Retail Sales from Friday

Retail Sales was released on Friday. The release impacts real consumer spending, a large component of GDP. The consumer has been driving the increase in GDP over the past few quarters. Prior to this release, the consumer spending growth was 2.0 percent. With a GDP forecast of 0.8 percent, it is easy to see that consumer spending is driving the growth in GDP.

The release on Friday dropped the consumer spending growth rate to 1.7 percent. Because of its out-sized influence, the fourth quarter GDP estimate dropped to 0.6 percent. I am starting to become alarmed, but not because of the drop in the estimate. The blue chip consensus saw an increase in the estimate for GDP as the high-end of the estimates moved up to 2.5 percent. The divergence that occurred with the Friday release of GDP Now is startling. What are other economists seeing that would result in their estimate increasing?

The next estimate will be released on Wednesday.

GDP Update

The GDPNow estimate at the Atlanta Fed has experienced a wild week. Let’s go through the changes so far. The estimate had been stable for a couple of weeks through the end of 2015 as there was no activity. We began the week with a fourth quarter estimate of 1.2%.

On Monday the ISM Manufacturing Index was released and it was dismal. When I go through the numbers remember this release was just for the month of December.

  • The estimate on PCE Goods went from 3.0% to 2.5%
  • The estimate on Fixed Investment went from -0.4% to -2.1%
  • The estimate on Residential Investment went from +1.3% to -2.9%

Overall, the GDPNow estimate fell to 0.7%. This is a significant cut for a number that impacts only one of the three months in the quarter.

I heard exactly one reaction and it was flawed. On Tuesday the minutes from the December meeting of the Federal Reserve were released. This was the meeting where the Fed decided to raise rates. After the minutes, everyone was quick to note the vote to raise rates was barely in favor. The analyst I heard mentioned that if the Fed knew the GDPNow number would drop to 0.7%, it was likely they would have held off on raising rates.

I think that is incorrect. The Fed is responsible for stable prices and increasing employment. They are not responsible for growth of the economy. Growth in the economy has two precursors — productivity growth and population growth. With CPI or the PCE deflator well under 2% and employment continuing to increase, the Fed is achieving both targets and beginning to normalize rates is the correct response given their mandate.

Yesterday, figures on International Trade were released. This impacted GDPNow by raising the estimate of Q4 to 1.0%. While exports remained at 0.2%, imports went from 2.5% to 1.0% and since Net Exports is Exports minus Imports, the decrease in imports is a net positive for GDP.

Tomorrow is jobs day in the US as employment figures are released for December. This will not impact GDPNow. Later in the morning, figures on Wholesale Trade will be released and that will have an impact. Once we get those numbers, economic statistics affecting GDPNow will be absent for one week.

The current estimate from Blue Chip Forecasts that the Atlanta Fed uses is constructed by taking the top ten forecasts and the bottom ten forecasts. The range for Q4 is 1.5% to 2.6%. This is well above the GDPNow estimate of 1.0%. We are three weeks away from the official first estimate which leaves plenty of time for revisions. I hope to have time to follow this as it appears this might influence Fed actions. It shouldn’t, but if someone expects it to enough to make the comment publicly, there could be some interesting commentary for the January Fed meeting.

GDP and Recession Risk

As we face the first increase in the targeted Federal Funds rate in nine years, I hear some analysts complain the Fed is behind the curve and others say the economy is likely to move into recession because it cannot handle the increase in interest rates. No matter which side you are on, there are already some indicators we can follow to see where the economy is headed and what the probability of recession is.

Two of these indicators we are already following. The first is the expected inflation rate for the next five years. This indicator is not based on actual data, but rather is a number tracked by the bond market. Thus it is an indicator of where market participants are betting the inflation rate will likely be. As of December 10th, that number is 1.20%. It was 1.30% at the end of October 2015. It was 1.27% on December 10, 2014. That is a narrow range and stable over the past year. It is also nowhere near the Fed’s stated target of a 2.00% long-term average for inflation. The conclusion we should come to is the Fed does not need to raise rates since the market is saying inflation, one of the key Fed guiding measures, will not be a problem for the next several years.

The next indicator to observe is the two-ten spread. This measure is the difference between the yield on the ten-year U.S. Treasury bond and the yield on the two-year U.S. Treasury bond. When this indicator turns negative, there is a high likelihood of a recession starting within two quarters. As of December 10th, the spread is 1.29%. As of October 31st, it was 1.41%. As of December 10, 2014, it was 1.59%. It has not been a straight line down over the past year, but a thirty basis point move over the past year is something to follow. For now, this indicator is well above zero. I do not expect to get concerned until it drops below 50 basis points. I think the financial media will get interested if it drops below 100 basis points.

The previous two indicators I have been following on the Analytical Road at blogspot. The next two I have just recently been reading about and both are hosted at the Federal Reserve of Atlanta. One uses historical GDP to predict the likelihood the U.S. is currently in a recession. This is useful since the NBER is the official body which can declare a recession but can sometimes have multi-year delays in their decision. The second uses current data and estimates for an in-period forecast of quarterly GDP. We will start with a look at that indicator.

GDPNow is updated at least once per week. On December 4th, the forecast for the fourth quarter was 1.5%. On December 11th, it moved up to 1.9%. The change over the week comes from the increase in real retail sales and the decrease in wholesale trade and retail inventories. At 1.9%, it won’t raise any concern even though that is a low number. A 1.5% number for the fourth quarter would raise concern. Using the current estimate of 1.9%, it appears the economy is not outgrowing its long-term average. There aren’t too many more financial numbers before the end of the quarter and I suspect the estimate will start to decrease volatility and the focus will turn to the first quarter of 2016. For now, this indicator seems to suggest no change is needed.

The other indicator from the Atlanta Fed is called the GDP-Based Recession Index. This indicator uses historical GDP and a large number of probability estimators to estimate the likelihood the U.S. economy entered a recession in the previous quarter. This indicator was last updated on August 10, 2015 and reads 13.3%. This is significantly below the level of 67% which is the trigger to indicate a recession has begun.

Of these four indicators, the forward five-year inflation rate and the two-ten spread are collected daily. GDPNow is updated weekly. The GDP-Based Recession Index is updated quarterly. I have thought about putting these together into a single page, but there is another indicator we need to watch because we have an extraordinary market with the Fed’s zero interest rate policy. This measure also comes from the Federal Reserve of Atlanta and is called the Wu-Xia Shadow Federal Funds Rate. When the Fed moved rates to zero, there was academic talk about the lower bound of zero. While some European economies and the ECB have moved their rates below zero, the Fed has held rates at the zero bound. Researchers Cynthia Wu and Fan Dora Xia used some clever data to calculate what the Federal Funds rate should have been. The shadow rate reached a low in May 2014 at -2.99%. As a saver, I am very pleased the Fed did not lower rates to that level. The rate as of November 2015 is -0.004%. Since that May 2014 low, this shadow rate has been moving very quickly higher. It seems reasonable the Fed would want to stay near this rate as this is what the market and economy indicate is necessary. In that case, a 25 basis point move this week would not be unreasonable.

The result of this walk through our data is to conclude that a rate increase is needed by one measure and not necessary by others. Our two daily indicators are subject to the emotional volatility of the market and based more on what market participants expect rather than what has occurred. The next week will be interesting to see how these indicators react. I am assuming the Fed does increase rates but will also say future increases are data dependent. I am not expecting another date to be explicitly mentioned. I would expect that to be the unwelcome market moving event. Once we move off the zero based policy, the shadow rate will go away. What we will be left with is two market based indicators and two GDP based indicators as a set to indicate what the Fed is likely to do. I will work on making a cohesive case for these over the next few months.

November Update of 2016 Indicators

I don’t know what it would take to become a labor economist, but I find myself focusing more frequently on labor through employment, wages, and spending. The place I have been collecting data is contained on the page with the 2016 Indicators. I recently did a data update with the employment data from the first week of November.

Employment Participation Rate is on a separate page. There was some discussion in the press about the declining participation rate. I don’t think there was enough. The rate for October 2015 was 62.5%. This is below the rate of 63.0% in October 2014. For both men and women, the participation rate is lower than last year and is below the twelve-month average. The trend for both is lower. This trend should continue through the beginning of the year and I’m making that judgment based on expectations of a December Federal Funds rate increase and the trend on the indicators page.

Capacity Utilization has continued its trend lower. It had a near-term peak of 78.7 in January and has slid lower throughout the year to the September release of 77.5. With that much spare capacity and the participation rate decreasing, there is quite a bit of slack of resources in the economy. You can see that in the inflation numbers — both past and future. The past twelve months has seen inflation at 0%. The result of these factors is a five-year inflation expectation of 1.2%. To summarize this into a phrase — there is no current inflation and no expected inflation for a number of years.

Real Wages is calculated quarterly and turned below zero in the third quarter. This indicates to me there is no wage pressure in the economy even though the unemployment rate fell to 5%. The participation rate is the driving factor of wage pressure, not the unemployment rate, and the data supports this position. One consequence of decreasing wages is the decreasing real retail figure. It is now below a 2% year-over-year rate. I’ve heard mixed expectations for retail trade in the holiday season. I’m beginning to think it will not be good and might be lower than last year. That will put pressure on the Federal Reserve to not raise rates early next year.

October 2015 Ten Year Yield

The yield on the ten-year Treasury has stalled (opens in new tab / window) for some time now. The passages between levels have become very short and the changes very modest. I have one adviser who says the higher lows indicate a major reversal is ahead. Another adviser says it is simply a bear reversal in the on-going long-term trend lower. I don’t mind the difference of opinion on the trend of the yield, but both opinions are based on different views of the economy. One thinks there are positive signs of a stronger economy and the other sees a recession ahead.

i generally prefer to have opposing views which lead me to keep a balanced portfolio. I get concerned when both opinions have the same conclusion. I choose these advisers because one is is pessimistic in that if one part of the economy is off, then the whole system is in jeopardy. The other is generally optimistic since the resiliency of the economy means little improvements have a lengthy and profoundly positive influence on investor behavior.

And still we wait on the Federal Reserve.

Federal Reserve Doesn’t Change

I am disappointed the Federal Reserve did not change their interest rate target. I have mentioned the length of financial repression that is taking place is unwarranted, but reading reports of the level of mal-investment caused by near zero interest rates means they are well out of bounds. There were extraordinary circumstances in 2008 that required an unusually low interest rate. Those circumstances were resolved by 2010. It’s time to get the productive part of the economy rewarded for doing the right thing. If the economy is so fragile that it cannot handle a change of 0.25%, then all of the QE in the world cannot make a difference either.


As I read back through my last few posts, I begin to understand more how Economics is more of an art than ever. The past six months has seen me begin to work on several projects that involve data science and will result in writing a few technical papers. In contrast I spend a fair amount of free time reading about economics and investments. They have become similar lately in both concern about the Federal Reserve and in purpose for writing.

The work around investments is close to what philosophy is — there are some generally accepted truths and many different derivative avenues from those. Economics has turned completely away from examining data and towards opinion and personalities. That is nearly what an art form is about.

In writing the technical articles, I have come to appreciate what is becoming accepted — “science is hard”. In reading economics, I have also come to appreciate that opinion is all that matters.

I listen to Bloomberg radio on my drive to work each morning. At least daily, a guest is asked their opinion about the timing of a Fed rate hike. Less than weekly does a guest discuss the consequences of a rate hike. It seems to me that is backwards — if we understand the consequences of an event, then whether to cause the event can be judged.

There is no one who thinks an increase in the Federal Funds rate will cause the trade weighted value of the dollar to fall. There are some who think it will not change because the rate increase is so well known. Most expect the value of the dollar to rise. Some think this will have little impact. Most understand this will increase the effects of disinflation (the difference between disinflation and deflation is the sign in front of the number). Thus, the only reason to raise rates is to curb inflation.

The July CPI was released this week. The one year inflation rate is 0.17%. The ten year annual inflation rate is 2.02%. These numbers tell me that inflation is not a problem and long term inflation is continuing to decrease.

The problem arises when we include information about the market. In five years, the market expects annual inflation to be 1.60%. This is a problem because this is not data — it is opinion. If we include this number in our analysis and say inflation looks well contained even five years out, we are no longer using data to make a judgment. Instead we are basing our judgment on the opinion of others. Discard this number and let’s go back to the ten year rate.

One year ago, the annual ten year inflation rate was 2.32%. Now it has fallen to 2.02%. That trend is very clearly lower. The current one year rate is well below the current ten year rate. That will mathematically keep pushing the ten year annual rate lower.

The next step would be to examine the possibility of this changing. With only one input, this is straight forward to do. The one year rate needs to rise above the annual ten year rate. In order for that to happen, there needs to be a sustained increase in those factors that enter the inflation numbers. Yet, commodity prices are heading lower, wages are low and stagnant, consumer demand is slowing (especially in the retail sales numbers), government consumption is slowing dramatically, and business investment has not changed in years. None of these items are showing any indications of leading to increases in the CPI.

This analysis and thought session has given me some indications for what to watch in late 2015 and beyond. The 2015 watch list is nearing the end of its interest and I have to wonder what is next. I’ll start working on the data series list that could provide indications of a change in the rate of inflation.