The Days Ahead: Fed black out. G7 Central Bankers meet.
One-Minute Summary: Sometimes you wait for some, any news to come around. Sometimes, it comes fast and understandable. Sometimes it comes so fast, you just have to wait to see how the air clears.
So last week, we had i) weaker manufacturing numbers but ii) okay services numbers iii) weak employment but iv) okay vehicle sales. Tech companies are under regulatory review. The Mexico tariffs took their toll. But by Friday, there was talk that there was a deal going through if Mexico agreed to buy more agricultural products (I know, I thought it was about immigration too).
Bonds rallied again, equities came back 4.5% and we’re now back to where we were in the beginning of May. Fed speak was mostly dovish ahead of the blackout period for the FOMC meeting on June 18.
The Fed has a tough task. They have to weigh up:
Signals that Fed should cut: trade, stock weakness, manufacturing, slower Q2 growth and low inflation
Signals to stay put: employment, claims, service industries, consumer and housing.
If there is a cut (we’d give it a more than 50% chance in the next three months) then we’ll see asset classes perform in this order of best to worse:
Good news! A sign that the Trade Wars may be behind us arrived in a new ETF called “The Innovation α® Trade War ETF”. It buys companies that are insulated from trade wars. Companies like GE, MasterCard, IBM and Xerox, most of which sell a ton overseas and have been bad investments because, well, they’re not great businesses. Of course, it’s back tested and looks terrific. So, whew.
But when these types of ETFs hit the market, they’re a decent contrarian indicator
1. Demographics as destiny. The fun part about demographics is that you can predict changes years ahead with some accuracy. After all, if you're alive today, you’ll probably be alive tomorrow and a year from now. So a birth cohort moves through the years pretty much unchanged.
Unless… unless, immigration increases, fecundity takes off or people start dying later than planned. In the U.S., immigration has slowed, birth rates are lower and later and life expectancy has dropped.
Put all these numbers together and U.S. population growth is around 0.6% a year, compared to 1.3% two decades ago. So instead of the population growing 3.3m a year it’s down to 1.9m a year. Labor force growth is around 0.9% compared to 1.8%. So that’s down from 2.3m to 1.4m.
So what? Why should we care? Well we should care very much because while the U.S. has an impressive GDP record, it has a decidedly less impressive GDP per capita growth record. Here it is for the last 30 years.
The GDP number (blue column) is always above the GDP per capita number (line), which means we’re getting about 30% of our growth through population increases. Or to put it crudely, we get growth through more people on the job rather than better productivity. It’s the reverse in Japan:
There, GDP per capita has tended to exceed GDP growth. It’s mostly down to labor productivity and increased labor force participation, especially for women which is 57% in the U.S. and 70% in Japan (using slightly different methodology).
So, ok, what next? U.S. growth is very population dependent. Slow that growth and GDP will slow. And that is precisely what has happened in recent years.
2. Great job numbers? Er, not this time. Before we dive in, following on from the last topic, the U.S. has to grow employment by about 187,000 per month to keep up with civilian Noninstitutional Population growth…yeah that’s a weird title but it's basically the U.S. population over 16 and not in the military, prison or nursing homes.
So any time you see a new jobs numbers below 187,000, then you can roughly say that it’s not keeping up with population growth and the difference will show up as “not in the labor force” or “unemployed”.
So this month it was 75,000 with no change in the already low unemployment rate.
It was also flattered by 1,000 Census workers. We bring this up because over the next year, the Census Bureau will hire and fire over half a million people for the 2020 census. Last time that happened in 2009 and 2010, a certain administration got a little carried away about job growth on their watch…and it’s possible, just possible that it might happen again.
The biggest hit came in the private sector where there was a decline of about 90,000 over the prior two months. State and local government jobs also were down. Hourly wage growth slowed.
It’s difficult to pinpoint “why?” But the China tariffs (the Mexico one wasn't known on the survey date) and general uncertainty must have played their part.
So, job growth has slowed and it gives the Fed a reason to cut rates. The bond market seems already there and the 10-Year Treasury dropped 3bps on the news.
3. What’s up with the yield curve? There’s more talk about the yield curve especially now the Fed Funds at 2.5% is above almost every Treasury bond out there until you get to around 25 years. One of the most cited spreads is the 10-Year and 2-Year Treasury, which are now separated by 24bps, up from 15bps two months ago.
As we've said before, yes, the inverted curve is a decent forward indicator of a recession but its timing is unreliable. In some years, it inverted and there was no recession, in some the recession came two years later and for some it came six months later.
And as we also like to say, being early and right is the same as being wrong.
We do know with some certainty that the Fed stops raising rates when the curve inverts. Sometimes they go on to cut but, again, with some delay. So, right now we'd say (and it's not a great insight but, hey, we’ll take certainty when we can get it) the Fed will not raise rates this year.
Bottom Line: Full pricing in Treasuries but still the best place to be in a risk-off market. Perhaps some tariff rate relief with Mexico but who wants to make an outsize bet on a tweet.
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