Capital Markets

A rational week. What a relief. The steep drops in interest rates and stocks stopped just where charts said they should, and both rebounded in predictable perfection, now dead neutral. US snowboarders should land so well.


Janet Yellen gave her first formal testimony as Fed… Chairman? Chairwoman? Chairperson? Madame Chairman? None of the above. In the self-effacing dignity and directness which will mark her years on the job, she has chosen officially… Chair.


A run of weak economic data is still dismissed as just another weather report, especially by Eastern-centric media. Atlanta has had a tough stretch, true. And it’s been cold in the upper Midwest, but ice-fishing is a hobby oop der. Philly’s all-time record four, six-inch snowstorms? Please. Wimps.
So, a .4% decline in January retail sales? Just the weather. Today the worst factory production report since 2009, despite a surge in utility output? NOAA says this has been the coldest winter since way back in 2011.


So if all is in balance, waiting for spring, no technical lean in markets, when and what will tip them over? Nobody ever knows when, but “what” has some clarity. The US economy in the near term is not likely to surprise. Odds are big that we plod and wobble on a 2.5% GDP centerline. If we’re going to get a near-term surprise, odds favor overseas, but there is no handicapping those contestants. The inability to see one of those coming is the main reason they have so much effect.


One source of surprise stands out above all others. One of Chair Yellen’s most important forecasting tools is MIA: the rate of unemployment in this cycle will not give advance notice of rising incomes. Fed success always depends on pre-emption, and in a normal cycle it always begins to tighten as unemployment falls to NAIRU.


Hah. Tricked the kids. We have not had to deal with these terms since the ’90s. The Non-Accelerating Inflation Rate of Unemployment — go below, get inflation. Great concept, although nobody knows how to nail the threshold exactly. Related to the Phillips Curve, the inescapable inverse relationship between incomes and inflation.


Less than a year ago the Fed identified 6.5% as the rate of unemployment at which it would consider raising the Fed funds rate from zero for the first time since 2008, intending to reassure markets that it would not tighten for a long time. Unemployment then dropped faster than anyone thought possible, inducing fear of Fed action, and an embarrassing retreat by the Fed. Chair Yellen quietly cancelled the concept in her testimony, pointing to broader measures of the labor market.


In previously reliable theory, as unemployment falls workers become scarce and employers begin to bid up wages. Initial stages of bidding-up are okay, part of recovery, but if bidding intensifies and wages rise beyond increases in productivity, that defines dangerous inflation. Hence the Fed’s wish to tighten just enough in early stages to prevent premature overheating.


Anybody out there see aggressive bidding up of wages? Specialized IT. ObamaCare programmers. The Seahawks’ defense. Health care invoicers. Snow removal.


Several common theories offer common explanations. The ‘Boomers are mailing it in, many early. Skills mismatch: we don’t need wrench-turners on the line, we do need robot repairmen. Automation. The 1% has all the chips and won’t play. Too much government, or not enough.


Look elsewhere, and look long-term. Automation is tempting, but it has been feared as a job-killer ever since the industrial revolution began 250 years ago. Stick with this: today’s unprecedented suppression of US wages has been caused by a wave of excess labor hitting global markets at the end of the Cold War, and a second wave of excessive investment in productive capacity, especially in China.


Chair Yellen’s top problem: the labor imbalance will stabilize without warning, global wages rising. Working-age populations are shrinking in all the developed world and China, and the emerging world does not have the social capital to replace them.