Tuesday, March 21, 2017

What's Up with the Economy?

I had made a prediction in the past about a recession coming in 2016. That didn't happen. The job now is to understand why.

Let's start by looking at the following chart. It gives quarterly US GDP growth, the same growth as a 12 quarter moving average, and the difference between the two. The moving average helps smooth out the volatility and noise to give us a trend.

Date         GDP      GDP SMA 12q  GDP-GDP SMA 12q
31-Dec-16    3.50%    3.62%        -0.12%
30-Sep-16    2.94%    3.68%        -0.74%
30-Jun-16    2.51%    3.71%        -1.20%
31-Mar-16    2.80%    3.71%        -0.91%
31-Dec-15    3.00%    3.74%        -0.74%
30-Sep-15    3.26%    3.76%        -0.50%
30-Jun-15    4.12%    3.83%        0.29%
31-Mar-15    4.45%    3.85%        0.60%
31-Dec-14    4.07%    3.88%        0.19%
30-Sep-14    4.90%    3.84%        1.06%
30-Jun-14    4.50%    3.73%        0.77%
31-Mar-14    3.34%    3.67%        -0.33%
31-Dec-13    4.31%    3.71%        0.60%
30-Sep-13    3.21%    3.73%        -0.52%
30-Jun-13    2.60%    3.85%        -1.25%
31-Mar-13    3.14%    3.96%        -0.82%
31-Dec-12    3.24%    3.87%        -0.63%
30-Sep-12    4.11%    3.61%        0.51%


One of the first things you will notice is that the moving average is rising until Dec 2014, after which it begins a decline. The actual GDP growth rate falls below the moving average in Sep 2015 and has stayed below that ever since. In times past, this kind of thing would kick off a recession by now. The start of the 2008 recession in Dec 2007 occurred with the 12q moving average falling for 5 quarters and the GDP growth rate falling under the moving average for 7 quarters. The 2001 recession occurred with only two quarters of each. The 1991 recession was similar to the 2001 recession in this regard. What is happening now? And why did the Fed just raise rates in a falling GDP growth environment? (Yellen claimed GDP is "noisy" - what the heck?!?)

The answer is employment. In the three previous recessions, the employment situation was deteriorating. Presently, the employment situation is still strong. Neither the unemployment rate, a 12mo moving average of the unemployment rate, the Labor Market Conditions Index, or a 12mo moving average of that, shows any major deterioriation. A little softness maybe, but that's it.

Here's unemployment (official UE rate, 12 mo moving average, and the difference):

Date          UE     UE12   UE12-UE
2016-01-01    4.9    5.2    0.3
2016-02-01    4.9    5.1    0.2
2016-03-01    5.0    5.1    0.1
2016-04-01    5.0    5.1    0.1
2016-05-01    4.7    5.0    0.3
2016-06-01    4.9    5.0    0.1
2016-07-01    4.9    5.0    0.0
2016-08-01    4.9    4.9    0.0
2016-09-01    4.9    4.9    0.0
2016-10-01    4.8    4.9    0.1
2016-11-01    4.6    4.9    0.3
2016-12-01    4.7    4.9    0.1
2017-01-01    4.8    4.8    0.0
2017-02-01    4.7    4.8    0.1


Here's LMCI (LMCI and 12 mo moving average):

Date          LMCI   LMCI12
2016-01-01    -2.2   1.7
2016-02-01    -1.9   1.4
2016-03-01    -1.8   1.2
2016-04-01    -2.1   0.9
2016-05-01    -2.3   0.3
2016-06-01    1.1    0.1
2016-07-01    2.2    0.1
2016-08-01    0.1    0.0
2016-09-01    -0.1   0.0
2016-10-01    0.8    -0.2
2016-11-01    1.0    -0.3
2016-12-01    0.0    -0.4
2017-01-01    1.3    -0.1
2017-02-01    1.3    0.1


There's just not a whole lot to see. Employment is steady amidst a backdrop of falling GDP growth. What gives? Or doesn't give...
Now I put my interpretive hat on. In the aftermath of the Great Recession, American organizations cut staffing hard. They cut to essentials, and they've been loathe to add positions since. There has been much employment growth, however, that has come in large part through people retiring or otherwise opting out of the workforce. While there is some spare capacity to cut, there isn't much. Continued low unemployment in the face of falling GDP growth, then, is a sign that American organizations are near-optimized as far as employment, with respect to the complexity of our economy. Since employment is staying steady it isn't forming a negative feedback loop with GDP, meaning GDP is not declining as fast as it would if companies were in a position to cut more. Specifically, GDP growth is generally not more than 1% below the moving average.
Well something has to give, does it not? Now I put my prediction hat on again. If the unemployment situation does not deteriorate, look for inflation. Then look for GDP to slowly rise eventually, not by virtue of economic output, but simply because of inflation. If this is what is going to happen, the Fed rate hike was exactly the right move.
If the unemployment situation does deteriorate, I would expect it to do so no later than the end of 2017.

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