Author Archive for Warren Mosler

Mosler: Time to Buy Equities

By Warren Mosler, Mosler Economics

I’m thinking it’s about that time for portfolio managers to buy stocks and go play golf for a few years, with the following very caveats:

1. A serious spike in crude oil/gasoline prices that undermines consumption
2. The euro zone could break down socially under the stress of continued austerity
3. Congress opting for ‘meaningful’ proactive deficit reduction

But apart from that it looks like relatively clear sailing to me. The Republicans are now softening on revenue increases to get past the fiscal cliff. And in any case the fiscal cliff may already be up to 50% discounted, as business has slowed due to delayed contracts, etc. & with top line growth still remaining modestly positive as the cyclical housing ‘recovery’ begins its multi-year upward grind, providing a powerful ‘borrowing to spend’ force for growth. I call it a drop in ‘savings desires’ as borrowing is in fact ‘negative savings’. This is fundamentally supported by continuing federal deficit spending that, while down from the peak, is still looking more than high enough to support a growing credit structure.

And the 4 years of ‘larger than ever’ federal deficits have added exactly (to the penny) that much in dollar net financial assets to the global economy, with much of that being added here domestically. This is evidenced by the full recoveries, and then some, of macro debt service ratios of all types. In short, ‘savings’ has been, for all practical purposes, more than sufficiently restored for a ‘normal’ recovery. This kind of underlying strength will quickly cause the Fed to re-evaluate policy as unemployment drops towards 7%, leading to a ‘normalization’ of policy, which means a fed funds rate at a ‘normal’ premium over ‘inflation’ for a ‘neutral monetary policy.’ In fact, as this happens, the higher rates from the Fed further support the expansion via the interest income channels.

The output gap is wide enough for this to go on for a long time without excess demand issues, again with the caveat of crude oil. Growth has already caused the federal deficit to come in lower than expected, which is helping put off proactive deficit reduction efforts. Yes, eventually, the automatic fiscal stabilizers will bring the deficit down too far for it to support the credit structure, and serve to end the cycle. But this is WAY down the road.

The first Obamaboom came from the ‘stimulus’ which wasn’t nothing, but was far too weak to remove the sudden drag on demand from the private sector credit contraction. The ‘crime against humanity’ was not implementing the likes of my proposed ‘payroll tax holiday’ in mid 2008 to support demand at full employment levels at that time. Instead, the govt allowed demand to collapse/output gap to widen. This did not have to happen. It was a total failure of govt.

Also, timing is also important, so mind the technicals!

GLOBAL THEMES

By Warren Mosler, Mosler Economics

  • Austerity everywhere keeps domestic demand in check and export channels muted
  • Non govt credit expansion pretty much stone cold dead in the US and Europe
  • Rising oil energy prices subduing global aggregate demand
  • US federal deficit just about enough to muddle through with modest GDP growth
  • Rest of world public deficits also insufficient to close output gaps, including China which has calmed down considerably
  • Zero rate policies/QE/etc. in the US, Japan, and Europe doing their thing to keep aggregate demand down and inflation low as monetary authorities continue to get that causation backwards
  • All good for stocks and shareholders, not good for most people trying to work for a living
  • Europe still in slow motion train wreck mode, with psi bond tax risk keeping investors at bay and ECB waiting for things to get bad enough before intervening

So still looking to me like a case of:

‘Because we fear becoming the next Greece, we continue to turn ourselves into the next Japan’

The only way out at this point is a private sector credit expansion, which, in the US, traditionally comes from housing, but doesn’t seem to be happening this time. Past cycles have seen it come from the sub prime expansion phase, the .com/y2k boom, the S&L expansion phase, and the emerging market lending boom.

But this time we’re being more careful of ‘bubbles’ (just like Japan has done for the last two decades). So I don’t see much hope there.

Still watching for the euro bond tax idea to surface, which I see as the immediate possibility of systemic risk, but no real sign yet.

A QUICK LOOK AT THE 489B EURO LTRO

By Warren Mosler, Mosler Economics

When it comes to central bank (CB) liquidity operations, as previously discussed, it’s about price – interest rates – and not quantities of funds. In other words, the LTRO is an ECB tool that assists in setting the term structure of euro interest rates. It helps the ECB set the term cost of funds for its banking system, with that cost being passed through to the economy on a risk adjusted basis, with the banking system continuing to price risk.

So what does locking in their funds via LTRO do for most banks? Not much. Helps keep interest rate risk off the table, but they’ve always had other ways of doing that. It takes away some liquidity risk, but not much, as the banks haven’t been euro liquidity constrained. And banks still have the same constraints due to capital and associated risks.

To it’s credit, the ECB has been pretty good on the liquidity front all along. I’d give it an A grade for liquidity vs the Fed where I’d give a D grade for liquidity. Back in 2008 the ECB was quick to provide unlimited euro liquidity to its member banks, while the Fed dragged its feet for months before expanding its programs sufficiently to ensure its member banks dollar liquidity. And the FDIC did the unthinkable, closing WAMU for liquidity rather than for capital and asset reasons.

But while liquidity is a necessary condition for banking and the economy under current institutional arrangements, and while aggregate demand would further retreat if the CB failed to support bank liquidity, liquidity provision per se doesn’t add to aggregate demand. What’s needed to restore output and employment is an increase in net spending, either public or private. And that choice is more political than economic. Public sector spending can be increased by simply budgeting and spending. Private sector spending can be supported by cutting taxes to enhance income and/or somehow providing for the expansion of private sector debt.

Unfortunately current euro zone institutional structure is working against both of these channels to increased aggregate demand, as previously discussed. And even in the US, where both channels are, operationally, wide open, it looks like FICA taxes are going to be allowed to rise at year-end and work against aggregate demand, when the ‘right’ answer is to suspend it entirely.

Addendum - The initial rate on the 3 year LTRO was reported to be ‘fixed’ at 1%, but turns out it adjusts with the policy rate and will be an average of the policy rate over the three year term. So it doesn’t fix rates for the banks, it just ensures funding at the policy rate. which makes sense, as the bank’s cost of funds is the policy instrument of the ECB.

Also interesting is how in the case of bank defaults the member nations guarantee the bank deposits. But those member nations get their funding from bond sales. And with the weaker ones that means bond sales to the ECB. So in that sense, the ECB is backing bank deposits, which means when it provides liquidity and takes collateral, should the bank subsequently realize losses, causing the ECB to realize losses on the funds provided to the bank for liquidity, the member nation would then sell bonds to the ECB to get the funds to pay for the loans it got from the ECB.

Again, it all comes down to the ECB writing the check. And it all works from a solvency point of view when the ECB writes the check. And the ECB writing the check introduces a serious moral hazard issue. Hence the (over) emphasis on austerity.

SAUDI OIL PRODUCTION HELPING AVOID A 70’S STYLE STAGFLATION

By Warren Mosler, Mosler Economics

The Saudis are the only producer with excess capacity, which puts them in the position of swing producer. They post prices and then let their refiners buy as much as they want at their posted prices. They have no choice but to be price setter, but they also don’t want anyone to know they are simply setting prices, so they talk around it and have obviously done a good pr job in that regard.

So after production spiked due to lost Libyan output, production now seems be falling back to prior level as Libya comes back online.  There are other things affecting supply and demand as well, also altering Saudi production accordingly. The Saudis lose control of price on the upside only when they don’t have sufficient productive capacity to meet demand. And they lose control on the downside when they can’t cut sufficiently to address a fall in net demand.

Looks to me like they will remain in that catbird seat for quite a while.  And if they keep prices relatively stable there will not likely be a 70’s style global inflation problem.

MACRO MUSINGS

By Warren Mosler, Mosler Economics

Best I can tell the jury is still out as to whether China is going through the ‘hard landing’ scenario that began when modest first half state lending was followed by lower second half state lending, all to control inflation.

Note the recent social unrest that could be inflation linked.All we know is the regime change risk was sufficient for them to cut back on growth.And so far not much sign of anything of consequence in the pro growth direction, which means the political concerns over inflation are still there.

The currency could also be heading south fundamentally due to inflation. Net FX reserves may be down to minimum levels
after factoring in their dollar debt that’s been indirectly supporting the yuan. And with foreign direct investment tapering off, that source of currency support seems to have subsided.

While slower growth in China hurts some US companies, lower resource costs for the US are consumer friendly.

If gold has lost enough of it’s bid from central bankers, it could be headed back to it’s marginal cost of production, 1980’s style, which is where it goes without global central bank accumulation. I recall the buyers earlier this year included the Greek and Mexican central banks, as well as the central bank of Bangladesh. I suppose with high unemployment, govt. figures it might as well put people to work in the gold mines? Whatever! Anyway, the final leg up for this cycle may have been the spike after Chavez opted to take delivery of his gold, which he now has, debunking the speculation that it wasn’t there to be delivered.

Next is whether Congress lets the FICA cuts expire and take maybe 1% off of Q1 GDP. The President just said he wouldn’t veto the Republican plan, so they may work something out. But with them being bent on ‘paying for it’ there is no telling what the final result will be.

SPR RELEASE WINDING DOWN

By Warren Mosler

This chart of West Texas crude prices vs Brent north sea crude prices was done a few days ago, with the spread subsequently narrowing further to under $10.

As previously discussed a few weeks ago, with the Strategic Petroleum Reserve release initiated by President Obama now winding down, the glut in Cushing that looks to have caused West Texas crude prices to fall to about a $25 discount to Brent crude and world prices in general looks to be coming to an end. Additionally, to help ensure it doesn’t happen again, it was announced the flow in a large pipeline will soon be reversed to allow crude to flow out of Cushing.

As a consequence the WTI price has been rising steadily and looks to me to be reconverging with Brent prices.  And it seems to me, watching the news broadcasting, the increase is at best very disconcerting to the US consumer in front of the holiday shopping season.

THE EURO ZONE RACE TO THE BOTTOM

By Warren Mosler

While the symptoms get continuous attention as they get threatening enough, the underlying cause-the austerity- does not. The euro zone, like most of the world, is failing to meet its further economic objectives because of a lack of aggregate demand. And in the euro zone, the fundamental problem is that the member nations, as credit sensitive ‘currency users’ are necessarily pro cyclical in a downturn, much like the US states, and therefore incapable of independently meeting their further economic objectives.

So even as the euro zone struggles to address it’s solvency crisis that threatens the union itself as well as at least part of what remains of the global financial architecture, the underlying shortage of euro net financial assets continues to undermine output and employment, with GDP growth now forecast to fall to 0 with a chance of going negative in the current quarter.

What this means is that without adopting an alternative to the current policy of applying enhanced austerity as the means of addressing the solvency issue, it all remains in a very ugly downward spiral with social collapse far less than impossible.

So yes, the solvency issue can continue to be managed by the ECB, the issuer of the euro, continuing to buy national government debt as needed. But that doesn’t add net euro financial assets to the economy. It merely shifts financial assets held by the economy from the debt of the national governments to deposits at the ECB. So it does nothing with regards to output, employment, inflation, etc. as recent history has shown.

In fact, nothing the world’s central banks do adds net financial assets to their economies. And much of what they do actually removes net financial assets from their economies, making things worse. Note that last year the Fed turned over some $79 billion in profits to the Treasury. Those profits came from the economy, having been removed from the economy by the Fed’s policy of quantitative easing, which the old text books rightly used to call a tax.

And meanwhile, the imposed austerity that accompanies the bond purchases does directly alter output and employment- for the worse. Additionally, for all practical purposes, there is universal global support for austerity as the means supporting global output and employment. So even if the euro zone gets the solvency issue right, with the ECB writing the check to remove all funding constraints, the ongoing austerity will continue to depress the real economies.

 

EARLY HOLIDAY CHEER

By Warren Mosler, Mosler Economics

As discussed last week, the latest euro package just announced is unraveling quickly as markets again realize there is no actual substance, and no operational path with regards to carrying any of it out. So things will deteriorate as described until markets again force further ‘action.’ At the same time, the austerity continues to weaken the euro economies, with q4 potentially going negative, driving deficits that much higher in the process.

The ‘answer’ remains the ECB writing the check, which they’ve sort of seemed to recognize, but they remain (errantly) concerned that reliance on the ECB is inherently inflationary, and thereby violates the ECB’s mandate for price stability. So it won’t happen until things again get bad enough to force it to happen.

The catastrophic risk remains a failure, when push comes to shove, to allow the ECB to write the check as they have been doing to allow it all to muddle through. The range of outcomes couldn’t be wider. Write the check and not much happens, don’t write the check and there is unthinkable collapse.

Meanwhile, the 1% running the US looks to be trying to take the lead in the global austerity race to the bottom as the Democrats in the super committee on deficit reduction have led off by proposing a $4 trillion deficit reduction package.

Toss in west texas crude prices heading to brent levels of about $110/barrel as the spr release winds down over the next three weeks and the looks to me like the US consumer crawls back into his foxhole just in time for the holiday season.

Not to mention Japan now dawning the torpedoes and buying dollars to take back a bit of the export market they lost by kowtowing to former Treasury Secretary Paulson’s demands to not be a ‘currency manipulator’ in the context of still weakening global demand in general. The number one threat to world order remains a failure to sustain demand. The good news is sustaining aggregate demand is a simple matter once the monetary system is understood. The bad news is there seems to be no one of authority who doesn’t have it all backwards.

THE BATTLE THAT NEVER NEEDED TO BE FOUGHT

By Warren Mosler

I realize it’s not a perfect analogy, but due to poor communications, the battle of New Orleans was fought  well after the War of 1812 had ended.  Likewise, the Congressional super committee is fighting the battle for deficit reduction long after the vaporization of the primary reason driving that move towards deficit.

The main difference is the stakes are much higher this time, with the real cost of the lost output from the excessive, ongoing, global output gap far exceeding all the real losses of all the wars in history combined.  The headline reason for deficit reduction was the rhetoric about the immediate danger of the US suddenly becoming the next Greece, with the US government being cut off from credit, interest rates spiking, and visions of the US Treasury Secretary on his knees, hat in hand, begging the IMF for funding and mercy.

And the looming flash point was the threat of a US downgrade if a credible deficit reduction package wasn’t passed before the August 2 deadline, when the Congressionally self imposed US borrowing authority was to expire.  After a prolonged Congressional process that was even uglier than the healthcare process, with already dismal Congressional approval ratings moving even lower, the debt ceiling was extended with a measure that contained some deficit reduction, and also set up the current super committee to ensure further defict reduction.

Soon after, however, Standard and Poors decided it all wasn’t enough, and the dreaded downgrade was announced. And then the unexpected happened. Rather than spike up as widely feared, market forces drove US Treasury interest rates down, substantially.  What was happening?  Where had the mainstream gone wrong? Former Fed Chairman Greenspan and celebrity investor Warren Buffet both immediately had the answer. S&P was wrong. The US is not Greece. The US government prints its own money, while Greece does not. The US always has the ability to pay any amount of dollars,that markets can’t take away.  And everyone agreed. And the driving force behind deficit reduction was suddenly not there, and the rhetoric of becoming the next Greece vanished from the national TV screens. And, unfortunately, just like the news that the War of 1812 had ended didn’t get to New Orleans in time to prevent thousands from losing their lives in that bloody battle that would otherwise not have been fought, the news that the US isn’t Greece apparently hasn’t gotten through to the Congressional members of the super committee now fighting the current battle over deficit reduction.

What was learned after the downgrade was that there is no such thing as a solvency problem for the US government. Short term or long term. True, excessive deficit spending may indeed someday cause unwelcome inflation, but the US government is never in any danger of not being able to make any payment (in dollars) that it wants to. And yes, the discussion could be shifted to a discussion as to whether current long term deficits forecasts translate into unwelcome inflation in the future that may demand action today. However no specific research has been done along those lines. And, in fact, inflation forecasts, which all assume our current fiscal trajectory, don’t show any signs of an inflation problem. Nor are the long term US Treasury inflation indexed bonds flashing any inflation warnings. 

In fact, the Fed and most other forecasters remain more concerned over the risk of deflation. And Japan, with a debt to GDP ratio about triple that of the US, has been fighting its battle against deflation for nearly two decades. So, clearly, shooting from the hip on this issue, by suddenly declaring long term deficits must be immediately addressed with cuts to Social Security, and with tax hikes, to prevent a looming inflation problem, (now that the prior errant reason, that the US could be the next Greece, has been dismissed) could only be considered highly irresponsible behavior on the part of the super committee. An informed Congress might recognize the reason for the urgent action to reduce the federal deficit, and the reason for the super committee, is no longer there. And, therefore, an informed Congress might suspend the super committee, and regroup and reconsider before taking action.

It is widely agreed the current problem is a massive lack of aggregate demand. It is widely agreed that a combination of tax cuts and/or spending increases will restore sales, output and employment. But instead of a compromise where the Republicans get some of their tax cuts and the Democrats some of their spending increases, and the economy booms, both sides are instead going the other way and pushing proposals to reduce aggregate demand, even though they no longer have good reason to do so.

The battle of New Orleans was fought after the reason for fighting it had ended.  And, likewise, long after the reason for deficit reduction vaporized, this battle continues to be fought with both parties continuing to enact their counter agenda.

CHINA’S “GROWING CONCERNS”

By Warren Mosler

So how about all that talk that it’s ‘regulation’ that’s holding back the US economy?  The regulation and government ‘interference’ in China is far beyond anything imaginable in the US, yet their growth rates are far beyond anything imaginable for the US, and they manage higher levels of employment with consumption at only about 35% of GDP.

So what’s the difference?   How about Chinese annual deficits running well over 20% of GDP (state lending is functionally very close to state deficit spending) in the normal course of business? Much like the US did in WWII? With similar growth rates?

Ok, so 20% might be a tad too high for the kind of price stability most in the US would prefer.   And so now China is fighting a 6% inflation rate. Hardly ‘hyper inflation’.  And certainly no reason for us not to go to the 12-14% annual deficits we probably need to sustain full employment, given current credit conditions.

In other words, for the size government we currently have, we remain grossly over taxed.

FED CONTINUES TO LEND U.S. DOLLARS TO THE ECB

By Warren Mosler

It remains my position that Congress should not allow the Fed to lend unsecured to foreign central banks without specific Congressional approval. But the Fed does currently have that authority and they are again using it to keep $ libor from rising. And that lending must be in unlimited quantities to insure $ libor is capped at the Fed’s target rate.

The Fed doesn’t want $ libor to go up because many US domestic loans are indexed to $ libor,
including adjustable rate mortgages. That’s why I’ve been proposing the Fed not let its member banks index loans to $ libor, but instead let them index to the fed funds rate, or some other rate controlled by the Fed. That would return direct control of US $ interest to the Fed, obviating the need to use unsecured (and unlimited) $US lending to foreign central banks.

By the way, when testifying to Congress the Fed Chairman states the lending is secured, with the Fed getting euro deposits as collateral. And he believes that. However, the euro are on deposit at the European Central Bank, who is also the borrower of the $ from the Fed. So if he ECB defaults on the $ loans, the only way the Fed could use those euro is by instructing the ECB to transfer them to another’s account so the Fed can buy the dollars it wants.

So what are the odds of the ECB even taking the call from the fed if they just defaulted on it’s dollar loans from the Fed?And what can the Fed do if the ECB doesn’t make payment and won’t let the Fed use its euro at the ECB to buy dollars? It’s like lending your dollars to someone in a far away land who uses his watch for collateral. But he gets to keep wearing the watch, and he’s out of your legal jurisdiction….

MACRO MUSINGS

By Warren Mosler

Interesting day so far – stocks down, interest rates down, commodities down, including gold (seems the found Hugo’s gold?) but the euro is up some, after falling some last week

With federal deficits too low most everywhere, it’s like a general crop failure, with the question being which crops will go up the most vs each other. Not easy to say, but the euro has to be a bit of a favorite given the sincerity and intensity of their commitment to austerity/deficit reduction? And their new good buddies, the Swiss, now helping out by buying euro as others buy their currency with their new cap in place.

However lower crude and product prices do help the US more than the rest, so that’s a factor that gives the dollar an edge. And the portfolio shifting/speculation/trend following in illiquid markets can overpower the underlying fundamentals as well medium term.

And the dollar and the euro are seeing bids from China and Japan now and then as those nations work to protect their softening export markets.

My least favorite currency longer term may be the yuan, with its inflation issue and ongoing deficit spending, both direct and via state bank lending, though they too seem to be cutting back some.
But until FDI (foreign direct investment) lets up, those ‘flows’ continue to support the yuan.

And commodity currencies are in a class of their own, weakening with weakening commodity prices.

It’s also noteworthy that the deflation is coming at a time when central banks, for all practical purposes, can’t be much more inflationary by (errant) mainstream standards of measurement.
Unfortunately, however, it’s not that they are out of bullets, it’s that the presumed lethal live ammo has turned out to be blanks, with mounting evidence that the gun was pointed backwards as well.

The obvious answer is a simple fiscal adjustment- just a few keystrokes on the gov’s computers can immediately restore aggregate demand/employment/output- but they’ve all talked themselves out of that one.

However it’s not total doom and gloom. For example, the US deficit is large enough to muddle through with decent corporate earnings and a bit of minor ‘job creation’ as well. And sequentially, GDP is slowly improving: .5 q1, 1.0 q2, and maybe 1-2% for q3. Good for stocks, not so good for people, but the bar is now set so low and the understanding so skewed that ‘blood in the streets’ isn’t yet even a passing thought, so don’t expect much to change any time soon.

And standby for the ECB writing the next check, no matter how large, to keep that all muddling through as well.

THE EQUITY STORM APPEARS TO BE OVER FOR A BIT…

By Warren Mosler

“Following Friday’s downward revisions, we now expect real GDP to increase just 2%-2½% (annualized) through the end of 2012 and the unemployment rate to rise slightly to 9¼% during this period.” – Goldman Sachs

This is still higher than the first half, so presumably corporations will have a better second half as well, and they did just fine in the first half.  And with lower gasoline prices, consumers get a nice break there which should firm their spending on other things as well. The tighter fiscal won’t matter for this year, and markets won’t discount what may happen in November until it’s closer to actually happening.

So still looks to me like the recent sell off in stocks was mainly technical, as the initial knee jerk sell off from the debt ceiling and downgrade uncertainties triggered further selling by those with short options positions, much like the crash of 1987.  And, like then, and unlike early 2008, the current federal deficit seems more than large to me to keep things chugging along at muddle through levels of modest growth, continued too high unemployment, and decent corporate profits and investment.

Yes, risks remain. Europe is a continuous risk, but the ECB, once again, stepped in and wrote the check. China looks to be slipping but the lower commodity prices will help US consumers maybe about as much as they hurt the earnings of some corps. So for now, with the options related stock selling over, it looks like we’re back to calmer waters for a while.

And Congress goes back to trying to cut the deficit to put people back to work. Someone needs to tell them they haven’t run out of dollars, they aren’t dependent on China, and they can’t become the next Greece, and so yes, the deficit is too small given the current output gap. etc.  But until then, we keep working to become the next Japan.

WEEKEND UPDATE

By Warren Mosler

It doesn’t look to me like anything particularly bad has actually yet happened to the US economy.

The federal deficit is chugging along at maybe 9% of US gdp, supporting income and adding to savings by exactly that much, so a collapse in aggregate demand, while not impossible, is highly unlikely.

After recent downward revisions, that sent shock waves through the markets, so far this year GDP has grown by .4% in Q1 and 1.2% in Q2, with Q3 now revised down to maybe 2.0%. Looks to me like it’s been increasing, albeit very slowly. And today’s employment report shows much the same- modest improvement in an economy that’s growing enough to add a few jobs, but not enough to keep up with productivity growth and labor force growth, as labor participation rates fell to a new low for the cycle.

And, as previously discussed, looks to me like H1 demonstrated that corps can make decent returns with very little GDP growth, so even modestly better Q3 gdp can mean modestly better corp profits. Not to mention the high unemployment and decent productivity gains keeping unit labor costs low.

Lower crude oil and gasoline profits will hurt some corps, but should help others more than that, as consumers have more to spend on other things, and the corps with lower profits won’t cut their actual spending and so won’t reduce aggregate demand.
This is the reverse of what happened in the recent run up of gasoline prices.

Japan should be doing better as well as they recover from the shock of the earthquake.

Yes, there are risks, like the looming US gov spending cuts to be debated in November, but that’s too far in advance for today’s markets to discount.

A China hard landing will bring commodity prices down further, hurting some stocks but, again, helping consumers.

A euro zone meltdown would be an extreme negative, but, once again, the ECB has offered to write the check which, operationally, they can do without limit as needed. So markets will likely assume they will write the check and act accordingly.

A strong dollar is more a risk to valuations than to employment and output, and falling import prices are very dollar friendly, as is continuing a fiscal balance that constrains aggregate demand to the extent evidenced by the unemployment and labor force participation rates. And Japan’s dollar buying is a sign of the times. With US demand weakening, foreign nations are influenced by politically influential exporters don’t want to let their currency appreciate and risk losing market share.

The Fed’s reaction function includes unemployment and prices, but not corporate earnings per se. It’s failing on it’s unemployment mandate, and now with commodity prices coming down it’s undoubtedly reconcerned about failing on it’s price stability mandate as well, particularly with a Fed chairman who sees the risks as asymmetrical. That is, he believes they can deal with inflation, but that deflation is more problematic.

So with equity prices a function of earnings and not a function of GDP per se, as well as function of interest rates, current PE’s look a lot more attractive than they did before the sell off, and nothing bad has happened to Q3 earnings forecasts, where real gdp remains forecast higher than q2.

So from here, seems to me both bonds and stocks could do ok, as a consequence of weak but positive GDP that’s enough to support corporate earnings growth, but not nearly enough to threaten Fed hikes.

PAYROLLS

By Warren Mosler

The labor force participation rate is falling roughly in line with productivity resulting in what I’ve been describing as an L shaped recovery as we remain grossly overtaxed for the size govt and credit conditions we currently have.

Better than feared and most importantly, lending some consistency with other labor market indicators (claims, ADP, ISM).
Much of the details reversing last month’s across the board weakness.

  • Payrolls rise 117k: Private payrolls rise 154k
  • Net revisions +56k (June report revised from 18k to 46k)
  • Unemployment rate drops from 9.2% to 9.1%
  • Avg hourly earnings rise 0.4% (prior 2mths 0.0% and 0.4%)
  • Hours index rises 0.1% (-0.2% last mth)
  • Median duration of unemployment falls from 22.5 weeks to 21.2 weeks
  • U6 measure falls from 16.2% to 16.1%
  • Part rate falls from 64.1% to 63.9%
  • Diffusion index rises from 56.6 to 58.6 with the following industries all showing net change of 10k or more jobs on the month
  • Education, Construction, Manufacturing, Retail, Finance, Temp help

Claims in low 400s and ISM employment in low-to-mid 50s consistent with private payrolls in 100-150k/mth range.
Also with consistent with Fed forecast of modestly above trend gwth and slow decline in the unemployment rate.

A risk to the outlook going forward is the ‘financial accelerator’ factor as coined by Bernanke and Mishkin. Growth in H1 was at least associated with supportive financial conditions (basically credit spreads and equities). Too many more days like yesterday will offset whatever comfort they get from reports like today’s.