Data Point Deceptions and the Lackluster Recovery
With all eyes on the Dow’s advance toward 11,000 yesterday, your California editor fixed his eyes on the 10-year Treasury’s advance toward 4.00%. By the end of the trading session, only one of the two had reached its target.
The 10-year Treasury kissed 4.00% – up from 3.20% just four months ago and up from 2.05% during the panic lows of late 2008. What does this rapid run-up in rates signify…and should we care?
“Don’t know” and “Not sure,” would be our responses. But let’s try to read the economy’s palm and see what we find. For starters, the economy’s “recovery line” is very short and features multiple breaks. This is never a good sign. Additionally, the economy’s “inflation line” is very long and pronounced. (Don’t be upset with us; we’re just the palm readers).
Turning to hard macroeconomic data, a similar storyline emerges. The economy is recovering, but its recovery lacks vigor. At the same time, inflationary forces are stirring.
“Private payrolls turned in a respectable 123,000 gain [in March],” observes economist David Rosenberg. “This was the third [private sector] increase in a row and brings the cumulative gain to 147,000. But let’s keep in mind that the comparable findings from the ADP survey are far different – down 23,000 in March and down 255,000 in the past three months.
“If you go back to the last jobless recovery,” Rosenberg continues, “it was not rare to see such a divergence, but in the end, only when both measures were rising in tandem was it safe to call for a sustainable economic expansion – both rose together each and every month from August 2003 to June 2007. But in the sketchy period of 2002 and 2003, there were multiple months where private payrolls in the nonfarm payroll survey were solid at a time when the ADP failed to ratify (October 2002, December 2002, January 2003, May 2003), and each time the ADP got the call right…
“Now, we are not going to dismiss the BLS data,” Rosenberg cautions, “but wouldn’t it be nicer if both surveys said the same thing? The ADP is a pretty simple concept – and does not have any ‘plug’ factors to try and assume how many new businesses were created or destroyed in any given month.”
Rosenberg’s analysis reminds us that honest data points sometimes produce powerful deceptions. Based on data points like GDP growth and “Core CPI,” the US economy is producing non-inflationary growth.
Conversely, based on data points like U6 unemployment; Consumer Spending, before changes in the savings rate and; CPI, excluding rents, the US economy is producing more inflation than genuine growth.
The “U6” measure of unemployment, which includes “underemployed” and long-term unemployed laborers, rose to a record-high 16.9% of the workforce in March. Not surprisingly, therefore, the “recovery” in consumer spending we have been reading so much about is a complete fantasy. “US consumer spending in the first quarter was higher,” Rosenberg points out, “[only] because the savings rate slipped to 3.1% from 4.7% at the end of last year… without that unsustainable decline in what is already a low personal savings rate, consumer spending would have actually contracted 0.4% in January and 0.6% in February.”
Yet, despite these real-world indications of sluggish economic activity, inflationary forces are gaining strength. Yes, yes, we know, that’s not what you’re hearing on CNBC. But here’s the skinny: the headline CPI numbers are subdued because the housing market is flat on its back.
About 30% of the CPI calculation derives from an estimate of residential rents that – more or less – reflects conditions in the residential real estate market. (To see the scintillating details of this calculation for yourself, click here). So when the housing market is weak, so are the estimates of “owners equivalent rent,” which represents about one quarter of the CPI calculation. (A separate “rent” estimate contributes another 5% to the CPI calculation).
Generally speaking, the residential rent estimates track closely with other components of the CPI calculation. But that has not been the case lately, as the nearby chart illustrates.
Instead, the headline CPI number, which includes residential rents, indicates that inflation is nearly nonexistent. However, the CPI calculation that excludes residential rents shows a very different picture. In fact, this calculation shows that inflation has been rising at a 3% clip since the end of 2007, despite the fact that the economy has been recessionary throughout most of this period.
To be sure, deflation in the residential real estate market is genuine deflation. So we are not discounting the value of this metric. On the other hand, the 70% of the CPI that measures the cost of the goods and service is telling us that inflation is far from dead. The bond market is telling us the exact same thing.
Like trying to fill a teacup with a fire hose, the Fed has directed massive quantities of new dollars and cheap credit into an economy that cannot efficiently utilize it. As a result, “too much money will chase after too few goods and services,” to cite Milton Friedman’s timeless definition of inflation.
That’s why bond yields are heading higher, no matter what the economy does from here. You may not have heard it here first, but at least you heard it here.