Tag Archives: fed

The Fed is wrong about the falling unemployment rate

On Nov 1, St Louise Fed President James Bullard lauded the US labor market and said the decline in labor force participation that has improved unemployment is a result of natural demographic changes. That simply isn’t the case.

I wrote about why the Fed is wrong about unemployment in a post in October.

Why the Canadian jobs market is much healthier than the US and why the Fed is wrong

Canadian unemployment is listed at 6.9% while in the US it’s 7.3% but that vastly understates the differences in the health of the relative jobs markets.

First of all, if you go back to pre-crisis times, Canadian employment was around 6% which is something akin to full employment by Canadian standards. Before the crisis in the US, unemployment was at 4.5%. Differences in how the countries measure unemployment, helps to explain the gap.

Skipping ahead to the present, Canada is now 0.9 percentage points away from pre-crisis unemployment levels while the US is 2.6 percentage points off.

Alone that’s an interesting story but it’s not even the kicker. The real story is in the participation rate. In Canada, the pre-crisis average was around 67.4% while in the US it was about 66.1%. Today, the Canadian participation rates has fallen by 1 percentage point while in the US it’s down 2.9 percentage points.

Canadian participation rate chart 2013

It’s been a much steeper fall in the US.

US participation rate chart 10 years

The nail in the coffin is demographics

The Fed has repeatedly pointed to demographics (ie older people retiring) as the reason for US workers exiting the workforce but US and Canadian demographics are very similar. What’s more is that based on demographics you would expect more Canadian workers to be leaving the workforce than the US.

The marginal worker leaving the workforce is 55-65 years old. In the US, the 55-59 year-old cohort is around 10% of the population; in Canada it’s 12%. In the US, 60-64 year olds are 9% of the total while they’re 10% in Canada.

US population pyramid

 

Canadian population pyramid

What does it mean?

A conservative (albeit simplistic) estimate would put Canadian unemployment around 3.8 percentage points healthier than the United States, far more than the 0.4 percentage point difference in official rates.

More importantly for traders, it shows that the Fed is vastly overestimating the health of the US labor market. It suggests that far more workers are leaving the US jobs market for reasons other than retirement/demographics — they’re likely discouraged workers.

What’s more, despite the large differences in employment, Canada doesn’t have any signs of inflation. The Fed may (and probably should) taper due to the financial risks of holding a $3.6 trillion balance sheet but any argument about tapering due to improved employment or inflation risks is a canard.

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Focus on Rumours and Financials

Rumours like the ones we saw today about trouble at SocGen are just the beginning. The three L’s of the rumour-monger are about to take front stage: liquidation, losses, litigation.

The 17% drop in the S&P 500 since the beginning of July is going to generate fund liquidations. Every holding in a funds will get rag-dolled when overall losses in the fund are in excess of 20%. The rumours of withdrawals and liquidations will cause many magnitudes more damage than the withdrawals themselves.

Losses are coming in an economy that is underperforming expectations. As Warren Buffett said: “It’s only when the tide goes out that you learn who is swimming naked.” Financials are especially vulnerable because talk and rumours of losses ALWAYS precede the real thing and cause far more damage.

Litigation is a special ‘L’ in the list because the declines now are coming on the heels of the financial crisis. We are now precisely in the window of time (3-4 years after the event) when lawsuits will peak. Talk of $40-50 billion in lawsuits hitting Bank of America related to mortgage fraud have hit. The desperation in the economy and markets is going to spark others.

We are major believers in following central banks for guidance and with what we heard from the Fed and the RBA in the past 10 days, we think the message is clear. The US is on the precipice of another recession. Now it’s time to sort out who will survive.

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Stocks Have Bottomed But AUD Hasn’t

The S&P 500 will continue to rebound after the post-FOMC rally but forex market risk trades like AUD/USD will underperform as the market adjusts to the zero-growth reality in the United States.

The FOMC decision set off a wild round of trading. In less than two hours, the S&P 500 traded in a 117 point range. Eventually stocks closed at the daily highs and pulled risk trades along for the ride.

Here are some highlights of the FOMC decision:

  • The Fed committed to keeping rates low until “at least through mid-2013”
  • Three FOMC members dissented to ‘mid-2013’ saying they preferred to keep the vague commitment to low rates “for an extended period.”
  • The Fed said growth so far this year “has been considerably slower” than expected. They noted a deterioration in the labor market. There is no longer any mention of “the recovery”. They also noted that temporary factors like the tragedy in Japan account for only some of the recent weakness.
  • Previously, the Fed said it expected the recovery “to pick up” in the coming quarters. It now expects “a somewhat slower” place of recovery. They compounded the downgrade by saying that downside risks have increased.
  • The outlook for inflation was downgraded.
  • The Committee discussed the range of policy tools available to promote a stronger economic recovery… and “is prepared to employ these tools”

The final point was key because it helps explain the rebound in risk assets. It sounds like the Fed has several ideas on how to boost the economy, if need be. The thinking is that after Jackson Hall something will be implemented. This was the course of action with QE2.

To us, a larger factor was the relative value of stocks compared to bonds. After the FOMC, ten-year Treasury yields touched a record low of 2.03%. Dividends on 22 of the 30 stocks in the Dow yield more than 10 years and the average yield is 3.26%. The market tried to bully the Fed into QE3. The Fed didn’t bite (yet at least) so the market took a second look at where it could stash its money and decided risk assets were still a good bet.

That’s the takeaway for the immediate term, but what about the next 4-6 months?

We believe the market is in the process of pricing in a long period of near-zero growth in the US — something akin to the Lost Decade in Japan.

The US government is tapped out and spending cuts will continue no matter the economic state. This will be a headwind to growth, cutting about 0.5% per year from GDP.

The Fed is tapped out as well. There is nothing the Fed can do to lending rates that will stimulate growth. Borrowing rates are next-to-nil and we they don’t have a mandate or the power to get the economy moving.

This scenario may sound negative for stocks but it’s not as bad as it sounds. 1) Companies with solid (A+) ratings can borrow at extremely low  rates. 2) The worldwide economy is growing, booming in some places. Multinationals are making a larger and larger portion of their revenues abroad.

In the forex market, this doesn’t translate into the ‘risk trade’. Slower US growth will hurt commodities more than corporate profits so commodity currencies will underperform. CAD is especially vulnerable because a) rate hikes are priced in. b) Canada is highly integrated with the US. c) raw commodity exports are a large part of the Canadian economy. d) Canadian house prices are overvalued.

The first thing to break down will be the carry trade. This has already begun and will continue as AUD/USD falls to 90-cents. The Canadian dollar will be the next to decline. Traders will increasingly look to emerging market currencies.

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