ADER’S MUSINGS: HOLDING PATTERN TO FOMC

(I'll admit, not one of my better Musings, but to everything turn, turn, turn. Anyway, I ask your help on some things. Feedback on these, pass it around, add people to my distribution list. I'm hoping to expand my network and dialog and can distribute this on Bloomberg and email as well as here.)

September 14, 2018

* Beige Book finds trade issues have held back some investment, -- all districts see input price pressures, cite tariffs, -- wage gains modest to moderate, -- no reason to change odds of hiking trajectory from this report. * CPI moderates (base effects in part), YoY up 2.7% from 2.9%, core up 2.2% from 2.4%. -- okay news on bond front, also on wage front as REAL AHE are up 0.2% YoY. * Real Average HH income in 2017 up, but statistically flat vs. 1999 and 2007 prior peaks. (see chart). * Get this, older people got most of the jobs since 2000 and 2008! -- this has economic implications (see below) * Fed sees recent gains in participation slowing, blame robots, foreign workers, prison, opioids. * EM weakness dominates media, not a new story nor much new insight. * Making the rounds; JFK on universal healthcare. (https://goo.gl/fjwa8v)

I have to again say, out of frustration, that I don’t understand how the people can ignore the real wage components to the current narrative in light of recent CPI and AHE figures. I don’t have any doubt that this will NOT discourage the Fed from hiking, but I don’t understand how so many people and the press are willing to ignore the real component to income gains. I suppose the news is simply so good everywhere else that this particular aspect seems the anomaly, but not enough for me to avoid bringing it up again and again. In any event, with the release of August CPI at least the real Average Hourly Earnings YoY gain is in positive territory albeit a pretty lame gain of 0.2%.

Semi-related to such wage issues was data from the Census Bureau on Real Median Household Incomes. The headlines sound good along the lines of “Incomes Rise, Poverty Falls Again,” and that is true; such incomes grew 1.8% over 2017, the 3rd consecutive annual gain (but at a slower pace). The flipside to that coin is that, according the Census, the gain is not ‘statistically significant.’ This is an interesting note because, as per the chart, the current level of $61,372 is barely above the prior peaks of 1999 and 2007, which is to say, we’re not better off than we were then in purely income terms.

In fact, the story is especially interesting when you compare Average to Median. The Average Incomes are up somewhat more than Median pointing to an outsized gain by a few at the upper tier of the income gain. This underscores the wealth divergence, call it income inequality, of the last two decades. 

I’ve read in recent days about higher Treasury yields as if another foray in 10s near 3% represents a new bear market. It’s a case of I think over emphasizing price action in a narrow context amidst a lot of perhaps confusing inputs and noise out there. I don’t see much direction. 10s have traded pretty much in a 20 bp range since late May, and I don’t yet see a break out. 2.80-3.00% has contained, what, 95% of the price action? That’s remarkable and revealing in that it implies the market is either at fair value or simply frozen by events. 

There’s truth in both aspects, but I’ll put more on the event component. We have ongoing trade tumult, the steady hand of the Fed (where Dec Funds now give 77% odds of a hike) boosting the dollar and flattening the curve with all that implies as 2s/10s flirt with 20 bp. There’s the repercussions for EM debt exacerbating the problems, political and financial, in specific countries and spreading to general risk aversion. There’s the mid-term elections. And there’s this Administration’s foibles, a word which is giving it the benefit of the doubt.

In short, I think we wait. The hike this month is all there with the nuance being is it a ‘hawkish’ hike that points to confidence (as per so much of recent Fedspeak) or a ‘dovish’ one hinting at a pause. My thoughts are they stay optimistic and can nuance things as those events I spoke of unfold.

I had a long conversation with an asset manager about the behavior of the long end coming out of the Lehman crisis, the question posed being why did long yields rise over 200 bp from the end of 2008 to the middle of 2009. The concern was that an increase in issuance could replicate that experience.  Is that a playbook? Hardly. First, the Fed was easing dramatically (a process that had started in 2007) and by year end 2008 Funds were at 0.25%. Second, BEIRs were plunging into the end of 2007 and had started to rise into an inflation that never materialized despite the Fed’s largesse and all the recovery programs then underway. Headline inflation was negative for nearly all of 2009, for example, while TIPS BEIR rose from 0.11% at the end of ’08 to over 2% towards the end of 2009. Third, the dollar index was under pressure, again, related to the goings on in terms of monetary policy.

The end of 2008 was in full panic mode, flight to quality, end of world, and the levels of 10s, 30s, obtained by mid-2009 were a response to the hope that policies would work. In context? 30s hit 4.7% in 2009. This is all to say there were other things going on unrelated to supply concerns that forced 30s to surge and, notably, that didn’t last too long. To their benefit was the whole array of contagions in Europe from Grexit to the peripherals to broader central bank largesse and negative rates. But, again, I don’t think the supply story was the driver then and don’t think it will prove the driver in the days to come.

CHARTS AND THEMATICS:   I’ve written a lot about the state of the jobs market, robust on so many levels, to scrape beneath the surface, point out the chinks in the armor.  Demographics are the main idea, where an aging population is content with working at all, with benefits and a bit of flextime at the expense of income gains. Whether you buy into that concept or not you can’t argue with facts. And the facts are that real wage gains have been lame, the workforce and population has been aging and most of the jobs are going to the older demographic cohort begging the question, ‘what do they really want?’  At least I think it begs that question!

My calculations show that those 55 and older took over 50% of all the job gains since early in 2009 and nearly 70% of those 25 and older. That is a remarkable achievement for older folks. Those 20-54 year olds have not fully regained the jobs they had in 2008. 

Obviously, there are various things at work here, not the least of which is sharp rise in the older cohorts as a % of the population and, perhaps, the young having had a harder time and stayed in school, stayed out of the workforce entirely, or something altogether different. The evidence for this broad shift can be seen in the Participation Rate by age group.  Those 55+ folks are at 40.2%; in 2000 their participation rate was just 32%. Part of the story is just that the country is older, but participation rates are about a specific group relative to itself not the population as a whole. Thus, it also shows that older people are staying in the workforce longer than ever.                                        

Meanwhile, overall participation has fallen: from 67.2% in early 2001 to 62.7% today. The best performing participation rate lies with those 55+.

The St. Louis Fed did a piece recently that challenges some of my figures. Their report (https://goo.gl/uTvS5B) on the matter runs “Staff Pick: Older Workers Account for All Net Job Growth Since 2000.” In other words, my numbers were not as dramatic as what these Fed researchers found; “all of the net increase in employment since 2000—about 17 million jobs—has been among workers aged 55 and older.” (This next chart is a replication of the chart in the Fed report.  I’m happy to share it with you if you have Macrobond or simply want the data.)

The authors caution that this raises the concern about slower economic growth as a result of this, let’s call it, phenomenon. While older workers are more productive, the lack of younger people coming in to learn skills, experience, work longer and consume come to mind as long-run problems. The researchers do suggest that this trend cannot continue at such a rate; people are aging at a slower rate and there is an end game to that older cohort if you catch my drift. Too, they don’t expect employment-to-population ratios by age group to diverge. The latter means that the employment-to-population ratio for 55+ is at 39% from just 31% in 2000 but has fallen to 72% from 77% for the youthful lay-abouts under 55. “Unlikely,” is how they put it, “although not impossible.”

For the investable future though, they still see the recent trends holding. For instance, based on Census data they see employment by age group for 55+ moving to 23.7% in 2027 from 23.1% today, and 65+ moving to 8.4% of total employment from 6.2% today. In other words, the aging population and workforce that may have held back economic growth will give way in, oh, “the next decade or so.”

The authors don’t really talk about why this all means slower growth, but you and I have a sense assuming you’ve been following my work for a while. First, as I suggested, older workers are increasingly less productive, so their best earnings gains are behind them. Thus, slow wage growth. Second, they have bought most of what they need and are well past the household formation stage and so buy/consume less. Third, in the wake of at least two recessions and more like three and four for the baby boomers, they are probably happy to have incomes -- vs. wage gains -- to help boost diminished or simply inadequate retirement savings. There’s more, I know, but I think that captures a good enough chunk. I also sense that there’s crowding out of younger workers in the process, but this is another matter.

IN OTHER NEWS:  I like when themes show up a lot which I suppose is why they’re called themes. To wit, another Fed piece, this one out of San Francisco and titled “The Prime-Age Workforce and Labor Market Polarization,” speaks to the fall in participation and suggests it’s not simply a function of the last recession. Rather, they seek to identify the other factors which explain participation rates are not likely to rise.

They begin with the nod to labor market strength best manifested by the Unemployment Rate and the dive into the ‘different’ signal offered by diminishing labor participation. They give top billing to what they call ‘labor market polarization’, a function of fewer and fewer manual-labor jobs out there which, in turn, helps explain and predicts the stylized term they use for less participation, i.e. declining worker attachment. They give honorable mention to more vague concepts like economic and social trend and health considerations. 

The Fed study notes that some observers use the lower participation rate as evidence that there remains a degree of labor slack not captured elsewhere. This is especially the case given the decline in the rate for people in their working-age prime, 25-54.  Cutting to the chase of the matter, they see the issue as one of long-term changes vs. cyclical weakness due, largely, to the loss of those middle wage and skills jobs. That alone accounts for half of the decline of the participation rate.

Certainly, people retiring is part of the overall decline, though again this particular cohort, 55+, grew as a percent of the labor force and has seen its participation rise and then hold since 2008. Obviously, retirement would not be a factor with prime age folk with a possible exception of lucky Silicon Valley types who made it big quickly.

Here’s the thing. If you look narrowly at those Prime-age workers since 2015 there’s been an encouraging increase in participation. The Fed paper, however, cautions that this is unlikely to be sustained and, indeed, is likely to fall back some. (NOTE that when participation falls, the Unemployment Rate looks better; simply, there are fewer workers deemed unemployed because they are not in the job market and so those working are a larger percentage of the labor force. We’ve seen this a lot in the recent cycle where UNR drops but is entirely due to the fall in participation. The improvement since 2015, however, is thus laudable.)

So why won’t this trend be sustained? The Fed cites a study by the NBER, “Explaining the Decline in the U.S. Employment-to-Population Ratio: A Review of the Evidence,” by Katharine Abraham and Melissa S. Kearney, which points to demand factors stemming from trade and robots as the key elements in the recent period and expect those to continue. They mention some increased participation in disability programs, which they deem less critical to the story, as well as the rise in minimum wage and number of folks with prison records as factors. Unknown contributors, in terms of magnitude, include drug use (opioids) and young people living at home, cost of child or old age parent care and a lack of worker mobility (think dual income households).  They also talk about the quality and technology of leisure pursuits taking away jobs. They don’t blame immigrants, by the way. 

The upshot they provide is that the loss of manufacturing jobs is the main culprit and the lack of comparable jobs in terms of skills or pay is the result. Jobs lost to overseas is a part of that (lower paying), but technology in both robotics to do manual tasks and technology as a well-paying but lower-employing industry get emphasis.

The Fed piece finishes with an obvious but I thought politically controversial potential. The say monetary and fiscal policies won’t reverse the trend, but if better participation is a goal -- and why wouldn’t it be? -- then skill training, better mobility, better workforce health, easing childcare constraints and other things to encourage prime-age adults are needed.  Alas, they don’t answer who pays for any of that.

I couldn’t end this section without commenting on the number of emerging market stories continuing to generate ink. The NYT greets the front page of a business section with, “A Chilling Growl From Emerging Markets; Edgy Investors Are Retreating From Risky Economies. How Far Will the Panic Spread?” And from the FT, “Hong Kong enters bear territory amid emerging market sell-off” with the WSJ offering, “The Bear Mauls Another Market.” (The latter led with Hong Kong.)

Let me whine a bit. I read these to gain a grasp on the future, but it seems, with the utmost respect, that simple price action is the story. The FT talked about specifics to the Chinese market, technology behavior, and I get the need to explain price action but would like to understand the whys of it without reference to the tariffs, Turkey and Argentina and EM contagion. Like, is it a legitimate selloff or more emotional? It’s emotional, we know that, but I scour for depth and vision and come up wanting.

The NYT piece is more of the same ilk, and the question “How far will the panic spread?” surely is provocative.   It asks good questions about what’s going on, doesn’t answer them, and I suspect raises nerves amongst investors individual and otherwise.  The last sentence, warns that if trust in EM sovereigns fades, “…look out below.” Is that helpful?  Indeed, all of them, articles on EM past, present and futures, are nothing if not unsettling and I wonder when, if, those transfer over to domestic market sentiment. 

No man is an island, right?  That companies are joining hands to attempt to persuade Trump to lighten up on the tariffs is telling especially in light of the Beige Book’s note about some firms holding back on investment. I have nothing much to add other than to watch how it unfolds.  

Dr. Derek Horstmeyer in a WSJ report on Fixed-Income Investing, talks about yield curve inversion and offers advice WHEN it inverts, noting that in recent years the inversion has been a very reliable precursor to a recession. His ideas? -- long bonds do best, shorter bonds next and stocks do the worst.  He rains on the parade, however, noting that after inflation bonds are the only asset class with even a paltry positive return; 1.3%. Better than nothing, right?  Oh he notes that in most recent episodes stocks to the worst with the inversion rather than the recession itself, suggesting a number of things not the least of which is that 1) the curve does anticipate the slowdown rather well, and 2) risk assets have increasingly gotten too rich for their own good beforehand, and, maybe, 3) stocks dividends have come down to the point where they no longer can temper a risk-off environment, especially when the nature of the S&P 500 is less ‘defensive’.

NEAR-TERM MARKET THOUGHTS:  The curve doesn’t have far to go to achieve the technical objectives and I can’t see the need to push 2s too much further into the September 26 meeting. I had thought we could get some corrective steepening but am losing that idea given the behavior of 10s near the 3% mark.   There could be a falling wedge reversal at hand, but my immediate objective is limited to say 2s/10s at 25.6 bp or the 40-day MA.  That said, I do see the potential for 2s to fulfill the objective and touch 2.79% With so much data out of the way and Fedspeak pretty clear, I simply don’t see any need to nuance this meeting further.  Too, with odds of a December move better than 75%, the thing that might skew that, the FOMC statement, has to wait. 

I don’t have much of a take on stocks, other than to reiterate they are too rich for me but being right and early is pretty much the same as being wrong. That said there is a possible rising wedge in place that targets the S&P 500 to around 2845. I’ll keep an eye on it.

I’ll concede this doesn’t demonstrate a lot of conviction, not does price action warrant it. I mean if after getting supply out of the way, a somewhat friendly CPI report, softer Retail Sales and big drop in Import prices yields can’t rally (much) and blame falls on rate locks I don’t think I can skew the picture one way or another.  Softer though this data be, the inability to rally and allure of 3% 10s and a discounted Fed hike leave me nonplussed.

David Ader, Chief Macro Strategist for Informa Financial Intelligence

Bringing 30 years of investment strategy experience to his role at Informa Financial Intelligence, David Ader has held senior positions at major investment banks and financial information firms as well as serving on investment policy committees and management teams. Most recently Partner, Head of Government Bond Strategy for CRT Capital, he headed the team voted #1 in U.S. Rates Strategy for 11 years and #1 in Technical Analysis for five years in Institutional Investor’s annual survey.

Informa Financial Intelligence obtains information for its analysis from sources it considers reliable, but does not guarantee the accuracy or completeness of its analysis or any information contained therein. Informa Financial Intelligence and its affiliates make no representation or warranty, either express or implied, with respect to the information or analysis supplied herein, including without limitation the implied warranties of fitness for a particular purpose and merchantability, and each specifically disclaims any such warranty. In no event shall Informa Financial Intelligence or its affiliates be liable to clients for any decision made or action taken by the client in reliance upon the information or analyses contained herein, for delays or interruptions in delivery for any reason, or loss of business revenues, lost profits or any indirect, consequential, special or incidental damages, whether in contract, tort or otherwise, even if advised of the possibility of such damages. This material is intended solely for the private use of Informa Financial Intelligence clients, and any unauthorized use, duplication or disclosure is prohibited. This material is not a comprehensive evaluation of the industry, the companies or the securities mentioned, and does not constitute an offer or a solicitation of an offer or a recommendation to buy or sell securities. All expressions of opinion are subject to change without notice.