Haver Analytics
Haver Analytics

Viewpoints

The Federal Reserve Bank of Philadelphia’s state coincident indexes in January generally showed moderate, but generally unspectacular, increases. 9 states show declines from December, but none especially large. Massachusetts had a robust 1.1 percent increase. New York was the only other state with a gain as large as .5 percent. Over the 3 months ending in January, Montana was the only one to show a decline, while Massachusetts was up 2.4 percent---a fairly low reading to the leader—while Arizona and Nevada were the only other states with increase of 1 percent or more. Over the last 12 months Massachusetts was also on top, and, again, its 4.6 percent increase was unimpressive for number one. Montana was down a sharp 3 percent, and Maine and West Virginia were also down.

The independently estimated national figures of growth over the last 3 months (.6 percent) a bit lower than the state estimates would have suggested, but the 12-month figure (2.6) percent) looks to be roughly in line with the state numbers.

The state coincident index measures are primarily based on state payroll employment data, and calibrated to state real GDP estimates. This report is a bit of an odd duck—it’s for January, even though the February payroll numbers have been released—and Q4 state GDP numbers will soon be released. On April 3 the February estimates will be available.

State labor markets were at best mixed in February. Only four states had Eight states had statistically significant gains in payrolls (Illinois, Iowa, Michigan, and Texas—Iowa was the only one with an increase larger than ½ of one percent). The other states, and DC, had no signicant change, with numbers showing point declines.

Three states had statistically significant increases in their unemployment rates in January, while three had significant declines. The largest move was an increase of .3 percentage point in Rhode Island. The highest unemployment rates were in California (5.3%), Nevada (5.2%) and DC (5.1%). No other states had unemployment rates of 4.9% (one point above the national rate) or higher. Maryland, Massachusetts, Minnesota, Nebraska, New Hampshire, North Dakota, South Dakota, Utah, Vermont, and Wyoming had rates of 2.9% or lower, with North Dakota at 2.0%.

Puerto Rico’s unemployment rate remained at 5.7 percent, with the island’s job count little-changed.

In its January 31, 2024 FOMC statement, the Fed said: “In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook.” The translation of this Fedspeak is that the Fed’s target level of the federal funds going forward would depend on the forthcoming data as they relate to the Fed’s dual mandates of promoting price stability and full employment. But what if the data upon which the Fed were depending to determine the level of the federal funds rate were undependable? In what follows, I will provide examples of “undependable” data and recommend a solution for how the Fed might conduct monetary policy in the face of undependable data.

In the Bureau of Labor Statistics (BLS) February 2024 Employment Situation, it was reported that the level of January 2024 nonfarm business establishment payrolls was 157,533 thousand, revised down from its preliminary estimate of 157,700 thousand. Mind you, this is just the first revision of January 2024 nonfarm payrolls. When the BLS releases its March 2024 Employment Situation report, there will be a second revision to January 2024 nonfarm payrolls. And then in 2025, there will be annual “benchmark” revisions to 2024 nonfarm payrolls, including those of January 2024. The level of February 2024 nonfarm payrolls reported on March 8, 2024, 157,808 thousand, was said up 275 thousand compared to the first-revised January 2024 level of nonfarm payrolls. However, compared to the first-reported level of January 2024 nonfarm payrolls, the level of February 2024 nonfarm payrolls was up only 108 thousand. And, of course, in the next two 2024 BLS Employment Situation reports, the February 2024 level of nonfarm payrolls will be revised twice. Because of monthly and annual revisions, the monthly reports of nonfarm payrolls would seem to be undependable data upon which the Federal Reserve might use to determine monetary policy.

On March 14, 2024, the Census Bureau reported that the level of February 2024 retail sales increased 0.6% compared to the revised level of January 2024 retail sales. However, the level of January 2024 had been revised down by $3,581 million or 0.5% from the originally-reported level. So, the level of February 2024 retail sales was up only 0.06%, not 0.6% from the originally-reported level of January 2024 retail sales. Based on revised data in the February 2024 retail sales report, in the three months ended January 2024, retail sales contracted at an annualized rate of 3.8%. Based on the data reported in the January 2024 retail sales report, in the three months ended January 2024, retail sales contracted at an annualized rate of only 1.8%, less than half the rate of contraction exhibited by the data revised in the February 2024 retail sales report. Again, monthly revisions to retail sales data would suggest that these data are undependable for the purposes of guiding monetary policy.

The next problematic economic report I will discuss is the Consumer Price Index (CPI), more specifically, the Owners’ Equivalent Rent (OER) component of the CPI. At 26.7% of the CPI, OER has the “heaviest” weight in the CPI. That OER has such a high weight in the CPI is understandable given that the US homeownership rate is about 66%. My quarrel is not with the weight of OER but how it is estimated. From what I have read about this estimation process is that a sample of homeowners are asked by the BLS what the respondents think their detached dwelling/condo/townhouse would rent for. How many homeowners, especially owners of detached houses, have a reasonably accurate estimate of what their abode would rent for?

OER was reported to have increased month-to-month annualized 6.94% in January 2024 compared to a 5.22% annualized increase in December 2023. The CPI excluding OER monthly increase was 2.66% annualized in January 2024 compared to 2.03% in December 2023. The month-to-month annualized change in the CPI-All Items was 3.73% in January 2024 compared to 2.83% in December 2023. The BLS received queries as to why there was such a relatively large percent increase in the January 2024 OER compared to December 2023. On February 29, 2024, the BLS issued a statement saying that there are now annual updates effective in January of a year in the weighting of the OER in terms of owner-occupied detached dwellings versus condos/townhouses. The BLS said that “[i]n January 2024, the proportion of OER weighted toward single-family-detached homes increased by approximately 5 percentage points.” My point, again, is not that OER is unimportant, but that its measurement is, for lack of a better term, “flaky”. Given the difficulty in accurately measuring OER, the European Union excludes OER from its calculation of EU consumer price inflation. Plotted in Chart 1 are the year-over-year percent changes in the All-Items CPI (the blue bars) and the CPI excluding OER (the red line). The year-over-year change in the CPI excluding OER in February 2024 was 2.27%, close enough to 2% for Federal Reserve work.

More Commentaries

  • In February, total consumer prices and prices, excluding food and energy, rose 0.4%, resulting in the last twelve-month increases of 3.2% and 3.8%, respectively. The consumer price report is the sole direct measure of retail inflation, capturing what people buy for consumption.

    However, the Fed favors the PCE deflator, which is not a direct measure but rather a blend of CPI prices with administered prices (Medicare and Medicaid). This preference is based on the belief that the PCE captures what people purchase in real time, reflecting the substitution effect of price change.

    But this claim is misleading. Detailed spending data, crucial for accurate measurement, is unavailable in real-time. The choice of the PCE over the CPI for inflation measurement is driven by political considerations, as it tends to produce a lower rate.

    The Bureau of Economic Analysis (BEA), the government agency responsible for estimating and publishing the PCE deflator, faces significant challenges in data collection for various product categories. For instance, while BEA has a small set of product details updated monthly, such as motor vehicles, prescription drugs, gasoline, and tobacco, other categories suffer from a considerable lag.

    For instance, food store sales are supplemented with annual scanner data, resulting in a one-year lag. Similarly, the yearly e-commerce survey report provides additional product details with a one-year lag.

    Detailed consumer expenditures for services are also unavailable when the PCE deflator for a given month is estimated and released. The Census's Quarterly Survey of Services (QSS) is released three months after a quarter ends. However, the QSS provides aggregate spending figures for various service industries and offers few details of how much of it is household spending.

    Without detailed data, the BEA is forced to rely on imperfect product-to-industry ratios, often based on data from the several-year-old 2017 Economic Census, to estimate household product and service spending. This reliance on outdated data is a significant drawback, as it uses spending patterns from years past to explain how current price inflation impacts people's spending decisions. This practice undermines the accuracy and relevance of the PCE deflator, raising concerns about its effectiveness as a current measure of inflation.

    The CPI has been criticized for what it is and isn't (See a recent article by Larry Summers on CPI missing financing costs for consumption). The same should apply to the PCE deflator. The PCE is not what people think it is. Choosing the PCE over the CPI is a convenient way for policymakers to argue that they are close to or hitting their target, even when the only direct measure of consumer price inflation (CPI) runs much higher.

  • State labor markets were generally mixed to improved in January. Eight states had statistically significant gains in payrolls. New York led in absolute numbers (59,300) and percentage (.6) terms, while three of its neighbors (Massachusetts, New Jersey, and Vermont). Only a small handful report point declines, none statistically significant.

    4 states had statistically significant increases in their unemployment rates in January, while 2 had significant declines. None of these movements were larger than .2 percentage point. The highest unemployment rates were in Nevada (5.3%), California (5.2%) and DC (5.0%). Illinois and New Jersey were also more than a point higher than the nation’s 3.7 percent. Alabama, Maryland, Minnesota, Nebraska, New Hampshire, North Dakota, South Dakota, and Vermont had rates of 2.7 percent or lower, with North Dakota at 1.9 percent.

    Puerto Rico’s unemployment rate remained at 5.7 percent, while the island’s payrolls rose 6,000—likely a statistically significant increase.

  • China’s National Peoples’ Congress (NPC) meeting kicked off today with Premier Li’s announcing its first Government Work Report. It’s definitely an interesting day for all China watchers and investors, as we are all looking for clues in China’s upcoming plans to prop up an economy that is grappling with deflation, a property market slump, heightened debt levels and low level of foreign direct investment. Before the meeting, many market participants are looking for bazooka-style stimulus or long-term structural reforms, however, the annual NPC is not really a platform for these policy announcements. Instead, we get a flurry of economic and budget targets, and a to-do-list for this coming year. In a nutshell, there is nothing juicy or new in this government report – with a couple of exceptions – it appears that China is still using old tools to fix the current economic problems.

    Let’s start with the targets, a couple of highlights. The 5% GDP growth target was in line with market expectations, and consistent with early growth targets released by the local governments. In my view, it is an aggressive target to achieve compared with last year’s, because 2023 growth target benefits from the low base in the year before when the economy was mired in zero Covid policy. By contrast, the base effects this year is unfavourable. Also, it is more difficult to hit target this year without any forms of fiscal and monetary support, given the deepening property market slump and lingering local government debt problems. The Chinese government realised the hurdles and hinted at further targeted stimulus, as Premier Li said in his speech “It is not easy for us to realise these targets. We need policy support and joint efforts from all fronts.”

    Interestingly, the unusual issuance of RMB 1tn central government bonds is a nice addition to the fiscal impulse from the local government special bonds quotas of RMB 3.9tn for 2024. This is the fourth time in the last 26 years to issue such sovereign bonds, the last couple of times it happened was in 2020 and 2023, to fund Covid-related expenses and post-disastrous reconstruction in north-eastern China after a major flood. We expected the central government to share the credit burden with the local governments going forward, because the hands of provincial authorities are tied. Local governments get a significant share of income from land sales to developers, but this is getting difficult on the back of tumbling demand for housing. Therefore, it makes sense for the central government to step in and allocate resources back to provinces, probably on more favourable debt servicing terms given its higher credibility and lower indebtedness.

    Property sector, which accounts for over 25% of the economy, saw no new concrete measures mentioned in this report. The NDRC did say they will try to address the root causes of the property malaise and mounting debt problems, but they stop short of spelling out what the solutions are. The crux of the property problem remains low level of confidence of prospective homebuyers, leading to a collapsed in demand for off-plan new housing. Homebuyers would rather sit on the sideline, worrying that troubled developers will not have sufficient funding to complete the projects. This in turn reduces the cashflow of property developers, including heathier ones. And the negative feedback loop repeats itself.

    But note a glimmer of hope that President Xi’s property slogan “housing is for living in, not speculation” is omitted in the policy wordings this time, suggesting that authorities are more determined to prop up the property market. Before this, mixed signals were sent to the market when property measures were relaxed, reducing the efficacy of the stimulus.

    Thus far, the government implemented a slew of measures to support the ailing real estate market, such as slashing the 5-year LPR, increasing the PSL funding, lowering the LTV requirements for first-time buyers and buy-to-let investors, also encouraging banks to lend more to white-listed property projects selected by local governments. Unfortunately, none of them had material impact on lifting sentiment or breaking the negative feedback loop. Rather, we continue to hear news in recent weeks about investors filing a lawsuit against Country Garden and Vanke delaying its debt repayments, further denting buyers’ confidence.

    In all, this is a fiscally expansionary budget, and it should cushion the economy currently in deflationary mode. The 5% growth target is only achievable with a strong dose of stimulus, so expect more targeting measures to be deployed. The Chinese authorities are still aiming for quality development over sheer growth, but structural changes for “new productive forces” and consumption to take hold won’t happen overnight, more stimulus measures are therefore needed in the interim period. But the lack of creative policymaking in Zhongnanhai to bridge this gap suggests that China may still be using old tools for new problems. We are not looking for sizable credit-fuelled stimulus in the past which would normally result in unproductive capacity, but timely and well-packaged policies that can address deficiency more quickly and broadly would vastly improve the recovery experience.

  • Understanding the cost associated with reducing the carbon footprint of buildings is crucial for the CRE industry's decarbonization efforts which however pose a difficult challenge. The European Commission and the European Environment Agency do not always add towards better understanding as their explanations of the CRE industry decarbonization targets can differ, while allowing only an indirect perception of associated costs. More concrete estimates, such as those from Oxford Economics one, suggest that the cost of decarbonization to extend the existing building life, by up to 25 years is approximately 30% of the buildings' capital values. However, this estimation is somewhat ambiguous, as the dynamics governing real estate values and costs associated with building decarbonization differ. The Deutsche Bank research paper associates the cost of decarbonization of its CRE portfolio mainly with retrofitting expenses aiming to reduce energy usage per square meter of buildings. The paper indicates that the cost of retrofitting Deutsche Bank’s existing residential real estate portfolio to the currently adequate Energy Performance Certificate (ECP) is estimated at around €80 Billion, while retrofitting its commercial real estate portfolio costs is at least ten times more. In this case uncertainty related to decarbonization costs estimates arise due to the changing nature of regulatory framework. For example, German form of ECP (Energieeinsparverordnung – EnEV) was introduced in 2002 and then amended in 2007, 2009, 2014, 2017, 2023, each time bringing more stringent regulations that were becoming more expensive to implement. The Catella Residential Investment Managament research paper estimates that the cost of decarbonizing typical residential dwellings in EU could be in the range of €25,000 to €40,000. This implies that the cost of decarbonizing the existing residential stock in the EU could be in a range €6 - €10 trillion. Expressed as a percentage, this accounts for approximately 65% of the annual EU28 GDP, as shown in the table.

  • In the last twenty-five years, asset price cycles have become more dominant in business cycle analysis, and in doing so, asset inflation cycles have become the modern-day form of inflation. Their importance has become so critical that they have become an explicit part of monetary policy via its new tool, quantitative purchases, whose primary purpose is to increase asset prices/values. With the Federal Reserve now a key player, do asset price cycles still exhibit similar boom and bust patterns as was the case in the past? Or can monetary policy permanently elevate asset prices above and beyond economic and financial fundamentals?

    Asset Price Cycles

    Several theories help to explain why asset price cycles have become more significant and more volatile over the past twenty-five years.

    First, monetary policymakers changed its operating framework in the mid-to-late 1990s, just before the asset price tech bubble. Policymakers abandoned the money supply and credit anchors and started to track real official interest (i.e., Fed Funds level less consumer price index). That created an informal price-targeting policy regime, which years later became formal and removed a policy framework that responded to financial conditions and imbalances that could trigger future inflation or economic problems. Ever since the change in its framework, policymakers have refused to use official rates to dampen speculative and significant asset price cycles.

    Second, in the late 1990s, BLS removed the house price signal (i.e., it stopped surveying owner homes for the rent calculation) from its measure of consumer price inflation. That change further broke the link between real estate and consumer price inflation and changed the correlation between real estate and equity prices to positive from negative. So, real and financial asset price cycles became mutually inclusive, which was the opposite of what was usually the case in previous cycles.

    Third, globalization (i.e., the ability to import cheap goods) played a role in the US inflation cycle as it helped dampen goods price inflation. With monetary policy shifted exclusively to reported inflation and less to financial conditions, tame consumer price inflation contributed to investors speculating, and often winning that monetary policy will remain easy regardless of asset inflation.

    Asset price cycles do not generate public outcry as general inflation cycles, even though history shows they can be equally destructive and destabilizing. That could be because asset price upswings can generate substantial wealth gains while general inflation penalizes everyone. Yet, policymakers have a mandate for financial stability, so they must stand up against the crowd even if it's politically unpopular.

    Asset price imbalances or bubbles are hard to detect in real-time and can last long. Yet, one can gain perspective by comparing current market valuations of real and financial assets to past periods of boom and bust.

    During the tech bubble, the market value of the real estate and equities on household balance sheets to nominal GDP spiked to a record 2.5 times, falling back to below two during the bust (see chart). The housing bubble helped fuel a more significant spike in market valuations to roughly three times GDP, and again, history repeated itself, as it often does in finance, with market valuation falling back to below two.

    The Fed's QE 1 program helped asset prices recover ground lost during the Great Financial Recession, and QE 2 has pushed asset values to GDP to a new record high. Based on Q4 changes in asset prices and GDP, the ratio is estimated at 3.5, just shy of the record high at the end of 2021. If history were to repeat itself, it would take a 35% to 40% decline in both real estate and equity values to match the fall in the Asset/GDP ratio following the tech and housing bubbles. That is not a forecast but an illustration of how far current valuation have deviated from trend. Liquid assets correct sooner and more sharply than real assets so the equity and real estate declines, if they do occur, would not be proportional.

    Can monetary policy permanently increase the nominal values of real and financial assets with its new policy tool (QE)? Monetary policy can make things look better and last longer, and QE has done that. But to permanently increase the earnings power and asset valuations is not something monetary policy can do. Every excessive asset and non-asset price cycle in history eventually broke for one reason or another. The current cycle should be no different.

    Policymakers are debating when to reduce official rates because general inflation has slowed. Reducing official rates would be a significant policy mistake because of the price imbalance in the asset markets. Instead, policymakers should comprehensively review their policies because the economy's performance, evident with the strong job and wage gains in January, says the total stance of monetary policy remains too easy. In doing the review policymakers will learn that their new tool of quantitative purchases offsets a significant chunk of their official rate policy. In the current climate, it makes more sense to accelerate the reduction of the Fed's balance sheet than to lower official rates.

  • As the real estate industry moves towards a zero-carbon world understanding the challenges of this journey is crucial. Recent discussions on decarbonization, within the industry, in large part focused on retrofitting and estimation of the brown discount's size. All in all, it is apparent that the commercial real estate (CRE) industry is gearing up to commit significant funds to this initiative. However, challenges have emerged as the era of abundant, cheap money for European CRE investment funds has come to an end. Investors are now seeking better returns in asset classes beyond real estate, leading to increased bankruptcies and starting to significantly affect residential developers and construction companies. In addition, there are substantial challenges posed by the expected refinancing gap over the next five years. City University's "Europe CRE Lending Survey" estimates commercial real estate debt at €1.5 trillion. The AEW research indicates a financing gap of around €46 billion over the next three years, a substantial increase from their previous estimates. Meanwhile, PWC research estimated cumulative financing for the next four to five years to exceed €125 billion. Simultaneously, European CRE transaction volumes have come to a halt, adding another layer of uncertainty for CRE decarbonization spending as there is uncertainty in respect of future real estate assets values.

  • The Federal Reserve Bank of Philadelphia’s state coincident indexes in December show continuing and slightly worsening softness. 30 states show declines from November, with Montana down 1.1 percent and Massachusetts off nearly .8 percent. Of the 20 states with increases, Minnesota led with a .7 percent rise. Over the 3 months ending in November, 24 states had no change (Hawai’i) or declines, with Montana down 2.5 percent, and West Virginia and Massachusetts both off by more than 1 percent. The indexes for both Minnesota and Nevada rose 1 percent over this period. Over the last 12 months Maryland was yet again on top, but its 5.6 percent increase was notably smaller than the last few months, and the same can be said of number 2 Vermont’s 5 percent gain. Montana was down 1.6 percent over the last year, and Arkansas and New Jersey both experienced declines.

    The independently estimated national figures of growth over the last 3 months (.7 percent) seems higher than the state estimates would have suggested, but the 12-month figure (3.0 percent) looks to be roughly in line with the state numbers.

  • State labor markets were soft in December. No state reported a statistically significant or loss in payrolls. Most had modest point increases.

    15 states had statistically significant increases in their unemployment rates in December, with the rates in Massachusetts and Rhode Island both up .3 percentage point. Minnesota’s rate fell by .2 percentage point. Nevada’s rate remained 5.4 percent, while California and DC were both at 5.1 percent. Illinois and New Jersey were also more than a point higher than the nation’s 3.7 percent. Alabama, Maryland, Nebraska, New Hampshire, North Dakota, South Dakota, and Vermont had rates under 2.7 percent, with Maryland and North Dakota at 1.9 percent.

    Puerto Rico’s unemployment rate remained at 5.7 percent, and the island’s payrolls edged down 700.