Feb 7. Yellen before Congress on Wednesday
Themes:
- Capital spending and stocks
- Reaction to employment/stagflation/higher wages lower productivity
- Yellen on Wednesday. In Sept, she thought international situation wouldn’t have much impact
CAPEX
Below is a chart of Core Capital Expenditures. The downturns in this series correlate well with the chart of SPX. Both peaked in 2000, 2008 and in 2014/15. Which one turns down first? The moves appear more or less simultaneous, but the point is that declines in capex aren’t good for longer term growth, and the past year of negative rates in capex (bottom chart) in spite of what had been a strong stock market, and near record high profits as a % of GDP, is certainly not a good sign.
Charts : Core Capex, SPX, and rate of change in Core Capex
So what does this chart remind you of? (Below is chart of SPX, same time frame)
The chart below is the percentage change in Core Capital Expenditures. Negative all last year.
Last week I touched upon the idea that the rest of the world is depending on the US consumer to hold up global growth. However, in the US, consumption as a % of GDP is already at an elevated level. From an article in the Telegraph today: “According to [former chief economist of the IMF] Blanchard’s calculations, a 20% decline in stock markets that persists for more than six months will translate into a decline in consumption of between 0.5 to 1.0pct.” Many stocks are off well over 20%. It could be a tough summer, and the charts above don’t give much hope for investment/ capex resurgence either.
Reaction to employment
Headline NFP was a bit less than expected at 151k, but the wage component was strong, up 0.5% with yoy +2.5%. Last Thursday’s Nonfarm Productivity number was -3%, with unit labor costs +4.5%. The broad picture seems to tilt toward stagflation: falling capex leads to lower productivity, while higher wages eat into corporate profitability. It’s probably about time that labor gets a bigger piece of the pie, but the pie might get a little bit smaller. Feel the Bern.
In any case, the wage gains have major forecasters setting their sights on a June hike rather than March (I saw notes from both JPM and Barclay’s targeting June). This change to June was readily apparent in the euro$ curve, with March’16/June’16 (EDH6/EDM6) surging 2 bps to 6 (that’s sarcasm) while June/Sept only went up 0.5 to 4. On the week, euro$ calendar spreads continue to be crushed, with new lows in all of the nearby one-yr spreads. For example, EDM16/EDM17 settled at just 21 from 32 last Friday. The red/green (2nd to 3rd year) pack spread settled at a new low just over 33 bps. The market continues to squeeze out the idea of hikes with the five year yield falling over 8 bps to just under 1.25%. Yellen might not know it, but persistent weakness in equities will create a negative feedback loop.
YELLEN ON WEDNESDAY, WILL LIKELY FACE SOME HOSTILE QUESTIONING
Yellen testifies on Wednesday. It’s a difficult position to be in. If she takes too much of a step back due to declining global growth and trade, then she might force a wicked rally in the euro, just as Draghi is preparing steps to further depreciate the currency. Improvements in European economic stats appear to be substantially linked to the weaker Euro. On the other hand, a weaker dollar would go a long way in stabilizing commodities, which would likely help some emerging economies. My guess is that she will attempt to characterize softness in China/Asia as transitory (as she did in September), but will vow to vigilantly watch for negative effects on the US economy. Data dependent.
I looked back at a Yellen speech from last September 24, just after the FOMC refrained from an expected hike. A couple of excerpts are below:
Persistently high inflation, if unanticipated, can be especially costly for households that rely on pensions, annuities, and long-term bonds to provide a significant portion of their retirement income. Because the income provided by these assets is typically fixed in nominal terms, its real purchasing power may decline surprisingly quickly if inflation turns out to be consistently higher than originally anticipated, with potentially serious consequences for retirees’ standard of living as they age.
Isn’t this the exact same problem defined by persistently low interest rates?
Inflation that is persistently very low can also be costly, and it is such costs that have been particularly relevant to monetary policymakers in recent years. The most important cost is that very low inflation constrains a central bank’s ability to combat recessions.
That’s the most important cost? I would say the most important cost is that it impedes companies from servicing debts that become ever more onerous with stagnant prices, leading to a negative spiral.
