Recap 2014-10-03


Goldilocks seems to be back. Higher employment on every metric, but weak wage inflation and hence inflationary pressure. Sure, some argue that on balance this should be hawkish given the Fed’s focus on underemployment, but as I’ve already noted, inflation expectations over the cycle (i.e. 5y) is now at just 1.6% and at the lowest levels since late 2011! Yes, the Fed is getting closer to fulfilling its employment mandate (though still over 1% away on the U-6 measure) but it is now substantially missing on its inflation mandate, given that total PCE has averaged just 1.7% over the past 60 months, and headline CPI has historically (over the past 30 years) averaged 50bps above total PCE. In other words, relative to their 2% target for PCE, they are already behind and the market is pricing in a scenario where they will be falling even further behind. And that expectation is over the expansionary part of the cycle, before the next recession, which will surely take rates lower.

The chart below (5y Inflation Breakevens in white, Fed funds in orange) highlights a few more points. First, the last two times the Fed has started to tighten monetary policy, (marked by the white vertical lines) the 5y ILBE measure was above 2.0% for at least several months. And the last few times the 5y ILBE has broken below 1.5% (in red but also in 2002 and 2003) the Fed has eased, either by conducting QE or cutting the Funds rate.

Now, it may well be the case the 5y ILBE is simply correlated to other variables that drive Fed policy. But I do think that given that the decline will give the doves on the committee a strong reason to push their case – after all, the Fed is now again missing on both of its mandates.

All this (if the interpretation is correct!) is bullish risk assets, but may be some headwind for the dollar. Macro funds have been heavy buyers in the past couple months. When there is a move this quick, you can be reasonably sure it is driven by portfolio rather than trade or FDI.


  • US Employment was strong, with payrolls rising 248k vs 215k exp an, and a +38k revision to last month’s figure. Unemployment dropped to 5.9% vs 6.1% exp and prev, while the Underemployment rate declined to 11.8% vs 12.0%. The participation rate declined a tad to 62.7% vs 62.8% prev. Though the decline in the headline UER wasn’t massive, the change in the handle likely had an impact on optics.
  • Earnings growth slowed to 2.0% vs 2.2% exp and 2.1% prev, even as average weekly hours rose to 34.6 vs 34.5 exp and prev
  • Services PMIs:
  1. ISM Non-Mfg declined to 58.6 vs 58.5 exp and 59.6 prev
  2. US Services PMI was revised up to 58.9 vs 58.5 exp and prev
  3. UK Services PMI declined to 58.7 vs 59 exp and 60.5 prev
  4. EU Services PMI was revised lower to 52.4 vs 52.8 exp and prev. Italy and France were both weaker than expected
  5. Australia Service PMI declined to 45.4 vs 49.4 prev
  6. China Non-Mfg PMI declined to 54.0 vs 54.4 prev
  7. Japan Service PMI improved to 52.5 vs 50.8 prev

Ben Bernanke at a conference: “Just between the two of us… I recently tried to refinance my mortgage and I was unsuccessful in doing so.” He went on to say “I think it’s entirely possible” that lenders “may have gone a little bit too far on mortgage credit conditions.” “The housing area is one area where regulation has not yet got it right,” Bernanke said. “I think the tightness of mortgage credit, lending is still probably excessive.”


  • Mon: RBA,
  • Tue: CanadaBuilding Permits
  • Wed: Japan Eco Watchers Survey, FOMC Minutes, UK RICS House Price Balance, Australia Employment
  • Thu: German Current Account, BoE, US Jobless Claims, Williams Speaks
  • Fri: Canada Employment, USDA report