Weekend Weimar and Beagle

It's that time of the week -- time to think about anything except the markets.

We'll all be back on Monday

Weekly Indicators for April 23, 2010

- by New Deal democrat

This was housing week in the monthly data department. Both existing and new home sales increased, new sales surprisingly so. I am taking both of these with a grain of salt, since the $8000 home buyers credit has been playing havoc with the numbers.

Durable goods orders for March tanked, including airplanes, but were surprisingly strong excluding airplanes (Boeing). This is a volatile number, so best not to read much into it either way.

The high frequency weekly data continued to tell a tale of a strengthening recovery:

▪ The International Council of Shopping Centers (ICSC) reported same store sales growth of 4.6% YoY, and 0.2% WoW.

Shoppertrak reported YoY sales increased 9.9%, and WoW sales were up 4.7% (note easy Easter comparison vs. last year).

The Department of Energy reported that the price of gasoline rose again, just barely, to $2.86 per gallon. Gasoline demand for the last month has run equal with last year, suggesting that prices are beginning to bite at least slightly.

The BLS reported that last week's initial jobless claims totaled 456,000. The 4 week moving average was 460,000. This series remains in a downtrend, but in a much more muted downtrend than last year.

Railfax recorded another strong week. Three of the four elements of traffic: baseline, cyclical, and total – are continuing to increase, and continuing to increase at a rate faster than last year. Intermodal traffic, which is a proxy of imports/exports, remains substantially ahead of last year, but is not significantly increasing. Crushed stone and lumber, Railfax’s “recession watch” traffic, have both increased over last year for a month now, and crushed stone is increasing substantially WoW in comparison with last year.

Finally, Daily treasury receipts continue their surge ahead of last year. As of April 21, 2010 (15 reporting days into the month), $105.2B in withheld taxes had been collected vs. $98.8B last year, a gain of $6.4B or +6.5%. For the last 20 reporting days, $130.0B in withholding taxes have been collected, vs. $118.6B last year, a gain of $11.4B or +9.6%.

From Bonddad:

According the Gallup:

Gallup estimates that more than 1.5 million Americans who were underemployed became employed to full capacity over the last month. Gallup's 30-day average underemployment measure (not seasonally adjusted) declined to 19.2% on April 18 -- a sharp improvement from the 20.2% reported on March 21 -- and essentially matching its best level of the year.

I point this out because one of this website's trolls has changed his economic indicators every time they turn positive. For example, he no longer quotes the BLS (which is rigged -- rigged I tell you!!!!!!) but instead relies on Gallup. However, now that this number reporting positive news, he'll have to find a more negative jobs number to claim is accurate.

Porn or Enforce the Law?

From the AP

Republicans are stepping up their criticism of the Securities and Exchange Commission following reports that senior agency staffers spent hours surfing pornographic websites on government-issued computers while they were supposed to be policing the nation's financial system. California Rep.

Darrell Issa, the top Republican on the House Oversight and Government Reform Committee, said it was "disturbing that high-ranking officials within the SEC were spending more time looking at porn than taking action to help stave off the events that put our nation's economy on the brink of collapse." He said in a statement Thursday that SEC officials "were preoccupied with other distractions" when they should have been overseeing the growing problems in the financial system.

The SEC's inspector general conducted 33 probes of employees looking at explicit images in the past five years, according to a memo obtained by The Associated Press. The memo says 31 of those probes occurred in the 2 1/2 years since the financial system teetered and nearly crashed.

The staffers' behavior violated government-wide ethics rules, it says. The memo provides fresh ammunition for Republicans who suspect the timing of the SEC's lawsuit last week against Wall Street powerhouse Goldman Sachs Group Inc. News of the suit came as the Senate prepared to take up a sweeping overhaul of the rules governing banks and other financial companies.

Ratings Agencies Dropped the Ball

From the NY Times:

In 2004, well before the risks embedded in Wall Street’s bets on subprime mortgages became widely known, employees at Standard & Poor’s, the credit rating agency, were feeling pressure to expand the business.

One employee warned in internal e-mail that the company would lose business if it failed to give high enough ratings to collateralized debt obligations, the investments that later emerged at the heart of the financial crisis.

“We are meeting with your group this week to discuss adjusting criteria for rating C.D.O.s of real estate assets this week because of the ongoing threat of losing deals,” the e-mail said. “Lose the C.D.O. and lose the base business — a self reinforcing loop.”

.....

In June 2005, an S.& P. employee warned that tampering “with criteria to ‘get the deal’ is putting the entire S.& P. franchise at risk — it’s a bad idea.” A Senate panel will release 550 pages of exhibits on Friday — including these and other internal messages — at a hearing scrutinizing the role S.& P. and the ratings agency Moody’s Investors Service played in the 2008 financial crisis. The panel, the Permanent Subcommittee on Investigations, released excerpts of the messages Thursday.

The released documents will be very interesting to read.

States' Revenues probably bottomed in Q1 2010

- by New Deal democrat

Last week the Rockefeller Institute issued its report on state finances [pdf] for the 4th quarter of 2009. Since it covers finances from 4 to 6 months ago, this is very lagging data. What is noteworthy is that the trend strongly suggests that on an annual basis state finances hit bottom at some point in the 1st quarter of this year, probably January or February, and are positive YoY now.

This by no means indicates that the states are out of the woods, or that more painful cutbacks aren't in store this year. In fact, if anything it makes the case for another big round of federal loans to the states to bridge the gap in their finances until they recover further.. Nevertheless, it appears the bottom has been reached. Here is the bullet-point summary of the Rockefeller Institute's report:

Total state tax revenues in the fourth quarter of 2009 declined by 4.2 percent relative to a year ago. The income tax was down by 4.6 percent, the sales tax was down by 5.3 percent, and the corporate income tax declined by 3.6 percent [vs. a year previously].
....
Preliminary figures for January and Februrary for 45 early-reporting states show continued weakness, with personal income collections dropping 7.1 percent and overall tax collections dropping 2.2 percent from a year earlier.
....
Preliminary figures for the 41 of 45 early reporting states with broad-based sales tax indicate that sales tax collections saw some trivial yet positive growth at 0.1 percent in January-February 2010 compared to the same period of 2009, but nonetheless the sales tax in the median state for these two months was down 4.2 percent. While March data could change the picture, the sales tax could see small positive growth in the January-March quarter as a result of stabilizing retail sales and consumption as well as legislated changes in several states

Note that these are all year-over-year calculations. The Rockefeller Institute explains that while

most economic time series have been adjusted to remove seasonality so that comparisons from one period to the next are meaningful[, g]overnment tax data, by contrast, rarely are adjusted to remove seasonal variations....

Looking at revenues on an annualized basis also makes sense because states are interested in how revenues compare with their annual budgets.

Although it was to be expected that on a year-over-year basis, state tax revenues would be worse in 2009 than 2008, given the freefall in the economy at the end of 2008 which bottomed in 2009, more important for our purposes is what the trend in tax collections portends for 2010. Here, the story is decidedly mixed, but late-breaking information suggests the turnaround probably occurred in March.

First of all, here is a chart from the Rockefeller Institute report, showing the trend in income, sales, and personal, corporate and sales taxes collections for the last 5 years



As you can see, tax collections fell off a cliff following the meltdown of September-October 2008, with YoY collections bottoming at (-27%) in the second quarter of 2009. If the upward trend of (+7.3 %) in the rate of change from the 3rd to 4th quarter of 2009 continues through the 1st quarter of 2010, Q1 2010, it will show a positive YoY comparison in tax collections.

When the Rockefeller Institute was preparing their report, they were pessimistic on this score:

[P]reliminary data on tax collections in January and February in 45 states show that year-over-year increases are few and far between. Tax revenue is continuing to decline in the median state, and at this point it appears as if the January-March quarter will have declines in the median state. … athough there is evidence of further slowing in the rate of decline. With preliminary data for January and February now available for 45 states, tax revenue for the two months combined has declined further by 2.2 percent versus the same period last year. About 84 percent of states reporting personal income tax data had a year-over-year decline, with a median decline of 7.1 percent, while 80 percent of states reporting sales-tax data had a year-over-year decline.

As indicated above, the late breaking news is March. The Rockefeller Institute report itself noted that "March data could change this troubling picture" and there is reason to believe it indeed has. According to the March 30 edition of Business Week:

The two-year slide in tax collections that opened a $196 billion gap in U.S. state budgets has stopped, easing pressure on credit ratings and giving leeway to lawmakers as they craft spending plans for next year. The 15 largest states by population forecast a 3.9 percent gain in tax revenue in fiscal 2011, budget documents show. The 50 states on average may increase collections by about 3.5 percent, the first time in two years the figure is expected to grow, said Mark Zandi, chief economist at Moody’s Economy.com. California took in 3.9 percent more since December than projected in January, Controller John Chiang said this month. New York got $129 million above forecasts in its budget year through February, according to a report from Comptroller Thomas DiNapoli. In New Jersey, the second-wealthiest state per capita, January sales-tax collections were 1.9 percent higher than a year earlier, the first annual increase in 19 months, forecasters said in a report last month.

In addition to California, New York, and New Jersey, I have been following about half a dozen other states to see when their sales tax revenues would increase YoY, ending any doubts about the upward turn in retail sales. Here are the results as of their latest reports:

- Ohio March sales tax receipts were up +2.4% YoY
- Pennsylvania sales tax receipts were up +8.5% YoY in March
- Alabama sales tax collection up +3.1% YoY in March
- Florida, which had been doing horribly, had sales tax revenues down only -0.6% YoY in March (compared to -4.3% in January, -4.9% in December and -8.1% in November)
- Tennessee, which had also been doing poorly, showed total tax revenues down only -0.4% in February, (compared with -1.8% in January, -2.9% in December, and -4.5% in November)
- Indiana, although still down -3.1% in March, was also an improvement from prior months (-4.3% in December, -6.1% in November)
- Texas, the only large state still doing poorly, reported sales taxes still down -7.8% in March, but overall revenues were up YoY. The sales tax decline was still a vast improvement over prior months' reporting, such as the -14.2% YoY decline in January.

As a side note, I am tracking these states in particular in response to the King of All Doomish Bloggers, Mish, who cited these states as proof that state sales tax receipts have not mirrored retail sales data, which turned YoY positive in October 2009. On this score, the Rockefeller Institute provides the perfect rejoinder:

while real retail sales have been rising from their lows for about the last year, they are still more than six percent below their prerecession peak. So even if sales taxes mirrored retail sales, they would be well below their recession peak. In fact, though, many state sales taxes exempt food and other necessities, and exempt or exclude many services, relying more heavily on non-necessities. Many of these taxable goods and services — such as cars, other durable goods and restaurant meals — are far easier to do without or postpone than are necessities and they tend to be more volatile and suffer greater declines in business downturns.

All of this is confirmed by what is happening with taxes paid to the Federal government. The Treasury Department publishes a daily report of its income and payouts. Even as the economy as a whole began to recover late last year, tax receipts were still down on a YoY basis (this is why raw YoY reports are problematic, unless you know the trend in the YoY numbers. A series inevitably will turn up from a bottom, but still be negative YoY for a number of months. Here is the Rockefeller Institute's headline chart entry as to personal tax withholding for the year 2009:

Given this trend, you would expect the comparison to turn positive in the first quarter of 2010, and according to the US Treasury Department, it did. Total receipts for February withholding tax receipts were only down -2.3% YoY, compared with January's -6.7% YoY shortfall. By the end of March, however, YoY tax receipts were UP 5% for the month. That improvement has continued this month. As of the latest report, April 2010 withholding tax collections were ahead of April 2009's collections by 6.5%. The below graph, which I have posted here before, is about 3 weeks old, but the trend is clear and speaks for itself:

So, are happy days here again? Of course not. Having most likely reached the bottom of the cliff, the states are on an absolute basis at the worst levels in decades, as reflected in the draconian cuts many states are making in their budgets. Undoubtedly some will have to continue to lop off many important services to bring their budgets into balance at this low level. The Rockefeller Institute believes that the average state has suffered a crushing loss of 18% in tax revenues from peak before the Recession, even if revenues are beginning to stabilize in early 2010:

What this post shows is that the fiscal situation is unlikely to get much worse. and should get better from here. The Rockefeller Institute report itself notes that it will probably take a number of years for states to repair the damage. The Business Week article noted that, although tax revenues are up compared with 2009,

This fiscal year, the 15 largest states expect to collect 11 percent less taxes than in fiscal 2008, budget proposals show. It won’t be until 2013 that revenue returns to 2008 levels, said New Jersey’s Rosen and Barry Boardman, the North Carolina General Assembly’s chief economist.

In the meantime, a continued Federal line of life support is necessary. Allowing fiscal assistance to the states to expire would be the worst kind of Hooverism (and actually, that's a slander on Herbert Hoover). The Federal government should extend low-interest grants to the states which do not have to be repaid until state budgets firmly reflect economic expansion.

Yesterday's Market

Let's take a look at the difference between the IWCs (micro-caps) and the SPYs (large caps)



a.) Prices move higher on a strong bar

b.) Prices inch higher, buy print small, bearish bars

c.) Prices again move higher strongly

d.) Prices consolidate

e.) Prices again move higher on a strong bar

However, notice there is a consistent uptrend and the bars are all moving to a place.


With the SPYs, we have three boxes of price movements, but there is little strong direction.

This is why the smaller cap issues have been leading the market.

Forex Fridays

The dollar is in a clear uptrend and has consolidated in several downward sloping pennants (a and b). In addition, the dollar is in a solid uptrend at point c. However, there is a strong fundamental reason for the upswing, largely caused by the situation is Greece which is leading to a flight for safety. In addition, notice the dollar and the euro are inversely related:

More of SilverOz's Thought Experiment

The ratings agencies are a big part of the problem. Most large institutional investors have funds that have specific investment guidelines, such as they won't invest in a bond that is below single a. By giving crap bonds a aaa rating, they allowed a lot of funds to invest in terrible paper. If the ratings agencies had done their job, they could have limited the fallout because fewer institutions would have purchased the lower rated bonds.

In my opinion the ratings agencies were central to the problem.

As if on cue:

A Senate panel is blaming credit rating agencies for helping banks disguise the risks of investments they marketed.

The Permanent Subcommittee on Investigations says in a report that the rating agencies relied on hefty fees from banks, which wanted them to rate risky investments as safe.

Ratings Agency Thought Experiment

I am posting this with a h/t to Barry Ritholtz over at the Big Picture who gave me an idea with his post on Fannie Mae regarding what would have happened had we completely removed FNM from the picture. I want to run a similar thought experiment, but replace FNM/FRE with the "ratings agencies" (ie Fitch, Moody's, and S&P).

Facts: The ratings agencies fell over themselves to give virtually all MBS "aaa" ratings no matter what the composition of the underlying assets (see ABACUS for a great example).

The Hypothetical Counter Factual: Way back when the first MBS is presented to the ratings agencies that has even one slice of subprime/alt-a/NINJA in it the agencies gave the MBS a rating less than "aaa" and further marked them down more based on the share of non-prime loans. The idea being that if a MBS comprised entirely of fully amortizing prime loans is "aaa", then anything even a bit less than that cannot get a "aaa" rating.

Question: Would the housing bubble/bust have still occurred? Would we have had a credit crisis? Would banks have fought over themselves to make any loan they could? Would it have even had to come down to the regulators?

Since I believe the answer to all these questions is in fact NO, then it seems to me we may have the root cause of our problem (and one that is not addressed in the "reform" package).

Jobless Claims Drop

From Bloomberg:

Initial jobless claims fell back to trend in the April 17 week, coming in at a largely as-expected 456,000 and reversing two weeks of administrative delays that swelled claims to as high as 480,000 in the prior week (revised from 484,000). The 456,000 level compares with 445,000 in the March 20 period, offering a flat comparison at best to gauge monthly payroll change. Despite the distortions of the prior two weeks, the four-week average shows a similar comparison: at 460,250 vs. 454,000 at mid-March. Continuing claims for the April 10 week fell 40,000 to 4.646 million with the four-week average down slightly to 4.644 million.

While the drop is good, notice that on the chart we're still in a range of 450-475/480.

Temporarily deleted while I clean up this post!

This post accidentally went "live" while I was trying to clean it up. I'll repost once done.

In the meantime, apologies to Brodero!

Update: Cleaned up and made presentable, here.

Yesterday's Market

The main issue this week is will the markets hold to their trends? There is a tremendous amount of downward pressure right now, largely from the Greek situation. So far, we've held, but the futures are trading lower as of this writing....

Thursday Oil-Market Round-Up

a.) Prices broke this uptrend three days ago, in the correction that started with the SEC's Goldman suit.

b.) This line of resistance is important for prices right now.

c.) Prices are currently in a downward sloping pennant pattern.

d.) The EMA picture is still bullish -- the shorter EMAs are above the longer EMAs. But there are important caveats now. Prices are below the 10 and 20 day EMA, both EMAs are moving lower and the 10 day EMA is about to cross below the 20 day EMA. This is not as important a development as you might think. largely because the 10 and the 20 day EMA are obviously more sensitive to price action. But it is definitely something to keep in mind as both now provide upside resistance.

e.) Momentum is moving lower but

f.) There is still money flowing into the market.

Welcome to Abnormal Returns Readers

We are glad you are here and pleased to be linked to from such an important blog.

Good News For the Bond Market

From Reuters:

Rising tax receipts will likely reduce U.S. government borrowing needs in the rest of this fiscal year and fiscal 2011, Morgan Stanley said on Wednesday.

Less supply may end up hurting bonds because it signals an improving U.S. economy -- which is typically negative for Treasuries, the U.S. investment bank's analysts said in a research note.

They predicted U.S. long-dated Treasury supply would fall by $52 billion for the remainder of fiscal 2010 and by $589 billion in fiscal 2011.

"While we are encouraged by this improvement it's hard to get too excited because it's like drowning in 75 feet of water instead of 100 feet of water," they wrote in the note.

Read This Now

Over at Macroblog there is a great discussion on bank size. As always, the issues are incredibly complicated.

Foreclosures: New wave or Crest (and is it bad or good)?

- by New Deal democrat

I got into a little debate with another blogger who viewed the March increase in foreclosures over February as the beginning of a new "tsunami." You can read his diary here if you wish. Mish also breathlessly reported that:

Foreclosure activity of all types spiked in the first quarter of 2010 according to RealtyTrac. Activity is now at an all time record of 932,234 properties.

[N.B.: Mish has been a reliable contrary indicator for the last year, unintentionally telegraphing turning points in data. Keep in mind below his contention that foreclosures "spiked" in the first quarter.]

In any event, I went back and dug out prior Realty Trac press releases, which suggest the new tsunami ain't necessarily so. I thought I'd share that data here, since it is worth tracking over the remainder of the year.

The genesis of this story goes back to this graph and others like it that made the rounds beginning in 2006:

showing that mortgage recasts and resets were coming in two waves: the first in 2007-08, and the second this year and 2011.

While we certainly have had a tremendous numbers of foreclosures, I have always been a little chary of the notion that the 2010-11 "back end of the hurricane" as Russ Winter once called it, was going to be nearly as big as advertised. That's because, while in 2006 lots of people were still deluding themselves that "real estate only goes up!" by 2008 and certainly 2009, they had been disabused of that notion. Thus, I expect that a lot of those homeowners, who are probably deeply underwater, already let their houses go into foreclosure, or else worked out a refinancing before now.

So, here are the year over year changes as measured in the last 12 months:

Month	YoY % change	actual foreclosures
04/2009	+32	342,038
05/2009	+18	321,480
06/2009	+33	336,173
07/2009	+32	360,149
08/2009	+18	358,471
09/2009	+29	343,638
10/2009	+19	332,292
11/2009	+22	306,627
12/2009	+15	349,519
01/2010	+15	315,716
02/2010	+6	308,524
03/2010	+8	367,056

Did anybody see that "spike" that Mish claimed happened in the first quarter? I don't think so. Note that my interlocutor said that the decline in percentage increases should be dismissed, because the actual numbers involved were so large. That doesn't appear to be the case either. So, contrary to March's increase being the beginning of a second wave, it seems more likely that this is the crest of the foreclosure wave

To be fair, though, our data up until now could be consistent with there being a lull during the "eye of the hurricane" in the graph above (that would have taken place early last year, so would be showing up in the last 5-12 months). If there is a new wave, or a "back side of the hurricane", then the percentages and the raw numbers of foreclosures ought to start increasing quickly. If, on the other hand, the 2nd derivative continues to be negative, then we ought to see foreclosures tip over into YoY negative percentages in the next few months, or certainly by the end of the year.

Of course, some people think that part of the increase we are seeing in retail sales (see my post below) is due to underwater homeowners "strategically defaulting" on their mortgage. If so, it is entirely possible that, on balance, an increase in foreclosures might be a net positive for the economy, as it means house prices aligning more closely with wages, and disposable consumer income increases. I happen to know of one young person who is doing exactly that after his bank refused to renegotiate his mortgage rate from 7% to 5%, on the grounds that he was a "poor risk" for the mortgage amount (Funny, the bank doesn't seem to feel that way about the mortgage at 7%).

In any event, I will update this graph from time to time. We ought to have a decent preliminary answer within the next 3 to 6 months.

Yesterday's Market

Consider the following on the QQQQ chart.

There is a head and shoulders pattern already formed along with a head that is a triple bottom.

On the DIAs, we have:



A double bottom.

Does this mean a move higher is guaranteed? Not at all. But it does tell us what other traders see for today's trading set-ups.

Wednesday Commodities Round-Up

In thinking about the housing market, I realized I haven't talked about lumber futures in -- well, a very long time. So, here are the charts:


Starting in 2005, lumber prices started a 4-year downward sloping channel line. In retrospect, this should have been a dead giveaway of problems in the US housing market.



On the weekly chart, notice that prices have clearly moved through key resistance areas.




a.) Prices are now in a clear uptrend.

b.) Prices have gapped higher in several situations

c.) The EMA picture is very bullish - all the EMAs are moving higher, the shorter EMAs are above the longer EMAs and prices are above the EMAs and are using the EMAs as technical support.

Is Deflation the Real Problem?

This is a follow-up to a post on Friday. This originally appeared at fivethirtyeight.com on Sunday.

Last week, the FT had a very interesting column which stated:

There is a growing risk that deflation will be seen as the gravest threat to the US economy by the end of the year, warns Nick Beecroft, senior FX consultant at Saxo Bank.

He notes that the minutes of last month’s Federal Reserve policy meeting show the US central bank becoming increasingly concerned with the fall in inflation.

And the latest consumer price data will have reinforced these worries, he says. “As the year progresses, the output gap – exemplified by the still chronically weak labour market and very low levels of capacity utilisation – will lead inflation inexorably towards zero.”

In addition, the minutes of the most recently released Federal Reserve Minutes had the following observations about deflation:

Meanwhile, a sizable increase in energy prices pushed up headline consumer price inflation in recent months; in contrast, core consumer price inflation was quite low.

.....

Although rising energy prices continued to boost overall consumer price inflation, consumer prices excluding food and energy were soft, as a wide variety of goods and services exhibited persistently low inflation or outright price declines. On a 12-month change basis, core personal consumption expenditures (PCE) price inflation slowed in January 2010 compared with a year earlier, as a marked and fairly widespread deceleration in market-based core PCE prices was partly offset by an acceleration in nonmarket prices. Survey expectations for near-term inflation were unchanged over the intermeeting period; median longer-term inflation expectations edged down to near the lower end of the narrow range that prevailed over the previous few years. With regard to labor costs, the revised data on wages and salaries showed that last year's deceleration in hourly compensation was even sharper than was evident at the January meeting.

.....

Headline consumer price inflation picked up around the world over the past two months, principally reflecting increases in food and energy prices. Excluding food and energy, consumer prices were generally more subdued.

.....

Reflecting these developments, inflation compensation--the difference between nominal yields and TIPS yields for a given term to maturity--declined over the period, a move that was supported by the somewhat weaker-than-expected economic data and the publication of lower-than-expected readings on consumer prices.

.....

Recent data on consumer prices and unit labor costs led the staff to revise down slightly its projection for core PCE price inflation for 2010 and 2011; as before, core inflation was projected to be quite subdued at rates below last year's pace. Although increased oil prices had boosted overall inflation over recent months, the staff anticipated that consumer prices for energy would increase more slowly going forward, consistent with quotes on oil futures contracts. Consequently, total PCE price inflation was projected to run a little above core inflation this year and then edge down to the same rate as core inflation in 2011.

.....

Participants saw recent inflation readings as suggesting a slightly greater deceleration in consumer prices than had been expected. In light of stable longer-term inflation expectations and the likely continuation of substantial resource slack, they generally anticipated that inflation would be subdued for some time.

.....

Participants referred to a wide array of evidence as indicating that underlying inflation trends remained subdued. The latest readings on core inflation--which exclude the relatively volatile prices of food and energy--were generally lower than they had anticipated, and with petroleum prices having leveled out, headline inflation was likely to come down to a rate close to that of core inflation over coming months. While the ongoing decline in the implicit rental cost for owner-occupied housing was weighing on core inflation, a number of participants observed that the moderation in price changes was widespread across many categories of spending. This moderation was evident in the appreciable slowing of inflation measures such as trimmed means and medians, which exclude the most extreme price movements in each period.

In discussing the inflation outlook, participants took note of signs that inflation expectations were reasonably well anchored, and most agreed that substantial resource slack was continuing to restrain cost pressures. Measures of gains in nominal compensation had slowed, and sharp increases in productivity had pushed down producers' unit labor costs. Anecdotal information indicated that planned wage increases were small or nonexistent and suggested that large margins of underutilized capital and labor and a highly competitive pricing environment were exerting considerable downward pressure on price adjustments. Survey readings and financial market data pointed to a modest decline in longer-term inflation expectations over recent months. While all participants anticipated that inflation would be subdued over the near term, a few noted that the risks to inflation expectations and the medium-term inflation outlook might be tilted to the upside in light of the large fiscal deficits and the extraordinarily accommodative stance of monetary policy.

So, the obvious question to ask is this: is the US economy facing an increasing possibility of deflation? To answer that question, I will look at overall CPI, along with the largest price components of CPI -- housing (41.960%), transportation (16.685%), and food and beverages (14.795%). I will also look at the GDP derived personal consumption expenditures' (PCE) price deflators (both overall and core), to see what conclusions the data leads to.

First -- what is deflation? Deflation is a situation where overall prices decline. While this might seem like a great idea, it is in fact one of the most dangerous situations an economy can face. As an example, at the start of the Great Depression, consumers greatly reduced their consumption. Therefore, to get consumers to start buying again, retailers lowered the prices of goods in their stores. These two events -- a drop in demand and a lowering of prices -- led to two problems. First, lower demand means fewer products are sold, which lowers the supply of a variety of goods. Secondly, lower prices lower retailers' profits. Lower supply of manufactured goods and lower profits at retailers leads to lower employment, which in turn leads to lower demand. This process becomes a self-perpetuating cycle. This process is called a deflationary spiral, and economists consider it one of the most damaging events an economy can face.

Secondly, what is core CPI and non-core CPI? Core CPI is a measure of prices without including food and energy. While this may seem counter-intuitive, there is a reason why it is an important measure. Food and energy prices are volatile and in some cases seasonal. For example, a series of spring-time thunderstorms in the mid-west could delay planting certain crops for a few weeks, leading to a spike in wheat and corn prices which would then drop when planting began. Or, a political development in the Middle East could lead to a spike in energy prices.Additionally, oil prices typically rise in the spring and summer because of the "summer driving season" -- the time of the year when Americans spend more time driving longer distances on summer vacations, thereby consuming more fuel. However, in all of the previously mentioned situations, prices typically return to a statistically "normal" level. In addition, by looking at the "core" CPI, FOMC policy makers are attempting to discern if commodity price swings are bleeding into other, non-core price areas, or whether commodity prices are isolated.

Finally, a little inflation is a good thing. It indicates that either producers have the ability to raise prices, or there is enough demand to increase prices or wages are increasing, leading to increased demand and therefore higher prices -- or a combination of the preceding three events. The first situation is referred to as supply push inflation, and it occurs when suppliers or producers have "pricing power" -- the ability to increase prices without seriously impacting demand. The second situation is "demand pull" inflation, and it occurs when more and more people demand the same amount of goods, thereby pulling prices higher. How much inflation is actually good is debatable. However, some inflation indicates the economy is growing.

The charts that follow are from the St. Louis Federal Reserve's FRED system. Please click on all charts to see a larger image. All charts use seasonally adjusted data.

Let's start with a look at seasonally adjusted CPI:


While the overall price level is increasing, the rate of month to month increase is very small. That means that overall prices are increasing at an incredibly low rate.



The year over year rate of change is running around 5%. However, note that level is in comparison to a negative year over year number a year ago. In other words, the year over year number is skewed. This is especially important in relation to the very low rate of change in the first chart which shows incredibly modest price changes.

Let's turn to the core CPI (CPI without food and energy prices) levels:


Core CPI has more or less stalled -- it dropped at the beginning of this year and has since risen a bit, but the rate of increase is incredibly low.



The year over year rate of increase is still positive, but the rate of the year over year increase is falling, and has been since roughly the third quarter of 2008. While the number is still positive, consider this chart in conjunction with the first core CPI chart that shows prices are barely increasing. The year over year rate increase will most likely continue to move lower (although still be positive) in the near future.

Let's look at some of the largest CPI component price indexes in the order of the largest to the (in comparison) smallest.

Housing related prices have stalled for nearly two years. Given the current state of the housing market, this is to be expected (see the discussion on the housing market here). But housing accounts for 41.960% of the overall CPI index, leading to a conclusion that these prices are having an incredibly negative impact on overall CPI.



The year over year rate of change for housing prices is negative. This is obviously having a very negative impact on the overall price level.


Transportation costs (16.685% of CPI) bottomed at the end of 2008, but have since been rising.




While the year over year number had a large drop at the end of 2009 that lasted through about mid-2009, the number has rebounded.




Food and beverage prices (14.795% of CPI) -- like housing prices -- have been pretty stagnant over the last two years.



And the year over year rate of change dropped into negative territory at the end of last year, but has been moving up since. It just turned slightly positive.

Let's now turn to the price deflator for personal consumption expenditures, which is found in the gross domestic product report.


The PCE deflator has increased from it's late 2008 lows, but has moved sideways for the last few months.


The year over year percentage change shot higher at the end of last year, but the reason for the increase is its rise from an incredibly low level in previous years. Considering that prices were declining for most of 2009, I would expect the year over year number to continue moving lower.


The core level has started to move sideways.




In addition, the core year over year rate of change has been moving lower since mid-2008.

The data indicates that deflation is not a problem -- yet. However, there is a tremendous amount of information indicating that deflationary concerns are well-founded. Housing related prices have been under pressure for the last two years. And considering there is no evidence of a massive housing rebound, this area of the CPI index will continue to move the index lowed. After spiking in 2008, the price charts for corn, wheat and soy beans have been in a sideways pattern. The only major CPI component that might provide upward pressure is transportation prices, but some of those effects will probably be seasonal. In addition, there is little reason to think the economy will experience either demand pull or supply push inflation in the near future. High unemployment means there will be little inflationary pressure from rising wages and the low rate of capacity utilization indicates there is little possibility of supply push inflationary pressures.

In short, deflationary pressures can't be ignored.

Finally -- and completely unrelated to this article -- IBLS has published a book I wrote, titled A Practitioner's Guide to U.S. Captive Insurance Law. It is available in their April 2010 Tax Law Review. For more information on this topic. please see this website.

Retail sales imply strong job growth for remainder of 2010

- by New Deal democrat

Introduction. Now that Jobs have bottomed, the question becomes, how quickly do they return?

In the last couple of weeks, we have gotten some economic data that is so strong it is almost scary. For example, just yesterday March Leading Economic Indicators were reported up 1.4%, meaning for the last 12 months the LEI are up ~12%! This is the strongest reading in two decades:

This implies a much stronger Recovery than either of the two "jobless recoveries" of 1992-3 or 2002-3.

Last week, retail sales were reported up 1.6% including autos due in large part to Toyota's rebates (blue line), and up 0.6% ex-autos (red line). This accelerates the return of the consumer since the bottom a year ago:

Since the consumer is 2/3 of the economy, and consumer spending is necessary for job growth, in the past I have pointed out just how important retail sales adjusted for inflation (a/k/a real retail sales) are. With the strong showing last week, there are major implications for job growth for the rest of this year, and that is what i discuss in this diary.

I. More than any other economic indicator, real retail sales have over the long run tracked consistently with payrolls

It is certainly true that any number of economic series have a correlation with payroll gains and losses. But none of them -- not GDP, not personal consumption, not person income, nor others -- over the long term tracks so closely with payroll growth. This first graph tracks real GDP (blue), real personal consumption (yellow), real personal income (purple), and real retail sales (green), along with jobs (red) since 1959, a period of over 40 years. It is easy to see that the red and blue lines track very close to one another, while over time the other three (GDP, consumption, income) all outpace job growth.


This second graph zooms in on the last 10 years. For a while, retail sales did diverge (demonstrating the impact of the "house ATM" or home equity extractions during the housing bubble).

But it alone has come back to earth, once again tracking the long term (lack of) growth in payrolls during the last decade.

In the past I have looked at GDP and compared it with payroll growth, noting that YoY percentage changes in GDP (minus two percent) appears to lead payroll growth:



The problem is that GDP is only reported quarterly, so by the time you learn the GDP for a quarter (like Q1 2010, you already know what the payroll growth was. At best, YoY GDP when initially reported, can give guidance about payroll growth over the next couple of months.

Similarly, Personal income (blue line below) seems to correlate well, but unfortunately as this graph shows it is not a leading indicator for jobs (red line) but only a coincident one -- the peaks and troughs occur simultaneiously:



In other words, it can confirm an already-reported jobs number, but cannot help us look at the future trend of job growth.

II. Real Retail Sales is the "Holy Grail" of Leading Indicators for Jobs

To the contrary, not only do real retail sales correlate closely with payrolls over the long term, but they are the "Holy Grail", consistently leading turns inthe job market. Here let me repeat something I have said in several prior diaries.

Contrary to the commonly held belief, historically it has not been the case that job growth leads to consumption. Rather, it is the other way around. Consumer spending typically leads jobs with a lag of about 5 months. Here is a graph showing that point as an average of all post-World War 2 recessions (0 = the month a recession ends):



Real retail sales (that is, retail sales adjusted for inflation) are the "Holy Grail" of Leading Indicators for job growth. They have consistently turned at both tops and bottoms, an average of 3-5 months before job growth or losses turned. Depending on the revisions to February's jobs report, and when the NBER decides to date the end of the Recession, this time around real retail sales, smoothed on a 3 month basis, bottomed either 8 or 10 months before jobs bottomed, longer than usual but not nearly with so much a lag as in the 2002-03 "jobless recovery."

In order to show you this relationship in the most comprehensive way, I am reproducing here graphs showing the entire 60 year record of real retail sales compared with jobs. With the sole exception of the 1961 recession, Real retail sales (the blue line) has consistently made peaks and troughs ahead of payrolls (the red line) ...

in the postwar period from 1948 through the 1962:



as it did during the 1970s recessions (ex the 1970 trough):


as it did during the 1991 and 2001 recessions and "jobless recoveries":



as it has just done with regard to the "Great Recession:"



Needless to say, this last graph strongly implies that, now that we have turned the corner and actually added 114,000 jobs in March, we will continue to have job growth.

III. Real retail sales suggest that we will have strong job growth for the remainder of this year.

But how much? For that, let's examine another way of looking at the relationship between real retail sales and jobs; namely, to graph the year-over-year percentage changes in each. That is what the next series of graphs show. Because real retail sales are historically much more volatile, these graphs take the YoY percentage change in real retail sales and divide by 2 (blue line), which historically yields a very close fit with YoY payroll changes (red line).

Here it is for the immediate postwar period:

And here it is for the 1970s recessions and recoveries:

And here it is for the two "jobless recoveries" and up until now:


Notice that the blue line turns both up and down first, before the red line. Also notice that the amplitude of the changes is usually very similar.

In fact, the weakest relationship by far occurred during the lame "Bush expansion." Real retail sales only went up more than 5% YoY (translating to 2.5% on our graph) for 4 months during that entire time: February and March 2004 and June and July 2006. It took 12 months thereafter for YoY job growth to peak at 1.7%. If our recovery winds up being as week as the Bush expansion, that would mean 2 million jobs added within the next 12 months, or an average of 165,000+ jobs a month.

On the contrary, following the deep 1974 recession, job growth lagged real retail sales in percentage terms by about 4-5 months. Following the severe 1982 recession, there was an average 8 to 9 month lag. In others, such as the 1992 recovery, there was only a 3 to 4month lag.

With regard to the "Great Recession", in percentage terms, real retail sales had their worst YoY decline in December 2008. Payrolls had their worst YoY percentage decline 6 months later, in June 2009. In the months since June, the YoY percentage of job losses/gains has continued to lag the YoY percentage losses/gains of retail sales by a median 6 months . If that relationship were to continue for the remainder of this year, then there would be 2.5% YoY job growth by September 2010, which translates into an average of almost 500,000 jobs gained for each of the next 6 months!!!

But let's be more conservative, and figure that, while this jobs recovery will be more robust than the awful "Bush expansion," it will not continue to be so V-shaped in percentage terms as it appears now. If we figure instead that the economy will grow by 2.0% jobs (not 2.5%) YoY by the end of this year (i.e., a 9 month rather than a 6 month lag), that means that in 2010, 2.5 million jobs will be added to the economy. Three months in, only 114,000 non-census jobs have been added. That means that beginning this month, the next nine months would average 250,000+ jobs a month, to grow the remaining 2.4 million. In comparison, that didn't happen until 1993 following the 1990 recession, and only happened at all sporadically during 2004-06 during the last decade.

Very few people have been calling for a job recovery that strong. It even gives me pause. And yet, that is what the data suggests, and so that is what I am reporting to you.