit more quickly than my simulations from a couple months ago implied.

The labor market tightening implied by B&L is not yet corroborated by a meaningful quickening of wage growth, which seems – understandably – to be providing some comfort in the bond market.  If wages were to begin to accelerate, then people would be much more concerned that the labor market was overheating. So I guess on Bayesian grounds, the absence of that development lowers the odds that we have already pushed to or through effective full employment.

On the other hand, the lead from achieving full employment to a quickening of wages could be quite brief.  This is not something on which I have a strong view.  The state of the art here is not that highly developed, so far as I can tell.

A couple months ago I mentioned that I would write a post going over the implications of the apparent decline of labor market slack.  I have failed so far to follow up, because other things have interested me more and because I am a bit of a multi-handed economist on this issue.  But here are a few interpretations offered as assertion and in point form:

Measuring the natural levels of unemployment and participation is not hard science or even best practice for social science. To the extent we use this concept to think about the inflation outlook, there is data mining involved, because estimates of the employment gap are themselves a function of historical inflation. It is good to be skeptical about this stuff, IMV.

One does what one can. Leaving aside the link between inflation and slack, the economy’s medium-term growth potential is more limited when labor resources are more scarce.  So any acceleration of demand growth from here would probably be self-limiting, in part (only) by provoking the Fed.

Somewhat related, the 2- to 3-year recession risk has risen, as the Fed’s priorities have shifted, and is probably now slightly above average. However, the approach of full employment has not historically been a pressing threat to the expansion, so far as I have studied (which is not fully).  And the economy does not now currently seem to suffer from major inflationary or real-side imbalances.  So, fwiw, I don’t see much reason to be alarmed by recent developments.

This would be an odd time to endorse fiscal stimulus on macro grounds, because there is no obvious deficiency of demand, as evidenced by the fact that the Fed is tightening. Were demand growth to be forced above its current trajectory, we would just get more tightening, rightly or wrongly. I would say rightly, but practically speaking it does not matter, unless you want to change the Fed’s mandate or leadership.

The tightening labor market slightly raises the urgency to tame demand growth to the economy’s apparently-reduced supply side potential growth rate, as mentioned. However, it does not follow from this that the Fed should follow the logic of the Taylor Rule or other reduced-form policy rules. That is a separate discussion.

I am sure MMT followers reading this post will be appalled and insist that this take is based on a flawed model.  Fine. We all have our models, whether they be mathematically formalized or more qualitative, as in my case.  I am not a fan of the MMT world view, as I have probably been clear enough about.  This post is not aimed at MMT. They are no more persuadable than I am on these issues.

In any case, there seems little need to pound the table here. As I read it, the current situation does not present an outlier.  We are arguably near full employment and the Fed is reacting appropriately cautiously to that.

Bernanke supports heretical take on inflation overshoot

My heretical take is explained here.

Bernanke’s discussion of the issue is a bit evasive — not to mention a couple weeks old.  But he recommends that the Fed be patient in tightening after zero-lower-bound episodes and explicitly relates this to the idea of price-level targeting.

It does not take a wild imagination to conclude this means he supports allowing inflation to overshoot the 2% long-term target in the late cycle to compensate for prospective (or even past, if you want to be more radical) periods of inflation undershoot.

Of course, Bernanke is not now in charge of policy, so how is this relevant?  I would note that he is now more free to express his view on than he was when he was Fed chair. And I would infer from that that the idea is probably less radical than it sounds and may have support within the current FOMC.

If the Fed wants to hit 2% on average over time, it would seem as though it would have to.  And actual Fed speech has been not-inconsistent with this take, although also not dispositive.

If my now-fairly-old take is right, then the Fed now finds itself in an awkward sitch. The Fed does not want the unemployment rate radically to undershoot the natural rate, whatever it might be.  And yet, inflation remains stuck below 2% at a time when the Fed would probably prefer it be slightly above 2%.

Life would be easier for the Fed if inflation were to start to rise again.  It would eliminate the need for Sophie’s Choice.  But if I am right that the Fed would all-else-equal prefer to see inflation above 2% in the late cycle, then that is a dovish influence and it does reduce the risk of recession in the next year or so.


GDP data suggest it is less a no brainer, but not yet alarming

Updated at bottom for the inflation side

Wall Street’s obsession with “current” quarter GDP estimate is probably mainly a waste of time.  Between late February and yesterday, for example, the Atlanta Fed’s GDPNow estimate fell about 200 bps, but the bond and stock markets basically went sideways.  The 10-year Treasury yield was down marginally and the S&P500 was up slightly.

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In fairness, the obsession to which I refer is probably less pervasive now than it was earlier in the cycle, even among the talking heads (such as myself), but it is still there to some extent.  You do see a lot of references to the Atlanta Fed as the quarter progresses.

From a social welfare perspective, there is probably also still too much emphasis on GDP.  However, that too seems to be fading. People increasingly recognize that GDP is not a good measure of aggregate happiness, and not just because of bean-counting minutia, like quality adjustment or path dependency in chain weighting.

More fundamentally, just for example, people are prone to jealousy, which makes adding up utility, as real GDP is meant to do, tricky! And even if people weren’t prone to jealousy (or less darkly, were cheering for their fellow man), aggregating utility is tough. In any event, nobody argues that the welfare aspect needs to be tracked quarterly.

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But the GDP release allows us to update some aggregates that may be helpful in assessing the cyclical position of the economy, developing imbalances, and the attendant risk of recession.  I like to follow the share of cyclical demand in GDP and the private sector’s financial balance implied by the (all-government) fiscal deficit and current account.  For a brief explanation of the reasons, you may see here and here.

We now have data to Q1 for the first concept and an ability to get a pretty good bead on the second, based on the movement in net exports to Q1.

On the basis of both these metrics, the risk of recession appears to have risen quite a bit from where it was earlier in the cycle I (and many others) had earlier argued that you cannot fall off the floor and that concept of a “stall speed” is not that relevant when the plane has not even really left the ground.  But such arguments are now a bit less forceful.

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The share of cyclical demand in GDP has risen, which suggests that pent-up demands are less present than they were, particularly away from housing. And the private sector financial balance is smaller, reinforcing the same point, although from a financial rather than real-economy perspective.  (Accounting relates the two, but not quite into identities.)

On the other hand, this is a case of not-as-good, rather than alarming. From the perspective of these metrics, at least, the situation does not appear yet to have become particularly dangerous. It just seems less the no-brainer than it was earlier in the cycle.

We can’t take a view on the medium-term outlook based just on these crude metrics, obviously. The approach of full employment and the Fed’s (slowly) evolving priorities are a bit of a caution, although also  not yet alarming, in large part because inflation is still too low.

But from the GDP report itself, the main points I would take away are largely shown in the charts immediately above.  And their signal evolves slowly, so it is not like we learned so much even about these in today’s release.


Afternoon Update: Quick comment on the inflation side

JPM estimates that the core PCE deflator for March will have been down 0.09% (false precision) on the month. The JPM estimate is usually pretty close, and it is good enough for me.

Today, we got the price data for Q1, although not the monthly breakdown for March in particular. But if we assume the monthly data to February will not be revised (neutral, but not realistic), then to get the already known quarterly result, we would have to pencil in a 0.07% decline March for the core deflator and roughly twice that decline for the market-price-only (MPO) component.  Just as a demonstration of mastery of Excel I do that below.

The precise monthly detail don’t matter much. Quarterly is fine, because we ain’t that smart anyway.  But my charts are monthly and using monthly avoids talking about base effects in the quarterly averages. So here is how one picture would look if we did that bit of interpolation.

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I see from a Bloomberg journalist on Twitter that MEN now hold the lowest expectation of long-term inflation on record. Not sure why men and women wold be different.  But maybe the men are extrapolating, after what has almost been a decade now of the Fed chronically missing to the downside. I doubt inflation expectations drive policy to the extent the Fed occasionally implies (when not dissing inconvenient inconvenient readings).  It is marginally corroborating is all.

Incidentally, ignore the GDP deflator — ALWAYS.  Never mind why.  Need to know basis only. And you don’t need to.


Trivial points on the labor share

Noah Smith has a Bloomberg View article going over possible reasons for the recent decline of the labor income share of GDP.   He assesses four hypotheses,  which he calls: China, monopoly, robots and landlords.

His piece is brief and maybe familiar to many of you, so I will not bother summarizing it, except to say that the thinks the first three forces may actually be parts of one big thing, while the last is perhaps separate.

I don’t have much to add to the basic argument he presents, but would offer just three trivial observations.

First, I was struck by his claim that, “For decades, macroeconomic models assumed that labor and capital took home roughly constant portions of output — labor got just a bit less than two-thirds of the pie, capital slightly more than one-third. Nowadays it’s more like 60-40.”

I think that is right.  The models made the assumption, although not necessarily for any particularly good reason, aside from it seeming temporarily to be supported by the data and perhaps simplified the math in some cases.

Second, I am not sure we all agree on what the data are in this case.  Perhaps it is the labor share of net value added, rather than gross, that “should” be stable.  Take a look at the picture below which shows two measures of the labor share, one with gross value in the denominator, and the other with net.  Note that the gross share is close to Smith’s 60%, which may be a happy fluke.

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I focus on the domestic operations of the nonfinancial corporate sector, rather than overall economy as measured in GDP, simply because these data a readily available, presented in a way that adds up, and relatively free of some of the abstractions found in the GDP.  But full disclosure: I think the issue I am about to highlight is most pronounced in the sector I choose to picture, and the data there are not free of controversy.

Anyhow, for the domestic operations of NFCs, the labor share of net is less than 1/3 as far off full-sample average as the share of gross.  This does not mean that the issue Smith is trying to assess is mostly a statistical illusion. I am not qualified to weigh in on that. I just find it interesting.  It probably has something to do with the average life of the capital stock moving around, which I think is something you would want to consider, although not necessarily by just netting out its effect.

Third, from an income equality perspective, I don’t think the main issue here is that something called “labor” is falling behind capital and rent, although that may be happening. Some owners of labor, capital and land, i.e. people, are doing better than others.  This is another area where I would not get too attracted to essences.

‘Terminal’ funds rate

Screen Shot 2017-04-22 at 11.32.50 AMTake the eurodollar futures strip. Please.

Some interpret it as showing that the “terminal” libor rate might be around 3%, implying a peak in the funds rate of about 2 ¾%.  Maybe that would go with inflation at 1 ¾% and a short real rate of 1%, which would put a top on the expansion.

But that is not really what the futures strip implies, as the peak rate on the futures strip is certainly not the expected peak of the interest rate cycle.

Let’s ignore the probably-small risk premium for simplicity. The reason the strip understates the expected peak of the rates cycle is that the date of that peak is unknown to investors, who must price the mean of the probability distribution for rates, which has to include the idea that rates will fall after they peak.

To see this simplify radically and assume that the peak funds rate is known to be 4% and that beyond 4 years, the only possible alternative is a return to zero.  Looking 5 years ahead, if we figured the funds rate were peaking with 75% confidence, then the forward funds rate would be 3%.  The curve peaks at 3% even though we (for sake of illustration) know the peak is 4%.  Not knowing the date of the peak matters a lot.

This simple point occurred to me while thinking about the fact that credit growth appears recently to have slowed, which seems mostly a lagging indicator of the fact that pent-up demand for durable goods has finally been exhausted and some technical issues, like the bust in the energy patch and the inventory correction.

Looking forward, credit growth should tend to reaccelerate above the pace of durable goods demand growth, following the automatic re-leveraging thesis set out by Jason Benderly.  In brief, Benderly shows that the gap between credit growth and growth in the spending it finances is itself cyclical, favoring spending growth early cycle and credit late in the cycle.  Just look it up.

The problem, though, is that this is actually a negative for spending growth, because the expansion now has less pent-up demand and is more dependent on credit expansion. FWIW, this does not have me in a “panic,” but it represents the disappearance of what had been a comforting positive.

Which brings me to a point Larry Summers has made – or a point that seems analogous to one Larry Summers has made. Summers claims that real interest rates were held aloft by during the mid-2000s by bubble dynamics in housing. From this he infers that his secular stagnation thesis actually applies to before the crisis.

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Summers argues that this differentiates his take from that of, say, Reinhart and Rogoff, as set out in This Time is Different (NOT Growth in a Time of Debt).  R&R claim that economic weakness is enduring but ultimately transitory, where Summers sees it as secular, barring a major policy change.

Applying an analogy to today, I would say that the pent-up demands are largely exhausted, at least outside housing, and that wealth effects have probably also peaked.  I am not sure why the equilibrium funds rate would surge from here.

People expecting the actual funds rate to surge may see it otherwise. I would guess, though, that a big part of the case for higher interest rates is just the continued influence of Taylor Rule type reasoning. As the labor market tightens, it is natural for the real interest rate to rise. But I don’t think we are in an environment where Taylor can work, for reasons I wrote down here quite a while ago.

This does not make me want to go out and buy a bunch of bonds, even assuming I had the dough. I still view bonds as offering return free risk.

Mostly it just reinforces my take that interest rate “renormalization” remains an extremely misleading model of the rates environment. Also it would probably be good for the Fed to allow inflation and expectations of it to rise a bit before risking putting a cap on the cycle.

These thoughts are in the Summer lecture I linked to above, but I have been pushing them a while independently.