• A comparison of a June, 2012 and May, 2015 speech from Fed Chair Janet Yellen
• Using this comparison to gain insight into how Yellen may view current economic data

“Recent unemployment benefit claims data and other indicators, appear to be consistent with an economy expanding at only a moderate rate, close to its potential ” is a quote from Janet Yellen that sounds like it could be very recent given today’s labor data. Only thing is, the quote is from a June 6, 2012 speech to the Boston Economic Club when she was still known as Vice Chair Yellen. At the time of the speech, the four-week moving average of initial claims was 374,500 whereas today, the average is 266,250 or 28.9% lower. Interestingly enough, 266,250 is the exact same previous low that was reached back on April 15, 2000 !! So if Vice Chair Yellen thought claims in 2012 reflected a moderately expanding economy that is “close” to its potential, then I would think Chair Yellen would say today’s data is a significant improvement. But as we see from her speech on Friday, we still have a labor market that is “approaching its full strength.” Dangling carrot, anyone?

So this past Friday, May 22, 2015, we got Yellen’s most recent thoughts on the economy as she spoke to the Providence, Rhode Island Chamber of Commerce. The part of the speech which got the most attention was her admission to raising rates this year assuming the economy continues to improve as she suspects it will. I found this to be rather hawkish given the removal of all calendar-based expectations in the most recent FOMC statement. That being said, other parts of the speech are much more telling as to how Yellen may be interpreting data especially when put into the context of her previous remarks. For example, in 2012, Yellen had this to say about housing:

“The housing sector remains a source of very significant headwinds. Housing has typically been a driver of economic recoveries, and we have seen some modest improvement recently, but continued uncertainties over the direction of house prices, and very restricted mortgage credit availability for all but the most creditworthy buyers, will likely weigh on housing demand for some time to come.”

Now, if we look at recent data on the housing market we can see that there has been a dramatic recovery since 2012. The S&P Case Shiller National index, which she refers to in the 2012 speech, is up 16.45% from then and only 9.6 % off its all time high. If we look at the FHFA House Price Index, which is a more broad index and is also equal weighted versus value weighted like the Case Shiller index, home prices are just 2.9% below their all time high set in March 2007. The important thing to keep in mind when looking at home prices and their peaks over time is the difference in lending standards. The 2006/2007 highs were driven by low quality and sometimes undocumented loans that were given to almost anyone. Today’s transactions are done under the strictest of lending standards helping to ensure the sustainability of the market. So for the housing market to again be just off its all time high is truly remarkable. This recovery in housing prices could only happen with purchasers having solid financials which is a reflection of a healthy economy.

In both the 2012 and 2015 speeches, Yellen refers to mortgages as being difficult to obtain for those without the best credit. While that is certainly a factor today, we can see in new (NHS) and existing (EHS) home sales data that transactions are growing. March NHS (April data not available as of this writing) were up 19% year over year while April EHS were up 6.1% year over year. April EHS were also qualified with comments stating that transactions were hindered by low inventory and high prices. Also, the new residential construction data we got for April showed building permits and housing starts with 10.1% and 20.2% gains, respectively, month over month. Clearly we can see that people are getting mortgages and that new household formation is picking up. Now, taking the comments from her 2012 speech, we see how critical Yellen thought the housing market was to the recovery. Given what housing has done since then, it would be impossible to say that it remains as a headwind. Hence the statement from the 2015 speech:

“In some respects, this headwind has diminished. Home prices have moved up appreciably in many areas of the country, alleviating the burden for many homeowners.”

The 2015 statement on housing still reads downbeat, but it’s not as dismissive as the statements on labor.

In Friday’s speech, I was happy to hear Yellen touch on the drop in oil prices and the positive impact it has had on household budgets and consumer confidence. This is a point that I and others have been making since the drop became significant in November, 2014.Yellen went on to cite information from the EIA which estimates 2015 annual savings of $700 per household with greater benefits accruing to those in the northeast. On a personal note, it bothers me whenever I read Wall Street research that looks at retail sales data and then says the drop in energy prices has done nothing for consumers. I find commentary like that to be both shallow in research and an insult to every person that drives to work everyday or pays to heat his/her home.

Wrapping up here, I wonder what Friday’s speech would have been like if Yellen had had Friday’s CPI data in hand before writing it. April came in with core CPI at +1.8 YoY with the below categories all 2% or over:

This report will definitely get the Fed’s attention because accelerating inflation is something that even the doves can’t ignore. The CPI data also shows the strength in the services sector of the economy. As I’ve pointed out in other reports, we are a services driven economy, and this is where the focus should be.

So, what am I getting at in all of this you might ask…Well If we take statements from Yellen when she was speaking about the economy when it was in a weaker state, I think we get a good reference point for how she will judge future data. In 2012, Fed forward guidance was not nearly relied upon as much as it is today, so I think we got a much more clear view of things. Also, I don’t think Yellen would have downplayed data in a somewhat fragile economy; then again, she is a cagey one!! So now in 2015 with Fed forward guidance at full throttle, I think it’s very useful to look back at old statements to filter out the rhetoric of the Fed speak we get today. Given Yellen’s past comments on certain data, I think she is more bullish on the economy than current forward guidance would allow her to state. This is the environment the Fed has created, so as investors and traders, we have to try and figure out what is the Fed thinking and how do they really view the data? With all this, I think if labor data were to just stay flat from here and inflation continues to drift higher as it is, I think the Fed will act more aggressively than most people and certainly the bond market are expecting. As Gordon Gekko said in the 1987 classic Wall Street, “Every battle is won before it’s ever fought.”

• Analysis of Friday’s Jobs Report
• Manufacturing versus Services job creation and the myth of lost wages
• Discussion on full employment and labor force participation rates

This week was all about jobs and fortunately, we got some. On Friday, we had the release of the monthly Employment Situation Summary from the BLS or what is more commonly known as the “jobs report.” The jobs report has always been widely watched, but has been a true focal point for the last couple years. Since QE began to wind down and now as Fed lift off has come into play, labor and inflation data have taken center stage. This month was business as usual with financial media gearing up all week for the report and Twitter finance flooding the net with the popular hashtag #NFPguesses. Finally 8:30 Friday morning came along and we got a +223,000 increase in nonfarm payroll employment versus 228,000 expectations. I myself was expecting a higher number given the solid services data we got in April. Equities and bonds loved the report initially as both rallied, but by the end of the day stocks were the last man standing. TLT, the long bond proxy ETF actually closed down for the day as it finished up a very active and rough week.

So let’s talk job report internals. Headline NFP came in at +223,000 with the bulk of that from the private service-providing category at 182,000. Within private services, professional/business and education/health services drove two thirds of the increase. The job growth was not in all waiters and bartenders as some financial websites like to so arrogantly promote.

On a quick side note, I have a couple issues when financial media and others discount (or just outright poo-poo all over) wait staff jobs. First of all, and most importantly, an increase in wait staff jobs is being driven by an increase in end-user demand which is a direct reflection of a healthy economy. Second, waiters and bartenders are not only honorable professions, but can also be very lucrative for those that choose to make the effort. As an example, anyone familiar with the NYC steakhouse scene has come across the legendary Mr. Patrick Ford in the grill room at Smith & Wollensky in midtown Manhattan. Pat Ford exemplifies a long-standing tradition of bartenders that not only serve drinks, but make customers want to come back to enjoy the environment they create with their humor and camaraderie.

With that off my chest, we can get back to the data and see what else we can dig up. March and April job reports have clearly been driven by the services sector. Corroborating this, we have gotten other reports from Markit and ISM that have shown an increase in services activity along with a decrease in manufacturing. Recent declines in manufacturing activity have been tied to the strong dollar, but the long run decline is because we have transitioned to a consumption / services based economy. This is very important to note when we analyze labor data. I don’t think people should be so alarmed by the drop in manufacturing jobs since it’s a function of a structural change in the economy. It’s no secret that personal consumption expenditure (PCE) drives 2/3 of domestic spending and that exports account for roughly just 14% of GDP.

*Chart shows decline in manufacturing labor versus growth in services labor

People will make the argument that all the high paying manufacturing jobs have been replaced by low paying service jobs, but that’s just plain wrong. If there was a real loss in wages, then I would expect the below chart to have flattened or declined since 2000.

*Nonsupervisory employees are those in services as defined by the BLS

Manufacturing jobs are good jobs, but so are service jobs. It really depends on the type of economy and society that you are talking about. In a developed consumer based economy like America, it is fitting that we would have more of a service based labor force.

The somewhat soft side of the jobs report were the minimal increase in average hourly earnings and unchanged hours worked. Though, AHE are up 2.2% over the past year which is still good and also shows some inflation.

Going back to a point I’ve been bringing up the last couple weeks is the notion of the labor market being at or near full employment. When we look at weekly claims data and the growth in payrolls since the crisis years of 2007-2009, it’s really starting to look like we may have reached it. The main argument most economists make against being at full employment is the low labor force participation rate (LFPR). As Gene Epstein has pointed in this week’s Barron’s Economic Beat, the LFPR has been declining because of the growing 55 and older segment of the workforce and not because of eligible people just dropping out for lack of work. So far that’s been the most clear and provable theory on LFPR that I’ve come across.

There were several other data points in the week outside of the jobs report that also need to be mentioned. The best surprise came on Monday and was the Factory Orders report for March that showed a headline increase of 2.1% from February with some pretty solid internals. New Orders were up a healthy 4.4% after having been down 1.2% the prior month, while shipments of durable goods were up 1.2% after having been down the previous two months. Shipments of nondurable goods were dragged down by oil prices. With that, given the rebound we have seen in oil over the last couple weeks, various economic stats for April and May should look a lot stronger.

International Trade data released on Tuesday showed our trade deficit widening to $51.4 Bn. At first, the reaction was negative as this would cause a further reduction in Q1 GDP. However the import figures do show an economy that continues to increase consumption. Leading in the import category were cell phones, textile apparel, furniture and other household goods. All of these categories were leaders in the most recent retail sales report. The export side was dragged lower primarily by the strong dollar. Also on Tuesday were service reports from ISM and Markit. Both showed gains, but the Markit report really showed some strong internals with input prices, new business and labor demand all well in expansionary territory. The labor data in the Markit report meshed nicely with the services growth in the jobs report.

Just prior to Friday’s jobs report, we got another very solid weekly unemployment claims number at 265,000. I keep saying it, I know, but these claims data are dead in line with a full participation labor force.

It was another crazy week but fun as always. Equities finished the week close to their all-time highs and bonds (Treasuries) squeaked in one up day out of what has been a rough two weeks with yields rising almost every day. Lots of data coming up this week with Yellen’s personal favorite JOLTS report and my personal favorite the NFIB Small Business Optimism Index both on Tuesday. Then we get retail sales, PPI and industrial production later in the week. The phrase sell in May and go away may be very relevant this year, except this time it’s for bonds…

The highlight of the week goes to our very own royal lady Janet Yellen and her supporting crew, the FOMC as they voted to leave the fed funds rate at its 0-.25% range. While the street was not expecting a change in rates, we were all at the edge of our seats waiting to see what changes in language there would be to the statement. What we got was the removal of all time dependent forward guidance. By removing calendar guidance and emphasizing data dependence, the Fed has actually given itself more flexibility in raising rates. I believe the Fed has now acknowledged investor reliance on ZIRP and wants to send a clear message that rate hikes are a reality. That being said, people forget that the Fed has hiked rates between meetings in the past and certainly could do so now. Especially with some of the data we got this week, a July hike as opposed to a June hike could certainly be in the cards. We have already read enough Fed minutes to know that there is struggle between the hawks and the doves. Now we know it all comes down to the data which may be the Feds first true act of transparency. On a much lighter note, am I the only one that sees a resemblance ??

“I’m talkin’ about workin’ for a livin’. I’m talkin’ about sharkin'”

This week had lots of data points, but two stood out in particular. The first of which was the Employment Cost Index (ECI) that came out on Thursday. The all civilian workers categories came in at 2.6% YoY gain for March. This is a significant jump from the March 2014 YoY gain of 1.8%. This increase which gets above the Feds 2% generic inflation threshold will definitely get the committee’s attention. If you take this data along with the recent firming in CPI, we can see that inflation has not only stabilized, but appears to be picking up. What’s interesting is, if we lag CPI 6 months behind ECI data, we can see a close relationship where I would expect CPI to pick up considerably in the near future.(see charts). Inside of the broader ECI, we also see that private worker wage gains grew 2.8% YoY versus 1.7% for March 2014. It’ll be interesting to see if the upcoming Nonfarm Payroll report will corroborate these wage gains in its average hourly earnings component. The second standout was this week’s unemployment claims data. Initial claims for the week ending April 25 came in at 262,000, down 34,000 from last week and was also the lowest print since April 2000!! The four week moving average of claims also dropped to their lowest level since December 2000. The persistently low claims data along with the current unemployment rate are consistent with a labor market that is arguably at or very near full employment.

**ECI private wage workers versus weekly initial unemployment claims.

**data from St.Louis FRED

Of no surprise this week was the weak Q1 GDP print we got on Wednesday. Q1 growth came it at just .2%. While that is a low number, it is certainly better than 1Q2014 that was finalized at -2.1%. The prevailing narrative to discount Q1 GDP of the last couple years has been to blame it on harsh winter weather. When it comes to blaming the weather, I’m a bit weary of that excuse for two reasons: 1.) Winter has always been cold and has come at the same time of the year as long as I can remember, but it’s only been until recently (last 5 years) that we started seeing exceptionally low Q1 readings. 2.) Many transactions captured by GDP are done online these days so weather should not be a factor. With this being said, perhaps there has been some other regime change that is affecting Q1 GDP reports. I guess we’ll have to look into that in another commentary….

Also of note for the week were a few data points on housing, services and manufacturing fronts. Monday had the Markit Flash U.S. Services PMI which came in at a healthy 57.8 (>50 = expansion). The most important takeaways from the report are that hiring hit its highest level since June 2014 and input prices climbed to a six month high. Even though the headline number came down from an elevated 59.2, the components of the report are still showing a healthy economy.

Tuesday started with the S&P/Case-Shiller Home Price Indices (CSHPI) which came in better than expectations as both the 10 and 20 city composites posted 4.8% and 5% year over year gains. Denver led all the cities showing a very robust 10% year over year gain with Washington DC at the bottom with 1.4%. The CSHPI corroborates the gains we had in last week’s FHFA home price index. When you combine the price levels of both reports with the current rigorous lending environment, we have a very healthy housing market. Then we had the Conference Board Consumer Confidence Index which was somewhat disappointing. The index was down to 95.2 from 101.4 in March driven by a decline in current and expected conditions. What is interesting here is that the softening in this report conflicts with the Consumer Sentiment (CS) report we got on Friday. CS showed gains from March in both current conditions and consumer expectations which reflected an optimistic consumer.

Later in the week, we had the Markit PMI and ISM manufacturing index releases. Both reports stayed in expansionary territory with readings over 50. I was expecting to see more of a downturn given other manufacturing data as well as the low durable goods print earlier this month. All in all the reports showed moderate activity with the strong dollar being a significant headwind. On the labor side of things one of the respondents to the ISM survey said “Labor, both skilled and unskilled, remains difficult to find qualified individuals.” The respondent was from the Furniture & Related Products category. This type of response goes back to the idea of the labor market possibly being at full employment.

We had pretty much another positive week in terms of economic data. The treasury market certainly paid attention as we saw 10 and 30 year bond yields widening out. Now we head into next week with all eyes focused on the mother of all labor reports, Nonfarm Payrolls. Let’s hope for the best, and see what we get.