The Fed’s Dual Mandate (And The Phillips Milk Of Magnesia Curve) — Why Wage Inflation Isn’t Happening

The Federal Reserve has a dual mandate to 1) promote maximum employment and to 2) keep prices stable.  The Fed has a target rate of core inflation that is 2%; however, it has been unable to achieve this target since the end of The Great Recession even though unemployment has declined.

Yes, the Dallas Fed’s trimmed mean Personal Consumption Expenditures Inflation Rate did exceed 2% back in January 2012, but generally it has been below 2% since June 2009.

But why is inflation so low even when unemployment is so low (as in 4.4% as of April 2017)?

A partial answer lies in the dismal earnings recovery after The Great Recession. Notice in the chart below that the U-3 unemployment rate (blue line) has declined below the natural rate of unemployment (red line) as economic recovery strengthens after each recession. Except for after The Great Recession. Once again, the U-3 unemployment rate has finally dipped below the natural rate of unemployment … yet no wage inflation.

The green line represents the inverse of YoY hourly earnings growth for the majority of the population (Production and Nonsupervisory Employees). You will notice that wage growth accelerates as unemployment declines, particularly when the underemployment rate is below the natural rate of unemployment. Except for the current “recovery.”

Bloomberg has a nice piece of several reasons why the current wage recovery is so low.  Another explanation that Bloomberg did not mention is that the US saw an unprecedented wave of regulations (Affordable Care Act, Dodd-Frank, EPA, the Consumer Financial Protection Bureau, etc.) most of which did nothing to help wage growth for mere mortals. Not to mention increase capital-labor substitution (robots replacing workers). But an easy answer is that the Phillips Curve is seemingly dead (decreased unemployment correlates with higher rates of inflation).

But WHY is the Phillips Curve dead? It makes intuitive sense that wages will rise as labor slack vanishes.  But what are some other explanations for the failure of the Phillips Curve to kick in? Or maybe it is about to kick in?

Clearly, outsourcing of higher-paying jobs overseas is a factor. Or could it also be the poor quality of American education that makes students uncompetitive in the modern economy? Or are US firms not investing in plants and equipment anymore?

But with commercial and industrial lending YoY slowing and the decline in real gross domestic investment (nonresidential equipment), wage growth may still be some time away.

The Fed’s zero interest rate policies (ZIRP) and quantitative easing (QE) ..

have certainly helped pumped up asset prices (like housing and the stock market).

But not wage growth (worst post-recession wage recovery in history … or at least since 1965). In other words, The Fed has not really benefitted wage growth, only asset price growth.

Suffice it to say that have full employment AND increased wage growth would be a blessing to the economy and housing market. I hope so. I am tired of reading research papers that claim that a HUGE Millennial wage of home purchases is going to kick in any quarter. At least I hope their predictions work better than the Phillips curve.

OCC: Citigroups Leads Bank Holding Companies With $22 Trillion In Derivatives Exposure (Mizuho Leads In Derivative-To-Assets of 12,000%!)

The Office of the Comptroller of the Currency (OCC) has released the Derivatives Exposure for bank holding companies.

Of the top ten bank holding companies, Citigroup leads in total derivatives exposure (futures, options, forwards, swaps, credit derivatives, etc). Citi is closely followed by JPMorgan Chase, Goldman Sachs, Bank of America and Morgan Stanley.

In terms of derivative exposure to assets, Japan’s Mizuho leads with a whopping 12,136.54%. Followed by Goldman Sachs at 4,792.91% and Morgan Stanley at 3,505.69%. Wells Fargo is has the lowest derivatives to assset ratio of the top ten holding companies.

In terms of credit derivatives, JPMorgan Chase leads, followed by Citi. State Street actually has no credit risk exposure.

Of course, as long as there is no sudden shock (or even slow m0ving disaster … like collapsing home prices and a surge in mortgage defaults), everything is copacetic. But in case of a shock, counter party risk rears its head (such as in ‘The Big Short” where problems occured in shorting  Credit Default Swaps, at least momentarily). Or an insurer like AIG not being to pay off on its Credit Default Swaps claims.

Now that the US banking system is highly concentrated,

we shouldn’t see the same pattern of bank failures that we have seen in previous financial crises, like the financial crisis of 2007-2012.

Did someone mention Stanley? With a derivative-to-asset ratio of 3.505%, (Morgan) Stanley should be happy!

Q1 2017 US Homeownership Rate Declines To 63.6% (Back To Clinton, Pre-bubble Levels)

According to the US Census Bureau, the US homeownership rate is back to pre-bubble levels.

“The Great Leap Forward (in homeownership)” from various Presidential administrations (most notably Clinton’s with HUD’s “National Homeownership Strategy: Partners in the American Dream”) nhsdream2 helped increased homeownership to unsustainable levels following 1995). Homeownership rates ALMOST reached 70% but then the wheels came off home prices, foreclosures surged and homeownership fell back to pre-NHS levels.

Despite all the monetary stimulus thrown to the banks, homeownership rates continued to fall.

Of course, the amazing disappearance of low credit score mortgage borrowers didn’t help. But there has been a recent uptick in low credit score originations.

Now that mortgage foreclosures are down near pre-bubble lows, we are at stable homeownership levels. That “Great Leap Forward” towards 70% homeownership rates resulted in “The Great Fall Backwards.”

The Taylor Rule (according the the SF Fed’s Rudebusch specification) should be 5.83%. It is currently 1.00%.

Yellen must think that the Taylor Rule is a ham product rather than a guide to monetary policy.

“I could have sworn that incredibly low interest rates would work.”



Wells Fargo Mortgage Applications Fall To Lowest Since 2005* (The Wells Fargo Mortgage Wagon ISN’T Coming!)

It is reporting season for American banks and Wells Fargo’s came out today. first-quarter-earnings-supplement

Of particular interest is the decline in residential mortgage applications for Wells Fargo, the lowest since 2005. Because that is the last year for which there is data on Bloomberg for Wells Fargo.*

Mortgage originations? About the same as Q1 2016, but substantially below levels seen in 2012. Q1 2017 is the second lowest level of originations sine 2005.

It just isn’t Wells Fargo. Take Bank of America. But Wells claimed their niche was the residential mortgage market while other banks retreated from the market.

Low wage growth coupled with regulatory overreach by Dodd-Frank and the Consumer Financial Protection Bureau has diminished residential mortgage lending by the banks.

So, the Wells Fargo (mortgage lending) wagon isn’t coming. And it isn’t for other big banks either. But PROFITS increased for mortgage bankers  in 2016.

While Wells Fargo was still the leading mortgage originator in Q3 2016, shadow bank Quicken is challenging Chase for 2nd place with PennyMac challenging US Bank for 4th place in the mortgage origination derby.

Maybe Dan Gilbert, the CEO of Quicken Loans and the owner of the Cleveland Cavaliers basketball team, should adopt the Wells Fargo wagon song for Quicken! Because it seems that Wells Fargo’s wagon isn’t bring the home loans as expected.