Initial Claims was reported as-expected at 457k; some observers tried to make much of the fact that the 4-week moving average fell to its lowest level in a while, but of course that’s because of the very low number recorded two weeks ago when the seasonal adjustments looked for an auto shutdown that didn’t happen.
I guarantee that the 4-week moving average will jump the week after next (when that data falls out). After all, each week only adds 1 data point. It doesn’t matter how you smooth it: every week has the same informational content. Focusing on the 4-week moving average is a way of keeping one’s self from getting too excited about this week’s number, but the easier method is…don’t get too excited about one week’s number. Each data point is the result of an experiment, measuring an unknown (and unknowable) underlying reality. Each data point, or collection of data points, has more value when those numbers start to diverge from those suggested by your operating hypothesis, causing you to question or reject your thesis. In this case, the operating hypothesis that the underlying rate of Initial Claims is approximately stagnant at roughly 460k per week is not threatened by this week’s 457k number, nor by the 464k number last week, nor by the 452.5k 4-week moving average. The jobs picture is the same as it has been: tepid.
Now, we did have an exciting (for an inflation guy) unscheduled release yesterday, when St. Louis Fed President James Bullard released a pre-print of his suggestively-titled “Seven Faces of ‘The Peril’”, an article scheduled to appear in the September/October St. Louis Fed Review (the article is available here). In the abstract, he says “In this paper I discuss the possibility that the U.S. economy may become enmeshed in a Japanese-style, deflationary outcome within the next several years.” As you might expect, it hit the headlines immediately.
I have yet to read the whole paper (tonight’s chore), but from a scan it looks very interesting. I don’t agree, at the outset, with some of his conclusion, but I am willing to be swayed on the reading. The conclusion reads, in part,
During the recovery, the U.S. economy is susceptible to negative shocks which may dampen inflation expectations. This could possibly push the economy into an unintended, low nominal interest rate steady state. Escape from such an outcome is problematic. Of course, we can hope that we do not encounter such shocks, and that further recovery turns out to be robust but hope is not a strategy. The U.S. is closer to a Japanese-style outcome today than at any time in recent history. In part, this uncomfortably close circumstance is due to the interest rate policy being pursued by the FOMC.
Specifically, he is critical of the policy of the FOMC to pledge to leave interest rates very low “for an extended period,” and instead says “A better policy response to a negative shock is to expand the quantitative easing program through the purchase of Treasury securities.”
It certainly seems that Fed officials are starting to try and make it clear that they are willing to gun the motor a bit to make sure inflation achieves ‘escape velocity’ and doesn’t keep falling back to the neighborhood of zero. As readers know, I think that they are misguided, since ex-Housing, there is nothing approximating deflation in the U.S., but with money growth low and money velocity probably leveling out but with steady pressure on financial leverage (which is a concept related to velocity), it is not ridiculous to be worried about it. My models suggest core inflation is already beginning to bottom, and as I have written recently I think the “negative shock” about which Bullard speaks – he may even explicitly have the coming fiscal contraction in mind – will be addressed by the Fed as the only arm of government left that has any bullets. And I think that means inflation has potentially a lot of upside, as the Fed in Q1 will probably be pushing prices higher along with the already-generated upstroke.
But I am always disheartened to see policymakers look at Japan and despair of being able to force prices higher. Japan was extremely conservative in their pursuit of ZIRP, and then QE. I will say it again: it is trivially easy to get inflation. Add zeroes to the currency and you are absolutely, 100% guaranteed to get inflation. It is targeting responsible inflation that is the challenge. Japan did the monetary authorities of the world a great favor by conducting a dosage experiment. They didn’t give the patient a big enough dose. Just because the patient did not respond to 1cc of penicillin is no reason to throw out penicillin as a helpful medicine. It may require 2cc. Or maybe 10cc.
It is a little concerning to see quack theories gaining credence before we have tried a little harder to get the proper dosage of a medicine we know works. But what do you expect, I guess? Monetary policymakers today are barely a generation removed from the monetary policy witchdoctors of yesteryear...
I was musing yesterday about investments. We know, of course, that we live in a “low return world,” as Mauldin would say it, or the “New Normal,” as Bill Gross likes to call it. Low returns are the order of the day, which is frustrating to everyone. Yields are low, real yields are low, prospective equity returns are low, etc. But there is one investment that can return you a guaranteed 5% or 6% nominal return with no risk. Yeah, I know we all want 15%, but that’s not available. 5% or 6% with no risk isn’t bad (especially if you believe we are headed into deflation, which I do not, but some do).
Pay off your mortgage. Paying 6% less in interest is equivalent to earning 6% on your investment. (You may say “but you get a tax break on that 6%!” Sure, but you pay taxes on that 6% investment; moreover, I am not sure the mortgage interest deduction is sacred any more…are you?)
Now this leads to a thought that I found interesting and I hope you will too. Could the low-return world be actually contributing to de-leveraging? Look, if you’re borrowing at 6% to buy a 10% investment, it makes sense to do so (well, if you can handle the variance in the investment). But if the investment only yields 4%, then borrowing at 6% to buy it is silly. That’s what you’re doing right now if you’re buying Treasuries at 3%. But if everyone realizes this, then … well, we know that credit demand is falling and the standard story is that Americans are growing more responsible. Could it simply be that they are making the best-available use of their money? (Note this is different than a low interest rate world. If rates are low but prospective returns higher, then more leverage makes sense. But once all returns have been forced down, it makes sense to de-leverage).
I doubt that the average homeowner is performing that calculus. Most of us fall into the common behavioral trap of thinking of our “borrowing” and “investments” as coming from two different pockets. We are not the homo economicus of theory. But perhaps at the margin this is happening, and it makes a more plausible story to me that investors are being somewhat rational rather than (alternatively) suddenly “coming to Jesus” on their borrowing-and-spending ways.
Today, Friday, brings some significant data. First we get the first look at Q2 GDP (Consensus: 2.5%; +1.0% on price deflator). Simultaneously, the Employment Cost Index (Consensus: +0.4%) will give a read on wage and benefit growth. Last quarter the ECI was +0.6%, but most of that was from a +1.1% jump in benefits while wages were +0.4%. The question is whether benefits merely drop down into line at +0.4% or +0.5%, or if they overcorrect. I suspect those cost increases were real, and think there’s some upside risk to this figure (although I don’t feel strongly about it). At 9:45ET, the Chicago PMI is expected to decline further to 56.0, and shortly thereafter we get the revision to the Michigan Confidence data (the least important indicator of the day, easily).