Broken Velocity: Yellen’s Low Inflation Quandary (Hint: FHFA Home Price Index Growing At 6.62% YoY)

Here is a brief summary of Fed Chair Janet Yellen’s thoughts from yesterday courtesy of Deutsche Bank’s Peter Hooper: The Fed is on track to raise rates once more this year and three times in 2018. Yellen recognized that inflation has been running low recently, and that while there was some uncertainty around this performance, one-off factors that are not expected to persist, and which have not been associated with the performance of the broader economy, have been important. At the same time, Yellen noted that monetary policy operates with a lag and that labor market tightness will eventually push inflation up.

Inflation has been running low “recently”? Actually, “inflation” (defined as core personal consumption expenditure price growth YoY) has been below 2% since April 2012 and below 3% since July 1992. Notice that hourly wage growth for production and nonsupervisory employees has remained low as well, particularly since 2007.

Of course, home price increases have been far greater than the “inflation” rate used by The Fed. The recent FHFA Purchase-only home price index YoY (released this morning for June) has US home prices growing at 6.62% YoY while “inflation” is growing at a palty 1.40% YoY.

But nothing really seems to be working as expected by some. Expanding the M2 Money Supply was supposed to increase Real GDP, but that really hasn’t worked since the Reagan/Clinton recovery when M2 Money Supply growth dropped from over 12.5% YoY in 1983 to 0.1% YoY in April 1995 under President Clinton and Federal Reserve Chair Alan “Maestro” Greenspan. Robert Rubin was the Treasury Secretary.

Notice that M2 Money growth has almost always been higher than real GDP growth since 1995. Hence, M2 Money Velocity has mostly been declining since 1997.

What about the old model where additional Federal debt is okay as long as real GDP growth is greater than Federal debt growth? We are nearly at that point again after decades of rapid Federal debt growth with modest real GDP growth.

I am guessing that rather than raise rates next year, The Fed may be forced to expand their balance sheet … again. Giving more oxygen to the asset bubbles.

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As many Americans are forced to switch from exotic beers like Heineken to less expensive beers like Pabst Blue Ribbon. 

 

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Atlanta Fed’s Q3 Real GDP Forecast Dwindles To 2.2% From 3.0% (NY Fed Nowcast Q3 Forecast Plunges To 1.34%)

According to the Atlanta Fed, the GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2017 is 2.2 percent on September 15, down from 3.0 percent on September 8. The forecasts of real consumer spending growth and real private fixed investment growth fell from 2.7 percent and 2.6 percent, respectively, to 2.0 percent and 1.4 percent, respectively, after this morning’s retail sales release from the U.S. Census Bureau and this morning’s report on industrial production and capacity utilization from the Federal Reserve Board of Governors.

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The New York Fed’s Q3 forecast plunged to 1.34%.

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The alleged culprit? Hurricane Harvey.

Between a lack of inflation and dwindling GDP growth, The Fed is going to be hard put to raise rates at the December meeting.

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Industrial Production Falls -0.9% MoM In August (Worst Since May 2009), But +1.54% YoY [Hurricane Harvey?]

US Industrial Production fell -0.9% MoM in August, the worst decline since May 2009 during The Great Recession.

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The Federal Reserve blamed the decline on Hurricane Harvey.

Hurricane Harvey, which hit the Gulf Coast of Texas in late August, is estimated to have reduced the rate of change in total output by roughly 3/4 percentage point.

The index for manufacturing decreased 0.3 percent; storm-related effects appear to have reduced the rate of change in factory output in August about 3/4 percentage point.

The good news in that Industrial Production YoY is growing at 1.54%.

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But what is lost in The Fed translation is that Industrial Production growth YoY was NEGATIVE in 2015 and 2016. 

Capacity utilization? Despite The Fed’s massive intervention starting in late 2008, capacity utilization has never gotten above 80% and recently declined to 76.11%.

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The Federal Reserve’s message is truly “Lost in Translation.”

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Atlanta Fed Increases Q3 Real GDP Forecast To 3.0% As Catastrophe Bonds Plunge (Fed Not Likely To Raise Rates Again Until September 2017 Meeting)

The Atlanta Fed’s GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2017 is 3.0 percent on September 8, up from 2.9 percent on September 6. The forecast of the contribution of inventory investment to third-quarter real GDP growth increased from 0.87 percentage points to 0.94 percentage points after this morning’s wholesale trade report from the U.S. Census Bureau.

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Of course, these GDP numbers do not yet include the horrific damages caused by Harvey or Irma (while Jose is pushing out into the Atlantic Ocean). The damage to housing, commercial real estate and automobiles from Harvey and Irma will be quite extensive.

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Catastrophe (Cat) bonds took a big plunge on Irma.

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The extensive hurricane damage is likely to reduce the chance of a Fed rate hike. As of today, the implied probability of a Fed rate hike does not exceed 50% until the September 26, 2018 meeting. And then it is only 55.3%.

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The most likely path of Fed rate hikes is beginning to look like the train from the movie “Snowpiercer.”

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Be safe Texans and Floridians.

 

Already Gone II: Minnesota’s Public Pensions Drop To 7th-worst Funded From 30th (Heartache Tonight?)

The Eagles said it best in their song: (Minnesota’s public pensions are) already gone.  They left out the part where Minnesota tax payers are on the hook for $33.4 billion in debt ($6,000 for every resident).

(Bloomberg) — Minnesota’s debt to its workers’ retirement system has soared by $33.4 billion, or $6,000 for every resident, courtesy of accounting rules.

The jump caused the finances of Minnesota’s pensions to erode more than any other state’s last year as accounting standards seek to prevent governments from using overly optimistic assumptions to minimize what they owe public employees decades from now. Because of changes in actuarial math, Minnesota in 2016 reported having just 53 percent of what it needed to cover promised benefits, down from 80 percent a year earlier, transforming it from one of the best funded state systems to the seventh worst, according to data compiled by Bloomberg.

“It’s a crisis,” said Susan Lenczewski, executive director of the state’s Legislative Commission on Pensions and Retirement.

The latest reckoning won’t force Minnesota to pump more taxpayer money into its pensions, nor does it put retirees’ pension checks in any jeopardy. But it underscores the long-term financial pressure facing governments such as Minnesota, New Jersey and Illinois that have been left with massive shortfalls after years of failing to make adequate contributions to their retirement systems.

The Governmental Accounting Standards Board’s rules, ushered in after the last recession, were intended to address concern that state and city pensions were understating the scale of their obligations by counting on steady investment gains even after they run out of cash — and no longer have money to invest. Pensions use the expected rate of return on their investments to calculate in today’s dollars, or discount, the value of pension checks that won’t be paid out for decades.

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The guidelines require governments to calculate when their pensions will be depleted and use the yield on a 20-year municipal bond index to determine costs after they run out of money.

The Minnesota’s teachers’ pension fund, which had $19.4 billion in assets as of June 30, 2016, is expected to go broke in 2052. As a result of the latest rules the pension has started using a rate of 4.7 percent to discount its liabilities, down from the 8 percent used previously. Its liabilities increased by $16.7 billion.

The worsening outlook for Minnesota is in line with what happened nationally. Pension-funding ratios declined in 43 states in the 2016 fiscal year, according to data compiled by Bloomberg. New Jersey had the worst-funded system, with about 31 percent of the assets it needs, followed by Kentucky with 31.4 percent. The median state pension had a 71 percent funding ratio, down from 74.5 percent in 2015.

While record-setting stock prices boosted the median public pension return to 12.4 percent in 2017, the most in three years, that won’t be enough to dig them out of the hole.

Only eight state pension plans, in Minnesota, New Jersey, Kentucky and Texas, used a discount rate “significantly lower” than their traditional discount rate to value liabilities, according to a July report by the Center for Retirement Research at Boston College.

“Because of that huge drop in the discount rate under GASB reporting, their liabilities skyrocket,” said Todd Tauzer, an S&P Global Ratings analyst. “That’s why you see that huge change compared to other states.”

In Minnesota lackluster returns and years of shortchanging have taken a toll. The state’s pensions lost 0.1 percent in fiscal 2016.

But other factors also helped boost Minnesota’s liabilities: Eight of Minnesota’s nine pensions reduced their assumed rate of return on their investments to 7.5 percent from 7.9 percent, while three began factoring in longer life expectancy.

Minnesota funds its pensions based on a statutory rate that’s lower than what’s need to improve their funding status. School districts and teachers contribute about 85 percent of what’s required to the teacher’s pension, according to S&P Global Ratings.

“It’s woefully insufficient for the liabilities,” said Lenczewski, the director of Minnesota’s legislative commission on pensions. “You just watch this giant thing decline in funding status.”

Minnesota has officially joined other states in promising more benefits than can be delivered.

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While the public pension crisis isn’t a heartache tonight, it will in the near future. Add the growing debt issued to keep public pension funds going, and the amount of the tab for other government spending like The Federal debt (currently $165,819 per taxpayer) and unfunded liaibilities such as Medicare and Social Security ($899,500 per taxpayer) and we have a party.

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US Second Quarter GDP Revised Sharply Higher To 3.0% (Highest Since Q1 2015), ADP 237K Jobs Added

According to the Bureau of Economic Analysis (BEA), Q2 US Gross Domestic Product rose sharply to 3.0%.

The percent change in real GDP was revised up from the advance estimate, reflecting upward revisions to PCE and to nonresidential fixed investment that were partly offset by a downward revision to state and local government spending.

The biggest surge? Equipment rose 8.8%! For Personal Consumption Expenditures, durable goods rose 5.9% in Q2.

Personal consumption expenditures rose 3.3%, revised upwards from 3.0% in the advanced report.

According to ADP, 237,000 jobs were added in August.

 

 

Treasury’s Cash Balance Lowest Since Debt-Limit Reinstatement (Take It To The Limit)

(Bloomberg) — We’re still over a month away from Treasury Secretary Steven Mnuchin’s “critical” deadline for Congress to raise the debt limit, but the government’s coffers are already starting to feel the squeeze. With auctions cut back, the Treasury’s cash balance has fallen to $50.6 billion, below the Department’s quarter-end forecast of $60 billion and the lowest since the end of the debt-ceiling suspension period back in March. A smaller cash balance means the government has less of a buffer to pay its bills in case of disruptions in debt markets.

As the Eagles (and Randy Meisner) sang, “Take it to the limit.”

But it won’t be one more time, but many.