The US NGDP gap and NBER recessions
Plus, Australian Q2 wages and the new monthly inflation series
US July non-farm payrolls rose 528k, which was well above the market expectation of 250k, but closer to our model’s forecast of 347k. The unemployment rate finally caught up to where our model has had it for some months at 3.5%. The US labour market has now recovered its pre-pandemic levels on these measures. Taking the unemployment rate to two decimal places, we strictly speaking have a new cycle-low not seen since 1969, but you need a good sense of humour to make too much of that.
We argued last week that a strong payrolls report would only add to the cognitive dissonance on the US output recession and the employment numbers were themselves a mixed bag. The household survey had employment rising only 179k, the labour force participation rate fell and remains below pre-pandemic levels. The employment-to-population ratio remains 1.3 percentage points below February 2020 levels. Indeed, the US employment-to-population ratio never fully recovered from both the 2001 and 2008-09 recessions, much less the pandemic shock. The US employment rate has been trending lower for more than two decades.
This is an interesting contrast with the Australian labour market, where both labour force participation and the employment-to-population ratios have ripped to record highs, with the unemployment rate matching the US rate at 3.5%. There was a time when the unemployment differential with the US was taken as a measure of a structurally higher unemployment rate in Australia. My sense is that because the US has been harder hit by successive macroeconomic shocks relative to Australia, there is now more hysteresis in US labour market outcomes that offsets the effects of more liberal US labour market institutions.
The US 2-yr/10-yr spread managed to further invert to its most negative since August 2000 in the wake the payrolls release, suggesting markets did not take away much that was positive from the payrolls report. As we have noted previously, good economic news just seems to fuel expectations the Fed will over-do its tightening cycle, which in returns reflects the Fed’s failure to condition expectations for the termination of its tightening cycle. The ‘this yield curve inversion is different’ op-eds are doing a lot of heavy lifting at the moment, which is a signal in itself.
Further to last week’s discussion of business cycle dating, it is worth considering the relationship between the NBER BCDC reference dates and the Mercatus NGDP gap (which starts in Q2 1996). The gap measure peaks around 12 months before the onset of a NBER business cycle peak in the case of 2001 and 2007-09 recessions. It is remarkable that the NGDP gap remained positive through the 2001 recession, although turned negative during the 2002-03 global deflation scare.
Greenspan was noticeably better at stabilising actual and expected NGDP than his successors. The 2020 pandemic is exceptional as an exogenous shock which gives rise to a stronger contemporaneous rather than leading relationship between the NGDP gap and the NBER references dates. As Scott Sumner noted in The Money Illusion, his book explains every recession except the most recent one. A rollover in the NGDP gap in Q3 should be viewed as an important signal. As we noted last week, nowcasts for the Q3 real output gap are already pointing that way.
Australia’s Q2 wages forecast and August partial inflation
Australia’s Q2 trimmed mean inflation rate came in a touch weaker than our model was looking for, but not enough to change our Q2 wages forecast of 0.9% q/q and 2.8% y/y. It is noteworthy that the RBA’s SOMP took its Q2 wages forecast down a notch, from 2.7% to 2.6% y/y, implying 0.7% for the quarter, so our forecast would be an upside surprise relative to that expectation, although more consistent with anecdotal evidence of an acceleration in wages growth. The RBA also downgraded its nominal (non-farm) average earnings per hour forecast from 6% to 5.2%. That derived series won’t be available until the release of the Q2 national accounts in early September. Wages were the notable exception to the general pattern in the SOMP to revise up nominal variables and revise down the real, helpfully visualised once again by Matt Cowgill:
This points to an economy being hit by supply shocks on net, which is not to say there is no excess demand problem.
Next Tuesday, the ABS will detail its new partial monthly CPI release, which is expected to be released for the first time alongside the October release of the Q3 CPI. My understanding is that a different group of goods will be updated each month as prices become available. This will be a useful input into bottom-up forecasts for the quarterly CPI, but still leaves Australia (and NZ) in the internationally anomalous position of lacking a full monthly inflation series.
I made the case for a monthly CPI in this op-ed more than a decade ago. An underappreciated cost of not having a monthly CPI is that it limits offshore participation in Australia’s indexed bond market. Offshore portfolio investors are not set-up for the quarterly as opposed to the monthly indexation of cash flows and are not about to invest in bespoke systems just to cater to our idiosyncratic CPI frequency. The result is that the indexed bond market is not as liquid or informative as it should be, inhibiting price discovery in relation to inflation expectations, a critical input into monetary policy decision-making. That consideration alone should be sufficient to make the cost-benefit case for a monthly CPI. Similar cost-benefit considerations apply to the creation of macro futures markets. If policymakers think bond market-implied inflation expectations are a useful input into decision-making, the same must be true of nominal income and house price futures. We need more and better macro futures markets.
ICYMI
Robert Hetzel argues that if the Fed cannot admit that it makes mistakes, it cannot learn. Not just the Fed.
I nice appreciation by G. Patrick Lynch of one of my former teachers, Geoff Brennan.
Kevin Erdmann is one of the few people who gets how the housing market works and has a new service that provides detailed estimates of the sensitivity of US home values to macro conditions:
The RBA review makes the FT, albeit for the wrong reasons.
If you like 652% effective marginal tax rates, you will love the Australian tax and transfer system.
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