The September job report was full of countercurrents, some pointing to potential economic weakness and others to strength. This makes the Fed’s work extremely difficult. Will the economy be strengthened or weakened? What is the correct monetary policy recipe? Asset taper purchases? Raise interest rates? With payrolls so ambiguous in September, the October payment (which will be with the Fed before its November meeting) may shed a better light on economic trends.
Just to check the latest employment data, the most watched of the two Bureau of Labor Statistics (BLS) polls, the establishment (payroll) poll at +194,000 was pretty low compared to consensus expectation of +430,000. BLS admits the pandemic continues to skew the data, especially the seasonal adjustments. This time the distortions appeared in educational employment. Without teacher salaries, overall private sector employment growth (+317,000) was still quite modest compared to consensus.
Some of these weaknesses had been signaled in the Department of Labor’s weekly data for initial unemployment claims (IC) (ie new layoffs). As the graph shows, ICs rose in mid-September when the BLS conducted its polls. There seems to have been a slight improvement since then.
A similar pattern is shown in The Household Survey, a monthly BLS telephone survey of households (corporate payroll). That poll showed an increase of +526,000 in September, similar to August (+509,000) but much more slowly than in July (+1.043 million).
All polls show growth, but much more slowly than in midsummer. The graph at the top of this blog is the Atlanta Fed’s GDPNow estimate for real GDP growth in the third quarter. The line at the bottom of the graph (green) shows the steep decline in the Atlanta Fed’s GDP forecast from the end of August, but especially in the last few weeks up to the beginning of October. Our blogs over this period are in line with this GDP chart. The dark blue line now shows the significantly higher consensus estimate. The range is between 3% and 8%, and the consensus is 6.5%.
The chart below shows the NY Fed’s weekly economy index. While this index hasn’t fallen as dramatically as the Atlanta Fed’s GDP, its May peak has been falling for four months.
However, despite the slowdown in economic growth, interest rates continue to rise. 10-year government bonds rose from 1.3% in mid-September to over 1.6%, a value that has not been seen since the pre-pandemic in December 2019.
The alternative view
Together with the employment data, the BLS published data on wages and hours worked. Average weekly wages rose 1.2% on a monthly basis, partly responsible for the recent rise in interest rates. This has mostly happened in the leisure / hospitality and retail sectors. Employers in these sectors compete with the generous government fringe benefits and pandemic unemployment assistance (PUA) programs. After these programs expire, we believe that upward pressure on wages will also end. Still, there are some respected economists who theorize that the slow recruitment in September and rising wages point to a tight labor market and thus to continued upward pressure on wages. We disagree with this interpretation, as we see wage pressure dropping in these sectors as competition from the federal government has now ended. In addition, the Payroll Survey still shows five million fewer digits than in February 2020, the last month before the pandemic. How can the job market be tight when so many who were once employed no longer have a job? If we are correct, the rate hike discussed above will be reversed.
The Fed’s dilemma
As mentioned earlier, the Fed is due to meet in November, and Powell has promised that the FOMC will discuss monetary policy. The “tapering” problem has to do with the current Quantitative Easing (QE) program, although the media no longer uses this nickname to refer to this policy. But it’s QE because the Fed is creating and injecting $ 120 billion a month into the banking system. In previous blogs, we commented on the record highs of reverse repos. These are excess bank reserves. The graph below shows the recent huge surge in these reserves, reaching $ 1.6 trillion in late September before falling back to $ 1.4 trillion in early October. It is clear that QE has become exaggerated, only enters the banking system as excess reserves and does not have a positive effect on the economy.
When banks don’t lend …
We clearly believe that the expansion of the Fed’s balance sheet will have little positive economic impact as funding has gotten stuck in the banking system. If the banks do not lend these reserves, they will simply become superfluous. The business media believe that such money creation has the potential to cause “systemic” inflation, and we often read comments referring to the rapid expansion of the money supply as the potential for inflation. Another reason interest rates have risen lately. (But because the banks are not lending, the speed of money has slowed.) So until now there has been no economic or inflationary impact. In the end, the Fed can create an infinite amount of bank reserves, but if the banking system does not lend, the economic impact will be small. It’s like the Fed prints paper money, but puts it in a safe where it is wasted.
The chart below shows the total commercial and industrial lending by banks. Before the pandemic, such loans grew at an annual rate of 5%. Then came the pandemic, and as you can see from the graph, bank lending skyrocketed as companies used their lines of credit to fill their balance sheets with cash without knowing what might be in store for them. They did so because many had the 2008 experience of banks freezing those lines as the financial crisis unfolded. If you look at the graph you can see that the growth has slowed from the beginning of 2020 to the latest data from September 2021. (We did the math and the growth rate from March 2020 to the end of September is 3.3%.) Remember that pre-pandemic economic growth struggled to reach 2%. So with slower lending, we’re not seeing the economy hit the consensus forecast of 6.5% for the fourth quarter of GDP.
Is “tapering” really “firming”?
Markets are interpreting the impending “taper” of the current QE of $ 120 billion per month as a “tightening of monetary policy”. We believe this is a step to reduce the “redundant” ease as shown in the “Reverse Repo” graphic above. To use an analogy, it’s not like putting the brakes on a racing car; but they are about to release the accelerator. The policy will be ultra-simple for many months to come.
The economy has “recovered”
Real GDP of Q2 has caught up with that of Q4 / 19. In a way, we are now in an economy that has “recovered”. We see the following for the near future:
- There is still a lot of labor shortage with the economy still missing 5 million jobs from its pre-pandemic peak. We assume that a large part of this gap will be closed in the next few months, as the special (deterrent) unemployment programs expired at the beginning of September. (Note: Using the Department of Labor’s data up to September 25th, based on the week of May 15th, the opt-out states (those who have not paid the state unemployment benefit of $ 300 per week) are unemployed reduced levels by 52.7% (with the trend accelerating in September), while the same statistic for the opt-in states was less than half (23.8%).
- The BLS employment surveys were conducted between September 12th and 18th. We believe it was too early to consider these beneficiaries as already re-employed. However, we expect significant job creation in both October (release date November 5th) and November (release date December 3rd).
- Since both the PUA and the special surcharge of USD 300 / week as well as the rental moratorium for 11 million households expired at the beginning of September, we expect consumption (and thus GDP) to be weak in the fourth quarter. The Atlanta Fed is clearly seeing what we are seeing.
- We assume that the Fed will start its “taper” in November. You can no longer ignore the record levels of excess reserves in the banking system. Keep in mind that they will be adding to their balance sheet until mid-2022. That means the QE will last for another 9 months! But we don’t associate the “taper” with an interest rate hike. That move, we think, won’t come until the pandemic is a distant memory. Powell himself has told the media directly that the “dot plot” (the FOMC’s individual views on where the Fed’s policy rate will be in the future) does not predict policy, and Rosenberg Research has done quantitative work showing that the “Dot-plot” is a very poor prognosticator of what lies ahead.
- What GDP growth will look like is another question. Before the pandemic, 2% appeared to be the economy’s non-inflationary potential. We don’t see how the pandemic has significantly altered that economic potential. Recall that in 2018 the Fed started tapering its balance sheet (i.e. negative QE versus “taper”) but had to flip (the now famous “Powell Pivot”) when economic growth stalled.
- The rest of the world’s industrialized countries are also struggling. In previous blogs we talked about the slowdown in China, which is now facing major problems in its real estate sector, a sector that accounts for 30% of its GDP. And Europe is now facing a serious energy shortage that is sure to have a major impact this winter.
We have “recovered”. But we don’t see anything changed to change the pre-pandemic economy’s anemic growth path. But on the contrary. Demographics were already slowing growth, and the pandemic inspired many who were over 65 but were still working to retire and many who approached 65 to take early retirement. Retirees don’t spend as much as those in their working years. Then there is the skyrocketing level of growth-inhibiting debt in both the private sector (corporations) and the public sector (federal debt). For these reasons, we believe that Fed rate hikes are still a long way off.
(Joshua Barone contributed to this blog.)