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Wednesday, March 06, 2013

ADP - One Graph Says Everything

ADP employment report here - headline +198,000 in February:

But here's the tell-tale graph:

The gray line is the only one above baseline, and it is for small and start-ups. I believe a lot of this is construction, but some of it is surely startups.

When you see that, it's a sure bet that the structural underpinnings of the economy are finally starting to really improve. This one segment works differently from the others. It arcs up sooner, and then troughs considerably later (in early 2011). And now we have some energy there. 

A lot of this is just timing - it takes time to work off the structural problems from a panic. But five to six years in, a lot of that has worked through the system and now things have a strong natural bias for growth. 

Of course, all of CA appears likely to commit suicide, which is going to hurt us. The combination of high local tax rates, capital gains taxed as ordinary income, and the recent federal capital gains tax increase is probably fatal for CA, because investment has to be suppressed there.

But there is a natural growth surge in the system. This is one of the things that makes me believe that the Fed is a little off in its timing. It's really reacting to last year's slowdown, but its reaction is off-cycle. Therefore I conclude that there really is a hidden inflation risk in the system, and that the Fed is currently feeding it.

This growth impulse will work its way through the economy very quietly, but two years out all the money in the banking system is going to feed an expansion cycle, and once that really gets off and running, it will be hard for the Fed to stop it. Those cycles are self-feeding.



Is the Fed really focused on inflation and employment anymore? After all, Bernanke has been pretty clear in his testimony in hearings that he thinks monetary policy can't fix the economy. It seems to me that they're basing policy more on defending the banking system from systemic failure, either due to U.S. sovereign default or (perhaps to a lesser degree) deflation-induced asset write-downs.

Right now, their job is fairly easy, because of capital inflows from the rest of the lepers--China, Japan, the EU, maybe even South America and the Gulf. It's easy to keep rates down when the rest of the world wants your paper anyway. Or at least wants your private-sector assets. You can add to that the increased U.S. savings rate due to impending retirements.

But what happens after the Yen, Sterling, and Euro have blown up and destroyed the source of capital inflows? Or if mass retirements after 2015 depresses the absolute value of U.S. savings? Will the Fed continue to defend the banking system by buying assets? Or will they prioritize low inflation, even at the expense of allowing rates to rise and blowing up the Federal debt?

I'd say past performance is an indicator of future results, but who really knows what they'll do when all the options are painful?

Neil - My theory is that Bernanke is just trying to keep the boat afloat.

Obviously the events in Europe are deeply favorable to that endeavor.

Bernanke's problem is that up until now, the lack of demand for loans has meant that the Fed can shift rates to negative returns without any inflation risk whatsoever. That will end soon. When it ends, it may end explosively.

What I see is that over the next two years, loan demand may increase quite sharply. Then the Fed gets into the unpredictable zone.

Wouldn't they just increase reserve requirements? They could specifically target reserve requirements for real estate and commercial loans.

Of course, then they'd be intentionally hobbling the economy in order to bail out the Treasury. That may be a difficult sell, politically. Or maybe not, if there's a Democrat House and Senate.

Wouldn't they just increase reserve requirements?


Has that EVER happened in the history of the Fed?

I could see the current gang jacking up the reserve requirements on community banks. Even if I could entertain the thought of the Fed jacking up reserve requirements on all banks, I can't fathom it happening without the Fed paying more-than-token interest on reserves.
The ADP report is essentially a Mark Zandi report now.

Community banks would be the ones doing most of the small-business lending, wouldn't they?

So no recession?
Well, CF, looking at orders and inventories today was a bit daunting.

I still think we worked off some bad karma last year, but do you know what the political result will be for the US? We have to deal with the debt limit increase next.

There is some growth impetus in the system, but do light car and truck sales hold up? I'm guessing that they don't go down by much this year.

I'm watching bank deposits also. People may just run out of money.

Right now I would say it's 50-50. That's not bad under the circs. But I am looking a couple years down the road, because I am really thinking about the risk pic for mortgages with the new rules. And necessarily that has to include some theory on potential interest rate variability.

So that's the main focus for me right now.

The Fed's move is a big move, and it can't be discounted.
My best guess is we muddle through with 0-2% growth for next 2-4 years.

Then comes the inflation.
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