Twenty Six Million Persons in Job Distress, the Nascent Economic Recovery, the Debt, Taxes and Rising Interest Rates

Twenty Six Million Persons in Job Distress, the Nascent Economic Recovery, the Debt, Taxes and Rising Interest Rates
Carlos M Pelaez

The economic indicators released in the week ending on Apr 2 continue to verify the “nascent economic recovery” announced by Chairman Bernanke (http://www.federalreserve.gov/newsevents/testimony/bernanke20100224a.htm ). The indicators confirm that manufacturing is the worldwide driver of the recovery. Construction continues to show significant weakness. However, there are 26 million persons in job distress: 15 million people unemployed (of which 6.5 million for 26 weeks or more), 9.5 million employed part-time because they cannot find full-time jobs and 2 million marginally attached to the labor force because they do not believe they will find jobs. The priority of the national agenda is jobs as soon as possible or in the short run in which we live. The increase in nonfarm payrolls by 162,000 and revisions totaling 62,000 more jobs in Jan and Feb are good news and likely showing the initial reversal toward a trend of job creation but still only make a dent in relief for the 26 million under job distress. A rise in long-term interest rates and indications of at least temporarily higher yields for Treasuries than yields for similar bonds in other countries and yields for private interest rate swaps may signal that the growth of the federal debt toward 100 percent of GDP could constrain future economic growth and job creation by increasing taxes and interest rates. This post considers in turn below short-term economic indicators, interest rates, the rising government debt and some brief conclusions.
Short-term economic indicators. The week around the turn of the month is full of releases of indicators of the economy. (1) Personal income. The BEA of the Department of Commerce released the estimates for Feb of personal income, personal consumption expenditures (PCE), savings and the PCE price index (http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm ). Real personal income did not change in Feb after an increase of 0.1 percent in Jan but it increased by 2.0 percent in Feb relative to a year earlier following an increase of 1.2 percent in Jan over a year earlier. Personal income does not show yet strong growth. PCEs are important because they represent about 70 percent of GDP, increasing by 0.3 percent in Feb on a monthly basis but by 3.4 percent relative to a year earlier. The PCE price index did not change in Feb. The Fed uses the PCE as inflation indicator, meaning that interest rates targets could remain low on the basis of inflation. (2) S&P Case Shiller Price Index. This index estimates home prices in two indices of 10 US cities and 20 US cities (http://www.standardandpoors.com/indices/sp-case-shiller-home-price-indices/en/us/?indexId=spusa-cashpidff--p-us---- ). The Jan 10-city index remained unchanged relative to a year earlier while the 20-city index declined by 0.75 percent. There has been steady improvement toward erasing sharp year-on-year negative changes in house prices. Some cities still show deep decline of prices relative to a year earlier such as -17.4 percent in Las Vegas but there are price increases such as 9 percent in San Francisco and 4.1 percent in Dallas. (3) Consumer Confidence Index (CCI). The Conference Board released the CCI on Mar 30 (http://www.conference-board.org/economics/ConsumerConfidence.cfm ). The CCI rebounded in Mar to 52.5 from the depressed level of 46.4 in Feb. The expectations index increased to 70.2 in Mar from 69.2 in Feb. Consumption appears to be on an uptrend. (4) Manufacturers new orders. Manufacturing is the locomotive pulling the US and the world economy from recession. The US Census Bureau released on Mar 31 manufacturing orders and shipments for Feb (http://www.census.gov/manufacturing/m3/prel/pdf/s-i-o.pdf ). Manufacturers’ new orders have increased with healthy month-to-month seasonally adjusted percentage changes and only two declines in the past year: -1.7 Mar09, 0.7 Apr09, 1.2 May09, 0.7 Jun09, 1.8Jul09, -0.8Aug09, 1.8 Sep09, 0.8Oct09, 1.0 Nov09, 1.5 Dec09, 2.5 Jan10 and 0.6 Feb10 (http://www.census.gov/briefrm/esbr/www/esbr022.html ). (5) Construction spending. The US Census Bureau released the Feb construction report on Apr 1 (http://www.census.gov/const/C30/release.pdf ). The data still show weakness. The estimate for the annual seasonally-adjusted construction spending in Feb is $846.2 billion, 1.3 percent below the Jan revised estimate of $857.8 billion and 12.8 percent below the Feb 2009 estimate of $970.4 billion. In the first two months of 2010, construction spending is estimated at $116.2 billion, 14.4 percent below $135.7 billion in the same period in 2009. Construction spending in Feb 2007 stood at an annual rate of $1185 billion such that the annual rate of $846.2 billion in Feb 2010 is below that of three years ago by 28.6 percent. (5) ISM report on business. On Apr 1, the Institute for Supply Management released its report on business for Mar 2010 (http://www.ism.ws/ISMReport/MfgROB.cfm ). The manufacturing part of the ISM mirrors recessions. The index began to decline after Sep 2008 and to recover after Mar 2009. The recession was largely concentrated within those seven months. Index readings above 50 correspond to expansion and below 50 to contraction. A purchasing managers’ index (PMI) over 42 percent sustained over time signals expansion of the entire economy. The PMI shows growth over 11 consecutive months, suggesting that the overall economy has been expanding. The annualized PMI in Jan-Mar 2010 suggests growth of GDP of 5.9 percent. There were jumps in the PMIs for key countries worldwide in points from Feb into Mar: US 3.1, China 3.1, Euro Zone 2.4 and UK 0.7 (http://online.wsj.com/article/SB10001424052702303960604575157701739806306.html ). The world economy is recovering with manufacturing driving growth.
(6) Employment report. The most important release was the employment report for Mar by the BLS of the Department of Labor on Apr 2 (http://www.bls.gov/news.release/pdf/empsit.pdf ). There are two components in the employment report: nonfarm payrolls increased by 162,000 in Mar and the unemployment rate remained at 9.7 percent. This recession has been characterized by significant loss of employment, especially concentrated in the period of Aug 2008 to Jul 2009. The number of unemployed persons in Mar was 15 million. The jobless rate is particularly high for teenagers 26.1 percent, blacks 16.5 percent and Hispanics 12.6 percent but is also quite high for adult men 10.0 percent, adult women 8 percent and Asians 7.5 percent. The most shocking datum is that the long-term unemployed, who have been jobless for 27 weeks and over, increased by 414,000 in Mar, reaching 6.5 million, representing 44.1 percent of unemployed persons. The number of persons working part time for economic reasons, or involuntary part-time workers, increased to 9.1 million in Mar. These persons work part time because they had been cut back or because they could not find a full-time job. The number of people “marginally attached to the labor force” was about 2.3 million in Mar, higher than 2.1 million a year earlier. These persons are not counted in the labor force because they had not searched for work in the four weeks before the employment survey but wanted and were available for work, having searched for a job at one point in the prior 12 months. Marginally attached workers include 1.0 million discouraged workers in Mar, an increase of 309,000 from a year earlier, consisting of persons who are not searching for a job because they do not believe one would be available for them. The remaining 1.3 million of the marginally attached consisted of persons who had not searched for work in the four weeks before the survey because of school attendance or family responsibilities. Table B1 of the employment report provides the breakdown of the 162,000 new jobs in the survey of nonfarm payrolls of which 123,000 were in the private sector and 39,000 in government. The total number of people unemployed or underemployed is 24 million: 15 million unemployed plus 9 million employed part time because of economic reasons. The civilian labor force in Mar 2010 stood at 154 million. The 24 million persons unemployed or underemployed represent 15.6 percent of the labor force. There are another 2 million marginally attached to the labor force for total of 26 million persons in job distress.
Interest rates. A key event in financial markets is the rise in yields in the long-segment of the yield curve. On Apr 2, the 10-year Treasury closed at the yield of 3.94 percent, 9 basis points (bps) above the yield of 3.85 percent a week earlier and 32 bps above the yield one month earlier (http://markets.ft.com/markets/bonds.asp?ftauth=1270340644886 ). The 30-year Treasury yield closed at 4.80 percent, 5 bps above 4.75 percent a week earlier and 22 bps above 4.58 percent a month earlier. Actually, the yield curve of Treasuries has been shifting upward in the past month for all maturities such as from 2.27 percent to 2.66 percent for the 5-year and from 0.81 percent to 1.10 percent for the 2-year.
Another important development is the negative spread of Treasuries relative to debt of other countries. The 10-year Treasury traded on Apr 2 at 3.94 percent for a negative spread of 86 bps relative to the German bond that traded at 3.08 percent and also a negative spread of 39 bps relative to the Canadian bond that traded at 3.55 percent. Treasury debt sales in the week of April 5 total $82 billion (http://www.ft.com/cms/s/0/0002d4a4-3e7e-11df-a706-00144feabdc0.html ) of which $21 billion of 10-year notes on Apr 7, $13 billion of 30-year notes on Apr 8 and $40 billion of 3-year notes on Apr 6 (http://www.treasurydirect.gov/instit/annceresult/press/preanre/2010/2010.htm ).
On Mar 26, the 10-year interest rate swap was 3.73 percent while the 10-year constant-maturity Treasury was 3.79 percent (http://www.federalreserve.gov/releases/h15/data.htm ). On Mar 30, the 10-year swap rate traded at 3.82 percent for a negative spread of 5 bps below the 10-year yield of 3.87, which had not occurred before Mar, 2010 at least since 1995 (http://www.ft.com/cms/s/0/4f3f237c-3c46-11df-b316-00144feabdc0.html ).
There have been divergent trends of yields in Treasury and corporate debt markets. On Apr 1, the 52-week percentage change of Barclays Capital indexes for Treasuries were -11.74 percent for long-term price return and -7.28 for percent long-term total return in contrast with 30.13 percent for long-term corporate. The Merrill Lynch triple-C-rated (CCC) index 52-week change was 121.66 percent (http://online.wsj.com/mdc/public/page/2_3022-bondbnchmrk.html?mod=topnav_2_3000 ). The Merrill Lynch triple-C-rated (CCC) yield is trading at 11.703 percent while the high in 52 weeks was 36.725 percent and the low 11.508 percent (http://online.wsj.com/mdc/public/page/2_3022-bondbnchmrk.html?mod=topnav_2_3000 ). The return of risk appetite and the fears of the growing debt have channeled funds into corporate bonds, decreasing the spreads relative to Treasuries. Arbitrage strategies short Treasuries and go long other instruments to capture the shrinking or reversing spreads.
Government debt and interest rates. The yield curve continues to be J-shaped with percentage annual yields of: 0.17 3-months, 1.10 2-years, 2.66 5-years, 3.94 10-years and 4.80 30-years (http://markets.ft.com/markets/bonds.asp?ftauth=1270387583761 ). There are two threats of jumps and twists of this abnormal yield curve. First, the Fed holds a portfolio of $709 billion of Treasury notes and bonds, $1069 billion of mortgage-backed securities and $169 billion of federal agency securities for total of $1.9 trillion with excess reserve balances of $1051 billion and $125 billion in the Treasury supplementary financing account in the road to $200 billion (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1 ). The Fed has terminated its purchases of long-term securities under the policy of quantitative easing. Second, budget deficits are proposed by the Executive at $1.5 trillion in 2010, or 10.3 percent of GDP, and $1.3 trillion in 2011, or 8.9 percent of GDP (http://cboblog.cbo.gov/?p=482 ). The budget proposal of the Executive would increase the federal debt from $7.5 trillion at the end of 2009, or 54 percent of GDP, to $20.3 trillion at the end of 2020, or 90 percent of GDP. Sharp increases in long-term interest rates caused by unwinding the Fed’s portfolio of securities, financing budget deficits and refinancing maturing debt threaten the expansion path of the economy and recovery of full employment. The rising government debt is a two-edge sword, cutting on the side of increasing interest rates as well as on the side of increasing taxes. Efforts resolving the immediate employment situation are far more opportune than regulatory exercises with delayed implementation.
According to Alan Blinder, “Keynesians believe that what is true about the short run cannot necessarily be inferred from what must happen in the long run, and we live in the short run. They often quote Keynes’s famous statement, ‘In the long run, we are all dead,’ to make the point” (http://www.econlib.org/library/Enc/KeynesianEconomics.html ). The policy agenda, Keynesian or otherwise, should turn toward the critically relevant issues in the short run in which we live: the government debt, taxes, interest rates and relief for the 26 million people suffering job distress. Prosperity in the long run will be attained with repetition of successful short runs. (Go to: http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10)