Ignore The Bond Bears, The Fed Will Not Raise Rates

by: Larry Kummer

Summary

Many investors and economists are convinced that the Fed will soon end its near-zero interest rate policy and begin raising rates - "normalizing them".

As I and others have said since the crash, these times are not normal (i.e., the post-WWII era has ended).

Most economic indicators show flat or slowing economic growth.

The developed world has fallen into secular stagnation.

The next event is not a boom requiring higher rates, but a recession.

Short-term riskless US rates are set in the world's largest market: when will rates return to normal?

Secondary market yields of 3 month T-bils. From FRED.

We have been told for six years that soon interest rates will rise. During that time, the right-wing's inflationistas have predicted rising inflation, or even hyperinflation (remember the 2010 "Obama will turn America into Zimbabwe" scare?). Incredibly, many experts still believe this despite…

  • the slow economic growth (in September, the Fed expected GDP of 1.8% for 2016;
  • the slowing economic growth: on August 3, the Fed's GDPnow model forecast 3.2% GDP for Q3; it predicts 2.1% now;
  • the collapse of hope for eventual return to strong growth: In Jan. 2011, they expected long-term GDP growth of 2.5-2.8%; they now expect 1.7-2.0% (the low-end forecast has dropped by one-third).

None of this suggests raising rates is rational, since a rising rate cycle plus a little bad news (in a world overflowing with risks) would start a recession America is ill-prepared to face - unlike the typical situation at the end of a long expansion cycle (4th longest of the 11 cycles since WWII).

That's all esoteric reasoning. Much simpler data shows why the Fed will not start a new rate cycle. This is a consumer-driven democracy. The job market drives both the economy and public opinion (the Fed has little political legitimacy, and so is rightly sensitive to its image). The Fed raises rates when the job market is strong - threatening to overheat ("wage inflation," with workers' wages eating into profits) and able to withstand the drag from rates. That is not true now. The new jobs report showed that. Two new reports confirm it.

The Fed's Labor Market Conditions Index

If you want to watch only one economic index, this is it. As the Fed explains

"The U.S. labor market is large and multifaceted. Often-cited indicators, such as the unemployment rate or payroll employment, measure a particular dimension of labor market activity, and it is not uncommon for different indicators to send conflicting signals about labor market conditions. Accordingly, analysts typically look at many indicators when attempting to gauge labor market improvement. However, it is often difficult to know how to weigh signals from various indicators. Statistical models can be useful to such efforts because they provide a way to summarize information from several indicators. This Note describes a dynamic factor model of labor market indicators that we have developed recently, which we call the labor market conditions index (LMCI)."

This includes 19 measures of job activity. The average monthly gain of the LMCI during expansions since 1980 is 4. The change in September was +2.2. The sum of the monthly changes in 2016 YTD: minus 16 (data here). This is typical of a pre-recession period, not a boom requiring higher rates.

Fed

From the JOLTS survey: hires

The Job Openings and Labor Turnover Survey (JOLTS) provides another perspective on the jobs market, in addition to the other three sources of data: the Establishment Survey, the Household Survey, and the weekly unemployment claims data (that they all broadly agree is a powerful rebuttal to their critics).

Long-term economic numbers require context to adjust for the growth in the economy and population (otherwise, we conclude that Obama was the best president ever, creating more jobs in one month than Washington did in 8 years). Here the number of monthly hires (from JOLTS) is shown as a percent of the labor force (from the Household survey), both seasonally adjusted.

After increasing for eight years, the businesses are still not hiring at the same rate as they did during most of the 2002-2007 expansion. Worse, the acceleration in hiring has stopped - with the line flat since Spring 2015. This late in the cycle a flat period is usually followed (eventually) by a drop - not another boom.

Ratio of Hires (from JOLTS) to Civilian Labor Force (from Household Survey)

Might the Fed raise rates anyway, despite the slow & slowing economy?

Yes. History books often explain inexplicable events by saying "mistakes were made." But that's not the way to bet. Every day, the investment media must feed you exciting new stories (they need clicks). But the world usually changes slowly (i.e., punctuated equilibrium). Respect the trends. Don't assume the Fed's governors will ignore the obvious and uncharacteristically take a bold risky move.

What about inflation?

Just like GDP, inflation is locked into a slow trend (roughly 1-3%). With a world awash in excess capacity of things and people, that is not likely to change - especially with China slowing. Few people or industries have pricing power. Many are fighting for their lives (e.g., energy, materials, news media, many retailers running physical stores). It's not a world that generates accelerating inflation.

The monetary indicators are also quiet. Reserves are falling, the money supply is growing steadily, and the Fed has not added assets since ending QE3 (it is not holding rates down). Monetary velocity is at record lows and still falling.

Worrying about inflation is like breaking out the parachutes on a burning ship.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.