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.

New Home Sales In April Tank -11.4% MoM As Median Price Declines -3% (The West Coast Suffers -26.32% Decline)

Another disappointing new home sales report.

New home sales tanked -11.4% MoM in April.

New home sales remain considerably below any level around the housing bubble. Despite the YUGE intervention by The Federal Reserve.

But while the level of new home sales is considerably below pre-2008 levels, the MEDIAN PRICE of hew home sales is considerably higher than at the peak of the housing bubble.

New home sales fell the most in The West (-26%) and The Midwest (aka, Kasich Kountry) at -13%. Bear in mind that new home sales in California are mega expensive and unless they start buildig more in Riverside and the Inland Empire, new home sales are likely to be weak.

Is this a bubble?


The Not-yet Towering Inferno! The Federal Reserve, European Central Bank Race To The Top (In Asset Purchases)

The leading global Central Banks (the US Federal Reserve, the European Central Bank and the Bank of Japan) are in a race .. to see which one can expand their balance sheets the most.  It looks like a tie, but the ECB has taken the lead!! Yes, one more time. The ECB now purchasd more asset than even The Federal Reserve and Bank of Japan.

Here is a different view of the same data, showing the not-yet Towering Inferno of sovereign debt.

And the ECB has the lowest policy rate (as The Fed slowly increases their Fed Funds Target rate).

Check out the excess reserves trapped in The Federal  Reserve system ($2.218 TRILLION).

The real problem is that despite the massive asset purchases and repression of interest rates, it doesn’t seem to have done any good.

But unlike the film “The Towering Inferno,” the fire hasn’t started … yet. Run when someone on CNBC or Fox Business yells “Fire on 81!”

Venezuela’s 99.5% Currency Plunge Shows Why Protests Rage (Highest 2Y and 10Y Sovereign Yield In World)

Well, a 99.5% currency plunge isn’t the ONLY reason why protests are a daily occurrence in Venezuela.

(Bloomberg) — President Nicolas Maduro has overseen an unprecedented depreciation in his country’s currency since taking office, with the bolivar now down 99.5 percent to 5,100 per dollar in the black market that everyday Venezuelans use. The sharp decline has wiped out savings and made buying imported goods all but impossible, helping fuel the anger directed at the government in street protests that have turned deadly in recent weeks. While Maduro has raised the minimum wage almost 20 times during his tenure, it’s still the equivalent of just $40 a month.

Yes, the blackmarket currency which many Venezuelans use has actually fallen 99.5% under Maduro.

Say, The US Federal Reserve’s destruction of the purchasing power of the dollar since The Fed’s creation looks absolutely sedate compared to Maduro’s Bolivar destruction.

Here is the OFFICIAL CPI YoY for Venezuela (last reported at the end of 2015 and it was 181%). Things have gotten far worse since then.

Of course, Maduro and his pals have effectively destroyed the once productive oil industry (by replacing competent managers with political hacks). Then we have the nationalization of the the auto industry, forced production of goods (like ordering bakeries not to produce desserts and only produce bread), etc.  Very reminiscint of the old Soviet Union — a command rather than a demand economy.

Venezuela’s 2 year sovereign yield (in US dollars) is the highest in the world at 37%.

And Venezuela’s 10 year sovereign yield is also the world’s highest at 23.8% (once again, denomiated in US Dollars).

Venezuela sovereign yield curve is steeply downward sloping, as is their credit default swap (CDS) curve. Their 5Y CDS is at over 7,000 at the 6 month mark.

What a complete and utter disaster the once thriving Venezuelan economy has become under the dynamic duo of Hugo Chavez and Nicolas Maduro.

Here is Venezulan President Nicolas Maduro singing “Wasted Days and Wasted Nights” about economic progress under his iron-fisted rule.


TBAC(o) Road: Treasury Borrowing Advisory Committee Against Mnuchin’s “Ultra-long” Treasury Bond Idea (Competing with Japan, France, Italy)

While Treasury Secretary Mnuchin has been pushing extending the maturity of US Treasury Bonds beyond their current longest maturity of 30 years, the Treasury Borrowing Advisory Committee (TBAC) issued a warning against issuing “ultra-long” Treasury bonds.

Lastly, the Committee commented on the demand for ultra-long debt, noting that the regular and predictable issuance policy should remain the central consideration to minimize Treasury’s funding cost over time. While an ultra-long is most likely to be demanded by those with longer-dated liabilities, the Committee does not see evidence of strong or sustainable demand for maturities beyond 30-years. The Committee recommended that further work be done to study these demand dynamics to get a better sense of where an ultra-long bond might price, which could be above or below the longest maturity debt issuance based on the pricing of domestic ultra-long derivatives, ultra-long bonds abroad, and theoretical models.

The Committee suggested that other ways that Treasury might tap potential demand from long-duration investors. To that end, the Committee recommended that Treasury consider issuing a zero coupon 50-year bond, and coupon maturities between 10- and 30-years, preferably the reintroduction of the 20-year. Finally, the Committee recommended against issuing a 100-year bond due to limited pension or insurance cash flows beyond 50-years and the preferable attributes of stripped 30-year bonds to meet a similar duration as a 100-year coupon bond.

Well, 50 year zero coupon bonds seems pretty ultra-long to me.

But the missing point is that other nations that have issued sovereign debt with maturities longer than 30 years like Japan, the UK, France and Italy all have one thing in common — massive amounts of outstanding sovereign debt.

While Greece lead Europe in Debt to GDP, their maximum sovereign debt maturity is 25 years.

Of course, Japan has a sovereign debt to GDP ratio of around 235% while the US has a smaller ratio of sov debt to GDP at “only” 106%.

So, it appears that the US is in a competition with Japan, France, Italy and the UK to borrow as much as possible.

Yes, the US is truly on TBAC(o) Road.

Mnuchin: Damn, I didn’t realize that we owed that much and may have to double that figure!

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 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 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!”