Monday, March 29, 2010

A Note on Friday's Employment Report

Going into this Friday's March employment report, the market consensus is looking for an increase of about 200,000 in nonfarm payrolls, which, on the face of it, would represent a dramatic improvement by the standards of the last two years. In fact, if such a gain were to materialize it would be the biggest monthly one in three years and only the second increase since the onset of the recession in December 2008 (the other one being a 64,000 gain last November).

The main reason though for a potentially robust increase in the March payroll data though is likely to be the estimated hiring of about 125,000 census workers during the month. (The Labor Department is likely to provide an estimate of the number of census workers for the month).

This immediately suggests that the key number in this month's report will be the "private payrolls" one, which should still show a moderate gain- anywhere from 25,000 to 125,000. Inasmuch as an increase within the latter range would still be considered as fairly unimpressive (obviously a 100,000 plus gain would be appreciably more meaningful than a 20,000 one!), it should still be viewed as consistent with the ongoing underlying improvement in labor market conditions in recent months.

Initial unemployment claims have resumed their previously stalled downtrend in the last few weeks and the employment sub-component in the ISM is turning out some healthy readings lately- the latter reflecting a broad-based improvement in manufacturing activity. Irrespective of the specific reading (that is, initial print, before the inevitable subsequent revisions) in Friday's payrolls, there is a nearly inescapable expectation that the series is poised to embark on a sustained path of moderate job creation in the coming months.

Given that the Census hiring should continue distorting the headline payrolls number through the summer months, the focus should remain solely on private payrolls in the period ahead. At this point, it is not unreasonable to look for a monthly average gain of about 100,000 in the second quarter- excluding census workers- with further gains in the workweek from its most recent 33.1 hours.

Anthony Karydakis

Friday, March 26, 2010

New Home Sales and the Big Misconception

The 2.2% decline in February's new home sales to a record low of 308,000 units this week is disconcerting in that it shows that, despite some signs of tentative stabilization in existing home sales in recent months, the nearly five-year long slump of the housing market has yet to hit a reliable bottom.


On the face of it, the ongoing erosion in new home sales is somewhat perplexing. After all, mortgage rates remain at historically very low levels and the first time home owners tax credit is still in effect until the end of April 2010. In reality though, the failure of new home sales to show any signs of responding to those two seemingly favorable factors makes perfect sense.

One of the greatest misconceptions about the housing market in general is that it is directly responsive to the level of mortgage rates. The reality though is that this is not actually the case, as mortgage rates represent only one of the "second-tier" factors that influence the demand for housing, the primary ones being employment levels and associated income growth as well bank lending practices in any given period. It is a plainly absurd hypothesis to argue that much would change for home sales if the 30-year fixed rate mortgage were to dip to, say, 3%, in the midst of a broader economic environment characterized by high unemployment, slow income growth and famously tight credit standards by lenders.

It is key to remember that at the peak of the housing boom in the middle of the last decade, the 30-year fixed rate mortgage was hovering around 6.5% to 7% versus 5% these days. While it is true the impressively strong demand for housing at the time was supplemented in good part by a larger share of ARM loans than today, the overriding difference between the two periods was a booming economic activity and high levels of employment and income growth as well as notoriously- and disastrously- lax lending practices at the time.

To further put the generally tenuous relationship between mortgage rates and demand for housing in a more realistic context, it is a pretty reasonable expectation to have that, over the next three-year or so horizon, the latter will be considerably stronger despite the inevitably higher mortgage rates that are likely to accompany a broadening economic expansion and aggressive underlying Fed tightening. Higher mortgage rates will become nearly inconsequential in a context where lower unemployment and stronger personal income growth will provide households with enough confidence to proceed with the purchase of the ultimate big-ticket item.

Anthony Karydakis

Tuesday, March 23, 2010

The Weak Euro...Really?

That the much publicized fiscal troubles in some of the Eurozone countries recently have caused the euro to lose ground in the foreign exchange markets is obviously not in question. However, arguing that a fairly moderate decline in the value of the currency from a historically very high level of about four months ago is a dramatic development that is likely to reshape the landscape of the global competitiveness of certain eurozone countries' exports (and more specifically, Germany's) is a bit of an exaggeration and reflects a disregard for the history of the currency since its inception.

In January 1999, the euro was introduced at a rate of 1.16 against the U.S. dollar and suffered a significant erosion in its value, trading mostly within a 0.80 to 1.0 range against the U.S. currency in the following three years. Since then, it has been on a broad uptrend, reaching a high of 1.60 against the dollar in the summer of 2008, just prior to the financial crisis triggered by the Lehman affair. The most recent stage of its pullback, in the wake of the acute fiscal problems in the southern European countries, has still left the euro at historically high levels- about 10% higher than a year ago (Chart below).

The Euro vs. U.S. Dollar

Source: ECB

The euro remains at the upper end of the range that has prevailed against the dollar since its inception and it can be reasonably argued that its latest slide represents a relatively limited correction from unsustainably high levels it had reached last fall (and, which, Jean-Claude Trichet had repeatedly denounced at the time as not consistent with the underlying fundamentals in the eurozone but rather the result of excessive speculative activity that had pushed it to unjustifiably high levels).

It is, understandably, a welcome development for certain heavily export-oriented countries in the eurozone that the currency has retreated moderately in recent months. But, casting it as a a critical factor making countries like Germany a major export powerhouse is a misrepresentation of basic facts.

Germany had been steadily establishing itself globally as a major export-oriented economy (running the biggest trade surpluses in the world for years until it was recently surpassed by China) even during the period when the euro had been steadily rising earlier in the last decade. It is primarily through the competitive cost advantages related to the containment of real wages and increased productivity that the German economy has achieved this status and not because of any benefit related to a "weak currency".

Anthony Karydakis

Wednesday, March 17, 2010

Equity Market Rally: A Major Unrecognized Factor

With the still weak state of the labor market and associated moderate pace of income growth often identified as key headwinds facing the economic recovery, one key factor seems to have received fairly limited recognition for its potential to offset some of those headwinds and help sustain the household sector's spending ability in the balance of the year: equities.

As equity prices are hitting 17-month highs in recent days, a non-negligible wealth-effect is steadily brewing, which should supplement the somewhat underwhelming wage and personal income growth in the coming quarters. This can become a pivotal factor that can set into motion a self-reinforcing dynamic that will lead to an acceleration of economic activity in the second half of the year. The timing of this process would be particularly fortuitous, as it will be taking the baton from the inventory cycle that will slowly be running out of steam by the end of 2010.

It is helpful to keep in mind the critical contribution that an irrepressible equity market rally in the second half of the '90s made to the impressive, above-trend, pace of GDP growth during that period. The scale of the equity market rally now is still smaller than the one during the heady days of the infamous "irrational exuberance" of the late '90s. However, stock prices have rebounded by a spectacular 65% since their low in January 2009, which represents a very powerful move in terms of contribution to household net wealth.


Moreover, and despite some occasional expressions of disbelief that have been voiced about the sustainability of the current levels, it should be reminded that- the rally of the last 15 months notwithstanding, equity prices are still some 30% below their level in the summer of 2007 ("pre-subprime mortgage crisis"). This helps put things in perspective and highlight the reality that, in the midst of an economic recovery that is gaining solid traction, there is nothing truly unsustainable about the current valuations of equities.

Anthony Karydakis

Tuesday, March 16, 2010

The FOMC Statement And Its Key Wording

Despite growing reservations expressed recently by a number of FOMC members about the use of the expression that the "exceptionally low" interest rates will remain in effect for "an extended period" (, the Committee preserved once again that key language in its statement today.

However, the clear acknowledgment in today's statement that "economic activity has continued to strengthen and that the labor market is stabilizing" raises the odds that a modification of the "extended period" expression may be in the cards for the April 27-28 meeting. By that time, the Fed will have in its possession the vast majority of the economic data for March and a firmer sense as to the forward momentum of the recovery going into the second quarter. If the balance of such evidence continues to show that economic activity is gathering steam, then the expression that has been at the hallmark of each FOMC statement since March 2009 is likely to be replaced by something like "for a while" or "for some time", a view that has been openly advocated by Kansas City Fed President Thomas Hoenig recently (and who dissented again on precisely such grounds at today's meeting).

The debate over the use of the expression "for an extended period" is actually mostly a matter of semantics and tactics, rather than substance.

In other words, the adoption of a milder language in that regard should not be viewed as meaning that the timing of the Fed tightening process will have been moved up. It will rather be a gesture giving the Fed somewhat more flexibility to make that call depending on the way the various economic data behave in the second half of the year, without feeling constrained by the unspoken promise that the current language provides. Although the Fed has never attempted to be more specific as to how long that "extended period" is actually meant to be, the assumption is that it corresponds to at least a 6- to 8-month horizon. Replacing "extended period" with "some time" does nothing by itself to precipitate the beginning of the tightening process, but it gives the Fed leeway to do so in the event that the pace of economic activity suprises with its strength by late summer, without the trepidation of breaking an "unwritten contract" with the markets.

Still, all in all, in view of the ongoing downward drift of inflation, a respectable but not exactly explosive economic recovery, and the tight credit conditions, the earliest conceivable timing of the first tightening move remains the fourth quarter of the year.

Anthony Karydakis

Friday, March 12, 2010

Retail Sales Confirm the Consumer Comeback

The stronger-than-anticipated retail sales data for February represent a further encouraging sign that the consumer is making a credible comeback.

Not only did overall sales rise 0.3% last month (versus a consensus call for a modest decline) but the ex-autos part of the report was also up a robust 0.8%. (Auto sales themselves fell 2%, reflecting, in part, the Toyota-related issue, which was not immediately offset by a quick pick-up in sales of other brands). One of the most surprising elements in the report was perhaps the strong gain in department store sales (+0.9%), dispelling all earlier fears about last month's snow storms having been a significant adverse factor in that category.

Source: Bloomberg, Haver Analytics

For purposes of calculating personal consumption in the GDP data, the most relevant version of retail sales is the one that excludes autos, gas station sales, and building materials; that version of the report rose a very healthy 0.9%, following a thoroughly respectable increase of 0.6% in January. Based on the available data so far, consumption is probably running at a 3.5% annual rate in Q1, which should help support GDP growth in the 3% area for the period.

Of course, retail sales are one of the most "revisable" economic releases of the month and, in today's report, we had a taste of that again, as both January's and December's data were revised in opposite directions; the result of those revisions was a net small downward effect for the combined two-month period. Still, the monthly noise of the data notwithstanding, it is impossible to ignore the underlying uptrend in consumer spending, which, after all is said and one, constitutes the backbone of the forward momentum that the economy recovery is gathering.

Anthony Karydakis

Tuesday, March 9, 2010

The EU's Ideas to Deal With Another Greece

In the wake of the headline-making story involving Greece's debt situation in the last couple of months, the European Union seems to be setting its eyes on two possible remedies from preventing such crises in the future.

The first one is the project pushed by German Chancellor Angela Merkel to ban the use of CDS on sovereign debt of the eurozone countries. The idea is that this will help curb the speculative fever against the debt of countries with the heaviest bond issuance (namely Greece, Portugal, Spain, and to some extent, Italy and Ireland) and prevent the replay of Greece-style crises in the future. The idea appears to be gathering support among the powers-that-be within the EU and stands a reasonable chance of being converted into tangible regulation in the coming months.

Although such a ban would probably be helpful in that it will remove a relatively inexpensive tool for bet-making, it is far from certain that, it alone, can tame the speculative impulses of markets vis-a-vis countries that have a clear credibility problem in terms of their fiscal policies.

The reality remains that as long as selling a sovereign bond short remains a permitted activity, there is nothing that prevents hedge fund and other speculators from simply retooling their tactics and shifting the emphasis of their arsenal toward more good old-fashioned short selling. A variation on the theme of an outright ban on CDS contracts is a proposal that would ban the use of CDS by those who do not actually own the underlying bonds (that is, it would prohibit, naked short selling). A sensible proposal for sure, but, still, far from a panacea. On that score, it is useful to remind ourselves that the absence of a CDS market did not prevent George Soros from famously breaking the Bank of England in 1992.

The second major proposal that is also promoted by the Ministry of Finance in Germany is the creation of a European Monetary Fund, modeled after the IMF, for purposes of addressing future crises in eurozone countries. The idea seems to have gained traction quickly in the last few days and is even reported that it may become operational by June.

The creation of such a safety net has some downsides and also some powerful detractors. The Bundesbank President, Axel Weber, is already on record describing the idea of the "institutionalization of emergency help" as problematic, as it would detract from the main focus, which should be to force member countries to demonstrate fiscal discipline consistently. The clear risk with the creation of a European Monetary Fund mechanism, is that the existence of a permanent safety net within the eurozone bloc may lead individual countries to feel more confident that they will be rescued internally in the future and, therefore, they can afford to be lax in enforcing fiscal discipline domestically.

Somehow, the focus has not remained sharp enough on the most glaring fault-line that the Greece affair has exposed, which is the lack of any enforcement mechanism to credibly implement the 3% and 60% requirements for all eurozone countries in regards to the size of their deficit as a percent of GDP and total debt respectively. The irony here is that, as recent reports have brought to the surface, nearly all eurozone countries have blasted repeatedly through those ceilings in the last ten years and resorted more than once to obscure derivatives-based transactions to disguise those violations. Therefore, they do not seem to be very eager now to put themselves in a straight-jacket by seriously beefing up enforcement mechanisms and strict monitoring.

In other words, no country has completely clean hands here.

Anthony Karydakis

Friday, March 5, 2010

February Employment Report: Once Again, Not Much New, But...

Despite the moderate decline in nonfarm payrolls by 36,000, the employment report for February should be viewed as broadly consistent with the premise that labor markets are turning the corner- albeit slowly.

Last month's drop in payrolls is mitigated by two factors: a) The severe snow storms that impacted part of the East Coast during the survey week were likely a factor adversely impacting the number to some degree- an acknowledgment also made by the BLS itself (although it refrained from attempting to quantify the extent of that adverse impact and also warned that the storms may have also caused an increase in employment in certain types of jobs like cleanup and repair services), and b) A net cumulative upward revision to the numbers for the December-January period by 36,000 casts the February decline in a somewhat less downbeat light in terms of recent trend.

The snow storms may have also played a role in causing a drop in both the average workweek (by 0.1 to 33.8 hours now) and overtime hours (by 0.2). The 64,000 decrease in construction jobs, although one would be tempted to see the hand of the storms again here given the nature of the industry) is mostly in line with the employment trend in that sector in the last six months.

Source: Bureau of Labor Statistics

An encouraging element in the establishment survey was the (admittedly tiny) gain in manufacturing jobs (+1,000) following a healthy 20,000 increase in January, suggesting that the sector is plowing ahead, consistent with the solid readings of the various manufacturing indicators in the last few months. Also, the absence of a payback in the retail trade jobs category from its robust 42,000 gain in January (they were flat in February) does reflect an improving sense of confidence among retailers that consumer spending is making a sustainable comeback.

Signs of persistent cautiousness in terms of hiring plans were also evident in the establishment survey, as temporary jobs rose by another 48,000, bringing the total number of such jobs created since last September to 284,000, and reflecting a lingering hesitation by employers to add regular full-time jobs.

The actual distortion to the data from the ongoing hiring of census workers was much smaller than anticipated, as that number was only 15,000 in February. Census-related hiring still has the potential to disrupt some monthly payroll numbers in the period ahead- hence, a quick comparison of the total nonfarm payroll numbers with the private sector ones remains useful in the coming months' reports.

The absence of a partial rebound in the unemployment rate in February from its sharp 0.3% drop to 9.7% in January is the result of proportionate increases in the size of the civilian labor force (+342,000) and household employment for the month (+308,000). The steady unemployment rate raises the level of confidence in the prospect that the series may have already seen its high for the cycle at the 10% level reached in December.

All in all, the data offered little new insights into the underlying dynamic of labor markets but they leave the prospect of moderate job growth (to the tune of 50,000 to 75,000 a month) in the second quarter, intact. The turnaround of labor markets, following the devastation caused by the sheer size of losses suffered since the onset of the recession (8.4 million), is a circuitous and cautious process but there should be little doubt that it is already taking hold.

Anthony Karydakis

Wednesday, March 3, 2010

More Weakness in the Economic Reports Ahead

Inasmuch as the pattern of the overall economic indicators has been decidedly mixed recently, things are going to become even more complicated in the coming weeks as the February data are reported. The reason for this is the series of massive snow storms that hit the East Coast last month, and which are likely to have affected a fairly wide array of indicators.

To start with, February's nonfarm payrolls are likely to show a fairly substantial decline (potentially by as much as 100,000, or more) which, on the face of it, would seem to represent a setback to the profile of steadily diminishing monthly job losses in recent months. The severe snow storm that hit Washington DC, Delaware, New Jersey, and Pennsylvania particularly hard around the time of the BLS survey week in February is likely to have suppressed payroll data in the region with adverse consequences for the overall number. The workweek in Friday's employment report may also show a dip by 0.1 or 0.2 to 33.8 or 33.7, as a result of the snow storm-related disruptions.

(For the record, the February payroll data will also be subject to another distortion, which will be pulling the series in the opposite direction, therefore partially offsetting the drag from the storms: as many as 60,000 workers were probably hired by the federal government to conduct this year's census - a process that is likely to continue skewing the total payroll numbers to the upside for several more months).

But the adverse impact of the multiple snow storms that affected the East Coast last month will also extend well beyond the employment report. The severe weather is almost certain to have suppressed a number of other indicators for February, namely auto sales as well as broader retail sales (not exactly shopping-friendly weather conditions), in addition to housing starts and new home sales.

The essence of all of this is that the key economic releases later in the month are likely to continue projecting an aura of softening economic activity, following a set of other reports since the beginning of the year that seem to suggest a cooling in economic activity. As we argued in another piece earlier this week, the mostly mixed, or plain underwhelming, economic data recently should be viewed as the normal by-product of a historically sub-par economic recovery that fails to generate consistently healthy data. As such, it should not be viewed with particular concern, as they are unlikely to reflect any derailment of the economic recovery.

What the unusually harsh weather patterns experienced in February imply is that it will be a while before we are able to discern more accurately what exactly the underlying forward momentum of the recovery is in the first half of 2010. At this point, a reasonably good bet remains that the weather-induced weakness in a number of economic reports for February will be offset by a quick snap back in the March data and any doubts about the viability of the economic recovery will safely be put to rest then.

Anthony Karydakis