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.

California Admits State’s Contribution To Retirement Giant CalPERS To Double (As Recovery Takes Longer Than Expected)

California’s recovery from The Great Recession has taken longer that Governor Jerry Brown imagined.

Yet the slowness of the recovery hasn’t stopped Governor Brown from spending like the proverbial drunk sailor on big dollar items such as high-speed rail (for which Senator Diane Feinstein’s husband was award a near-billion dollar contract).  But as an economist friend of mine in California said “What do you expect when the Democrats have a super majority in California’s governing bodies?” And now Governor  Brown is asking President Trump for financial assistance in building the high speed train (and pay off Senator Feinstein’s husband).

When you spend like a wild man on government projects and combating poverty, something has to give. And one of the somethings is the California state pension program for teachers and public employees. Even big spender Jerry Brown has “suddenly” realized that CalPERS was only 65% funded  as of June 30, 2016 (CalPERS reported that the state plans’ unfunded liability totals $59.5 billion and is 65 percent funded, meaning that CalPERS only has 65 percent of the funding required to make pension payments to state retirees).

So what does a state do when they realize that they have woefully over-promised retirement benefits to state employees? Double the amount of taxpayer contributions to CalPERS, of course!

Absent additional action to address these growing liabilities, paying off retirement liabilities will require an increasing percentage of the state budget. For example, the state’s contributions to CalPERS are on track to nearly double from $5.8 billion ($3.4 billion General Fund) in 2017‑18 to $9.2 billion ($5.3 billion General Fund) in 2023‑24. In response, the May Revision proposes a $6 billion supplemental payment to CalPERS through a loan from the Surplus Money Investment Fund. 

This was inevitable since CalPERS massively overpaid management and advisors have produced terrible returns versus lofty expectations of returns of 7.5%.

The May Revision includes a one?time $6 billion supplemental payment to the California Public Employees Retirement System (CalPERS) in 2017?18. This action effectively doubles the state’s annual payment and will mitigate the impact of increasing pension contributions due to the state’s large unfunded liabilities and the CalPERS Board’s recent action to lower its assumed investment rate of return from 7.5 percent to 7 percent.

Seriously, with all the stimulus thrown at the economy by The Fed since 2008, CalPERS can’t even generate 7.5?

But yes, lowering the rate to more reassonable 6% requires substantial taxpayer bailout. And you know that Governor Brown will come to Washington DC begging for a Federal bailout.

Note to Governor Brown. If you declaring open borders AND promisng heathcare and other taxpayers benefits to undocumented imigrants, you might have to cool it on state pensions, high-speed rail, etc. Economics is the study of scarcity for which Governor Brown apparently now realizes is a reality.

On a side note, a friend of mine was Governor Schwartzenegger’s budget director. He sent me the California budget for several years along with “a noted economist’s” GDP forecast. Of course, the GDP forecast was ludicrous. Hence, here we sit today.



Hey Bartender! U.S. Job Gains Rebound as Unemployment Falls to 2007 Levels (Hourly Earnings Slow To Levels Seen At End Of Great Recession)

Another good news and bad news jobs report from the Bureau of Labor Statistics.

First, the good news. 211k jobs were added in April. And the U-3 unemployment rate fell to 4,4%, the lowest since May 2007. Since The Fed so heavily leans on the U-3 unemployment rate to guide their rate hike decision, this should be compelling information for the next FOMC meeting.

The U-6 UNDERemployment rate (including marginally attached workers) fell to 8.6% in April, also the lowest since 2007.

The labor force particpation rate fell slightly in April to 62.9%. It peaked in January 2000 at 67.3% in the waning days of the Clinton Administration. It has been all down hill from the point.

Now for the bad news. Yes, hourly wage growth YoY fell back to where it was at the end of The Great Recession. Great recovery when wage growth AFTER a recession is slower than before or DURING the recession.

And yes, there are 94.8 MILLION people not in the labor force (retirees, students, those who have given up working, etc).

Leisure and hospitality is once again the leading sector for jobs added!

Zerohedge has a good chart showing the difference beteween March and April jobs added. Same result in that Leisure and Hospitalilty lead the jobs added.

It looks like Lloyd the bartender from “The Shining” is back in business!

Hey Bartender! 


Trump Optimism Bubble Almost Gone In 10Y-2Y Treasury Curve Slope (On The Good Ship Bubble Pop …)

When Donald Trump was elected on November 8, 2016, investors were overjoyed at the thought of deregulating the economy, repealing Obamacare and (at least) parts of the Dodd-Frank financial regulations.

But as time passes and investors realize that there is considerable resistance in Congress to doing most anything, the 10Y-2Y Treasury yield curve slope has almost returned to where it was on election day.

The likelihood of a Fed Funds Target Rate increase at tomorrow’s FOMC meeting is 12.8% according to Fed Funds futures.

But it looks like the Fed Funds rate will be increasing.

Hopefully future rate increases don’t pop our asset bubbles!

Fed Chair Janet Yellen on the good ship Bubble Pop,

It’s PBR Time! Atlanta Fed GDP Q1 Forecast Falls to 0.2% (Declining Durable Manufacturing, etc.)

Today opened with several negative economic reports, including a MoM decline in wholesale inventories and durable goods order ex-transportation. Not to mention a decline MoM in pending home sales.

The Atlanta Fed has now lowered their Q1 (and final) GDP growth to an anemic 0.2%.

According to The Atlanta Fed GDPNow tracker,  Their model: GDPTrackingModelDataAndForecasts 042717

The final GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2017 is 0.2 percent on April 27, down from 0.5 percent on April 18. The forecast of first-quarter real consumer spending growth fell from 0.3 percent to 0.1 percent after yesterday’s annual retail trade revision by the U.S. Census Bureau. The forecast of the contribution of inventory investment to first-quarter growth declined from -0.76 percentage points to -1.11 percentage points after this morning’s advance reports on durable manufacturing and wholesale and retail inventories from the Census Bureau. The forecast of real equipment investment growth increased from 5.5 percent to 6.6 percent after the durable manufacturing report and the incorporation of previously published data on light truck sales to businesses from the U.S. Bureau of Economic Analysis.

Notice how The Fed keeps raising their Fed Funds Target rate as the Q1 GDP forecast deteriorates? Or is the NY Fed’s Nowcast Q1 forecast the correct one?

Q1 GDP growth of 0.2%??? No more Heineken for American consumers. Its Pabst Blue Ribbon time!

I wonder if Fed Chair Janet Yellen and Vice Chair Stanley Fischer will be tempted to take another hit of pure oxygen?


Seventeen EMEA Nations Still Have Negative 2Y Sovereign Yields (Venezuela Leads World With 30.97% 2Y Sovereign Yield)

Seventeen EMEA (Europe, Middle East and Africa) nations still have negative nominal 2 year sovereign yields.

The EU powerhouses, Germany and France, seem incapable of generating inflation (defined here as CPI YoY). And their GDP YoY is pretty bad too (1.10% for France and 1.70% for Germany. At least they are better than Italy with less than 1% YoY.

On the opposite extreme, that poster child of “government gone wild!,” Venezuela, has a 2 year sovereign yield of 30,97% with fellow Socialist nation Argentina at a whopping 18.8%. Brazil is close to the 10% yield barrier at 9.55% for their 2 year sovereign yield.

While Maduro & Company are terrible at economic management, they have been incredibly successful at one thing: inflation! Particularly the black market for their currency, the Bolivar.

So, is Venezuela a “safe place” to park money? Or the USA?’

Here is Venezuela’s El Presidente Maduro indicating what he and his followers have done to the Venezuelan economy. “Bang.”