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.

Pensions Gone Wild! Chicago Teachers Pension Fund Paid Out $1.5 Billion in ’16, Earned $7.8 million

Nobody malinvests or spends like government, particulary government pension programs.

According to Chicago City Wire,

The Chicago Teachers’ Pension Fund (CTPF) paid out $1.5 billion last fiscal year, mostly on benefits to retirees.

But it only earned $7.8 million on its investments, according to a filing it made with the Illinois Department of Insurance.

 

It cost CTPF $35.8 million in investment expenses to earn that $7.8 million, according to the filing, meaning it actually lost $28 million between July 1, 2015 and June 30, 2016.

Years like 2016 elucidate how the fund, which is supposed to pay for the current retirements of some 28,000 former CPS teachers and administrators as well as provide future benefits to another 29,000 active ones, is running out of money, and time.

At $10.1 billion, CTPF is less than half the size actuaries say it needs to be to earn enough investment returns to pay its obligations.

Ah, only way CTPF can do this is …. property owners are on the hook for paying property taxes to support the pension fund.

According to public reports by the Chicago Teachers Union and the state of Illinois, the fund’s nearly $9 billion in unfunded liabilities equates to approximately $7,500 of unseen debt for each of Chicago’s 1.2 million households. This invisible liability does not show up on a title, but it has a significant impact on a property’s value.

At least former President Obama, former Senator from Illinois and former resident of  Kenwood (just north of Hyde Park and University of Chicago) is back in Chicago pleading for fiscal restraint and cutting unaffordable pension benefits.

….NOT!!!

 

Office Bubble? Real Estate Deals Vanish in New York As Office Rents Decline (Northern Virginia Near Worst in Office Vacancy Rate)

Commercial office space has had a fantastic run since hitting bottom in 2009/2010. Much of it with the help of The Federal Reserve’s patented asset bubble blowing technology!

Bloomberg — Concern is mounting that real estate prices have peaked following six years of record-shattering growth, and there are signs of overbuilding in large cities such as New York and San Francisco—the biggest beneficiaries of the recent boom. Landlords are cutting rents and prices, spooked lenders are holding back, and the industry loses hope for Trump tax cuts. 

Much of the slowdown has nothing to do with Trump. Concern is mounting that real estate prices have peaked following six years of record-shattering growth, and there are signs of overbuilding in large cities such as New York and San Francisco—the biggest beneficiaries of the recent boom.

Let’s take a look at weighted-average asking rents for office space for the lowest 35 metro areas in terms of rent growth from 2016 Q1 to 2017 Q1. Silicon Valley leads the nation in largest asking rent decline (-12.19%) since 2016 Q1 while Midtown New York actually grew 0.40% over the past year. Suburban Maryland (-3.23%) and Northern Virginia (-0.25%) both saw declines in asking rents.

Here are the top 35 Metro area in terms of percentage change in asking rents. Notice that while Manhattan asking rents are flat to falling while Brooklyn asking rents rose 16.51%.  Same story holds for Silicon Valley (aka, San Jose). Silicon Valley fell -12.19% over the past year while just up the road in Oakland/East Bay, asking rents rose 15%.

Average office vacancy rates nationally stands at 13.2% in 2017 Q1, down ever so slightly from 13.4% in 2016 Q1. Northern Virginia (21.3%) was edged out for the worst office vacancy rate in the US by Dayton Ohio (23.3%) and Fairfield County, CT (23.1%).  Here is the Cushman Wakefield report on Northern Virginia’s overbuilt office market. CW_VA_Survey_1Q17 (1)

The lowest vacancy rate in the nation? El Paso, Texas at 6.4%. That is a far cry from Northern Virginia’s 21.3% office vacancy rate.

Fed Chair Janet Yellen standing next to her patented asset bubble machine.

 

Commercial/Multifamily Borrowing Up 9 Percent from Last Year (Retail Originations Down 23%)

The retail sector can’t seem to buy a break these days. With 8,600 brick-and-mortar stores may close their doors in 2017, lending was expected to decline.

According to the Mortgage Bankers Association, commercial/multifamily originations rose 9% from Q1 2016.

That is the good news.

The bad news? 1) Retail originations fell 23% from Q1 2016.  2) CMBS/Conduit originations were down 17%. 3) Hotel originations were down 40%.

The good news? 1) Healthcare originations were up 22%. 2) Industrial originations were up 40%. 3) Multifamily originations were up 14%.

Notice that Fannie Mae/Freddie Mac multifamily origination programs were up 33% from Q1 2016.  At the same time, Life Insurance Companies saw 0% growth in commercial/multifamily originations.

Thanks to The Federal Reserve, short-term interest rates remain suppresed and have for the last ten years.

Office originations grew at a listless 2% from Q1 2016. On-line retailers like Amazon have helped shrinked the retail footprint. But will shared office space and the internet finally drive a spike through office space when employees can work remotely?

So, will this be the final countdown for office space?

5.5 Million Homes Still in Negative Equity Territory (But 13.7 Million Homes are “Equity Rich” (Limited For-sale Inventory And Fed Policy Error)

According to data vendor Attom, there remains 5.5 million homes that are seriously underwater (slightly less than 10%). On the other hand, there 13.7 million homes that are “equity rich” (around 24% of homes).

Equity rich is defined as the combined loan amount secured by the property is 50 percent or less than the estimated market value of the property. Seriously underwater is defined as the combined loan amount secured by the property was at least 25 percent higher than the property’s estimated market value.

One culprit is limited for-sale inventory. This chart is from Zillow:

The other culprit is The Federal Reserve, who have kept rate depressed for around 10 years.

Yes, limited for-sale housing inventory and Fed-depresssed interest rates for 10 years is helping some but not others.

Now, take a wild quess which states are “equity rich?” If you guessed California and New York, you were correct!!

 

Yes, housing is getting progressively more unaffordable to many households as limited for-sale inventory and insanely low monetary policy have effectively jailed (locked-out) many households from owning a home in California and New York.

“Please Chairman Yellen! Stop driving up home prices with your super-low interest rates when for-sale inventory is so low.”

Trump Optimism Effect Gone In The Treasury Yield Curve, But Not in 10y Treasury Yields and 30Y Mortgage Rates

There was a burst of enthusiasm in capital markets surrounding Donald Trump’s election as US President. It was a hope for economic growth, higher paying jobs and undoing President Obama’s regulatory overreach.

But alas, continued stonewalling in Congress by Democrats (and RINOS) as well as threats of impeachment over Russia have killed off enthusian in the US Treasury 10Y-2Y yield curve. As you can see, the 10Y-2Y Treasury curve slope is now lower than before the November 8th election.

But that optimism effect has not declined appreciably in the 10 year Treasury and 3o year mortgage rate. The optimism effect has gradually declined to Nov 14th level, several days after the election.

While there has been a downward drift in the 10 year Treasury yield, The Federal Reserve has been merrily raising their Fed Funds Target Rate twice since the election, helping to flatten the 10Y-2Y curve.

With another rate increase expected at the next FOMC meeting on June 14th (90% likelihood), we should be a further flattening of the 10Y-2Y Treasury curve (ceteris paribus) and a further decline in the Trump optimism effect.

And there is a 6% chance that we could see a rate CUT at the July FOMC meeting.

Janet Yellen: “I swear that I will not raise rates and spook investors more than once, unless Donald Trump is elected.”

Americans’ debt back at record high after nearly a decade (YoY Household Debt Growing Faster Than YoY Earnings G

I was purusing through Jesse’s Cafe Americain and this story jumped out at me. “Americans’ debt back at record high after nearly a decade.”

Americans’ debt level reached a record high this year, surpassing the peak touched just as the worst of the recession was taking hold in 2008, and marking a milestone for households that now lean less on mortgages and more on auto and student loans.

Total U.S. household debt was $12.73 trillion at the end of the first quarter of 2017, up $473 billion from a year ago, according to a Federal Reserve Bank of New York survey released on Wednesday.

Total indebtedness is now 14 percent above the 2013 trough of household deleveraging brought on by the 2007-2009 financial crisis and Great Recession. The previous peak, in the third quarter of 2008, was $12.68 trillion, and the New York Fed stressed that the pull-back since then marked an “aberration” from what had been a 63-year upward trend in household debt.

Chart from the New York Fed: https://www.newyorkfed.org/medialibrary/interactives/householdcredit/data/pdf/HHDC_2017Q1.pdf

But in terms of change, student and auto loans are the leading debt products.

Here is household and nonprofit organization debt.

If we compare YoY growth in household debt compared to YoY growth since 2014, you can see that YoY earnings growth for production and non-supervisory employees (blue line) is growing at a slower rate than YoY household debt growth (red line).

I wish I had a GIF of Janet Yellen with a tea bag, but April Ludgate will do!