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.

Bubbles? Shiller P/E Ratio Nears Roaring ’20s Bubble High As Home Prices Increased 43.6% Since Feb ’16

Supreme Court Justice Potter Steward said in 1964 in the Jacobellis v. Ohio case,  “I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description [hard-core pornography]; and perhaps I could never succeed in intelligibly doing so. But I know it when I see it, and the motion picture involved in this case is not that.”

Asset bubbles too are difficult to define, but I know it when I see it.

Take Robert Shiller’s P/E Ratio measure for stocks. There was a Roaring ’20s bubble which burst in 1929 (Black Tuesday), there was the infamous Dot.com bubble. On March 10, 2000, the NASDAQ Composite peaked at 5,132.52, but fell 78% in the following 30 months.

Now we are seemingly in yet another stock market bubble and almost at the P/E Ratio level of the Roaring ’20s bubble (but not near the dizzying heights of the Dot.com bubble … yet).

Stocks do seem awfully “frothy.” But what about home prices? The Case-Shiller 20 composite home price index has grown 43.6% since February 2012.  While home prices are not growing as fast as they did during the home price bubble of the last decade, they are going at a rate that is twice as fast as earnings (wage) growth.

These certainly look like asset bubbles. If it looks like a bubble and acts like a bubble, it probablyis a bubble.

“Shhh. Don’t say the word “bubble!”

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.