Morning Report – FOMC data dump 6/19/14

Vital Statistics:


Last Change Percent
S&P Futures 1950.2 1.1 0.06%
Eurostoxx Index 3322.3 43.1 1.31%
Oil (WTI) 105.7 -0.2 -0.22%
LIBOR 0.23 -0.001 -0.61%
US Dollar Index (DXY) 80.25 -0.331 -0.41%
10 Year Govt Bond Yield 2.57% -0.01%
Current Coupon Ginnie Mae TBA 106.2 0.1
Current Coupon Fannie Mae TBA 105.5 0.0
BankRate 30 Year Fixed Rate Mortgage 4.26


Stocks and bonds are higher this morning after the FOMC meeting.
Some more economic data this am. Initial Jobless Claims came in at 312k, more or less in line with expectations. The Bloomberg Consumer Comfort Index rose to 37.1 from 35.5.
The FOMC meeting didn’t have any major bombshells, although the Fed took down its 2014 GDP forecast pretty aggressively, from a 2.9% estimate in March to a 2.2% estimate in June. The weather-related drag on the economy was worse than thought. Note that next week we will get the third and final revision to Q1 GDP, and the Street is forecasting it gets revised from -1% to -1.8%. Bonds rallied hard on the announcement, closing on their highs. In the press conference, Janet Yellen was asked about the latest CPI reading and she said that the CPI tends to be noisy. FWIW, the Fed uses a different inflation measure – Personal Consumption Expenditures for that very reason. The market took that statement to mean that the Fed is sanguine about inflation which gave bonds another excuse to rally. The forecast for the Fed Funds rate (Yellen’s dot graph) did not change from the March meeting. Overall, it was a “Goldilocks” type report, which gave stock and bond investors something to cheer about. Take a look at the chart below, and see how much the Fed has been overestimating future growth. This is their forecast for 2014 GDP growth going back to 2012.

Why does the Fed keep getting the GDP forecast wrong? It is probably because their models were built based on the typical garden variety post-Depression recession, which follows a Fed-induced recession process. The process is that the economy grows -> inflation picks up -> the Fed raises rates to quell inflation -> the economy begins to slow -> inventory builds -> people get laid off -> we go into a recession -> the inventory gets drawn down -> the laid off workers get re-hired -> and the economy recovers. The issue is that what happened in 2008 is that we had to deal with the fall out of a burst residential real estate market, and those happen every other generation. The recession is caused by a glut of bad debt, not a glut of inventory. And bad debt takes a lot longer to work off than a warehouse full of widgets.

There are 2 million “missing households” in the US – which represents pent up demand for new residences in the US. These are Millennials who are living with their parents or rooming together in an apartment. That represents 2 years of housing starts at the current pace. Rents are increasing, jobs are tough to get, and student debt is high. Fun fact – we haven’t been building this few homes since World War II, according to the NAHB. Let that sink in.

What does the declining labor force participation rate mean for the economy? There are two schools of thought going on here and this encapsulates the debate going on at the Fed. Does the long-term unemployed represent people who are essentially retired and will never return to the work force? If so, then there is less slack in the labor market that initially appears and therefore more stimulus will be inflationary. In essence that means the economy’s “speed limit” is lower than normal. Or is there a possibility that the long-term unemployed could return to the work force? If so, then more stimulus is not only necessary (though one can debate the efficacy of ZIRP on unemployment), but also will be non-inflationary. Note that we have been getting the worst of all worlds lately – increasing commodity prices, especially food prices combined with stagnant wage growth and slow job creation. While this is nothing like the stagflation of the late 70s, it still is painful.
FWIW, I personally think the long-term unemployed want (and need) to work and will enter the workforce as the economy improves. Employers have the luxury or choosing people with the wisdom of a 50 year old, skills of a 40 year old, the drive of a 30 year old, and the pay of a 20 year old. That won’t last forever. Also, the low capacity utilization rate means that inflation is a way’s off, and if anything increasing commodity prices are recessionary, not inflationary. They can only be truly inflationary if wages increase. Otherwise, people’s disposable incomes drop, spending decreases, and the economy slows, which lowers commodity prices. That said, I don’t think QE and ZIRP are having much of an effect on the economy, and the longer we stay with excess stimulus the harder normalization will be.
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