Wednesday, March 22, 2017

A look at yield curve compression


 - by New Deal democrat

Since the mid-1950s, an inverted yield curve has been perhaps the single most deadly harbinger of a recession in the next 1-2 years.  The most typical measurement has been the spread between 10 year and 2 year treasuries:



Typically these inversions have happened because the Fed raised interest rates in an effort to tame inflation deemed to high. Thus, because we are in a very low inflation and interest rate environment, I suspect this version of the yield curve is one of the most likely long leading indicators to fail to signal before the next economic downturn.  Most notably, the yield curve between short term and long term bonds never inverted at all between 1931 and 1954, as indicated by calculating the spread of the archival "long term government securities" data with 3 month treasuries:



My suspicion is -- and here unfortunately I do not have any old data to compare with -- that a compression at closer points along the yield curve is likely to be a more accurate signal in this environment.  To show you why, let's take a look at the spread between 30 year and 10 year treasuries (blue in the graphs below), 10 year and 5 year treasuries (red), and 5 year and 2 year treasuries (green).

Here is 1977 to 1997:



and here is 1997 to 2017:



The first thing I want to point out is that in advance of all recessions in the last 40 years, yield curve inversions happened across the board.  All three measures inverted.

Secondly, a compression of all three measures on the order of +0.5% or less was associated with stock market corrections (in the case of 1987, a crash!), but not an outright recession in the near future.  

Finally, the most likely measure to invert, including a number of "false positives" for recessions, was the 30 year minus 10 year measure.

With that in mind, let's focus on the last 5 years:



In this era of very low rates, the shortest term measure (5 year minus 2 year) has crossed the +0.5% threshold to the downside several times. The measure next out in the range (10 year minus 5 year) crossed once -- the middle of last year.  The longest term measure (30 year minus 10 year) has never crossed the threshold.

We can put this information together by calculating the average spread among the three measures, by taking each value, adding them together, and dividing by 3.  When we do so, here's what we get:



No matter how you look at it, at least compared with the last 40 years, no aspect of the yield curve is signaling any danger now.  

But if we suspect that it is not necessary for the yield curve to outright invert before the next recession (noting how little of an inversion there was in 2006 before the 2008 recession), then at least we can raise the caution flag in the event that either one or both of the following two things happens: (1) all three term measures declined below +0.5%; and/or (2) the average of the three term measures declines to +0.3% or less.  

It is certainly not a perfect work-around.  Although the data series are different, no compression at all between long term and 3 month securities occurred before the 1945 demobilization recession, nor before the severe 1938 recession (which appears to have been caused fiscally rather than by Fed action). 

But even so, if we think that this low interest rate and inflation environment will function more like that of the 1920s-early 1950s, then measuring yield curve compression across maturities will at least keep us on our toes.

Tuesday, March 21, 2017

What's behind stalled nonsupervisory wage growth?


 - by New Deal democrat

Wage growth for nonsupervisory workers nominally has been stuck in the +2.3% to +2.5% range (or worse) for three years.  Why? 

Over the weekend I was cleaning out some old graphs, and came across this one from the Atlanta Fed, suggesting that the Phillips Curve (the tradeoff between unemployment and inflation) is very much alive, with the tweak that the amount of wage growth follows a decline in the unemployment rate with a one year lag:



The red line is the progression of the Phillips Curve since the beginning of 2011. The dotted line indicates that the Altanta Fed's model was calling for a significant acceleration of wage growth between the spring of 2016 and spring this year.  [NOTE: all of the discussion in this post is about nominal, not inflation-adjusted wage growth, which has an awful lot to do with the volatility of gas prices.]

Except when we look at wages for nonsupervisory workers, that really hasn't happened, at least not through February.  The below graph compares the YoY change in the unemployment rate (blue) and YoY wage growth for nonsupervisory workers (red):



As noted above, wage growth has been stuck at between 2.3% YoY and 2.5% YoY with some (mainly negative) exceptions since the end of 2013. 

Using the U6 underemployment rate to capture the broader picture doesn't change the outcome:



So, what's going on?

I suspect that the change in the labor force participation rate (i.e., that portion of the population actually in the job market, whether employed or unemployed) is the answer.

When I use the labor force participation rate for the prime working age population (ages 25-54) (blue) and measure that YoY vs. wage growth, even going all the way back over half a century to 1964, here's what I get:



With the very significant exception of most of the 1980s, the trend in prime age labor force participation appears to lead the trend in wage growth by one to two years.

What is most interesting is that in the era of labor force bargaining power (up until about 1982), a big increase in the labor force lead to a considerably larger amount of wage growth. Once labor's bargaining power was broken during the early part of the Reagan Administration, the big secular  increase in labor force participation did not show up as wage growth inflation, but rather as more job growth with outright *decreases* in the average hourly wage. 

Note further that since the late 1980s, twice an increase of +0.6% YoY in prime age labor force participation has led to nominal wage growth of +4.0 YoY about one year later.

Now let's zoom in on the last 5 years.  The below graph compares the growth in employment (blue) averaged over each half year, with that of the overall labor force participation rate (red) and the prime age participation rate (green):



What is interesting is that over that entire time, average employment gains over each period have not varied that much.  What *has* happened, especially notably with those of prime working age, is a temporary pause in the decline in early 2014 and 2015, coincident with the first stalling and then decline in wage growth, and then a surge of participation in 2016, especially during the first half of the year.

To put this in perspective, the participation among the prime 25 - 54 age group plateaued beginning in 1989 (after the secular rise due to women entering the labor force):



So here is the YoY change in the participation by those in prime age since that time:



The YoY change in participation in the last two quarters of 2016 (the last two bars) averaged +0.65%. That is the biggest such increase in participation in the last 30 years!

Putting this together, it appears that the surge in new participation in the labor force, with no surge of employment growth, showed up in a pause in the decline of the unemployment and underemployment rates.  As shown below, in the year from September 2015 through September 2016, the unemployment rate only fell -0.1%, from 5.0% to 4.9%. The U6 underemployment rate only fell -0.3%, from 10.0% to 9.7%:

  

This surge in competition for new jobs acted to depress wage growth.

If the long-term graph comparing wage growth and the prime age LFPR is correct, however, and particularly if the same pattern of the late 1980s and 1990s is followed, then the surge in the LFPR does portend a significant acceleration in wage growth for nonsupervisory employees -- finally -- later this year.  That the U6 underemployment rate has declined significantly again in the last 3 months is supportive of that suggestion.

We'll find out soon enough.

Saturday, March 18, 2017

Weekly Indicators for March 13 - 17 at XE.com


 - by New Deal democrat

My Weekly Indicators post is up at XE.com.  This week it is pretty self-explanatory.  Nearly all short leading and coincident indicators are positive.

Friday, March 17, 2017

Housing, production, and JOLTS all good news


 - by New Deal democrat

We've had a good run of economic news this week.

First, in the leading housing sector, both of the most important datapoints made new highs.  Single family permits, which are just as leading as permits overall, but much less volatile, made yet another post-recession high.  Further, the three month rolling average of housing starts, which are more volatile and a little less leading, but represent actual economic activity, also made a new post-recession high:



The headline number for industrial production for February was flat, but once again that was due to the seasonally-adjusted big decline in utility production due to a very warm February (sure glad that global warming is a hoax perpetrated by the international scientific community).  Manufacturing output rose to another new post-recession high (although, to be fair, still below its peak from one decade ago), and mining output continues its big bounce off last year's bottom:



Finally, for once we got a truly good JOLTS report (for January), showing that the quits rate rose to a post-recession high that also equalled its high (save for one month)  during the Bush expansion:



and actual hires (as opposed to the overrated and somewhat fictitious openings) also rose, although not quite to a new post-recession high:



Not perfect, but really good news on a number of fronts representative of the Indian Summer of this expansion.