Farewell to unemployment rate. Dove signs from a larger dataset

Following some influent FOMC members, I believe Janet Yellen will spend a good part of her first press conference trying to explain FOMC´s brand new forward guidance. Last week, New York Fed released a new set of charts measuring various dimensions of the labor market.

The problem here is related to the difficulty to communicate based on 34 series. If FOMC chooses this way, it will come back to some kind of qualitative forward guidance. But the committee also has the option to consolidate all the information contained in the dataset (Bank of England did something likethis, calling this consolidated information output gap).

I´m not sure what option they will choose. But if they decide for consolidation, they might find a very dove sign. At least this is the message passed by the principal component (PC) of this dataset, showed in figure 1. As we can see, PC suggests that there´s much more slack in US labor market than we can conclude focusing only on unemployment rate.

cant believe these russians...

http://www.project-syndicate.org/commentary/sergei-guriev-breaks-down-the-direct-and-indirect-costs-of-russia-s-intervention-in-ukraine

China will not sink

They are taking steps to address the shadow-banking problem.
Concretly, they are moving faster to make capital mkts competitive by letting the private sector in, and also are freeing interest rates from central control.
I admit the S.Run may entail some ups and downs, but these guys are doing reforms!
Whereas here..

Copom Ata II

I’ve also read it. Agree it doesn’t hint at stopping. But I think they will, if nothing surprise. My call is not based on their communication, but on my impression of their dovishness.

European Unicamp

Back from London. I had the chance to talk with many European and UK economists. Fun.

For some reason European economists are very different from US economists. The latter got their PhDs, spent some time at the Fed, think in terms of models. The former are very well read, use great metaphors, but seem not to know the basics of supply and demand (of course I’m not talking about all of them).
I guess Unicamp opened a branch there.

Copom Ata

no news...

my reading: they didn´t signal they finished the task

but..

the Ata is not sufficient to discriminate between one more 25bps raise or a bit more than that -- though i am betting they stop at 11%

Felipe Curve

CORE inflation on unemp and Y/L for the USA:

R2 of 50%. The steep decline in inflation in 2009 (around 60) closely tracks U3 soaring by that time

25 bps

As I had been predicting for a long time. Why 25?
Because now they are quite close to the neutral rate, meaning the risks of accelerating inflation are tiny. If they get to 11% and stop (as I predict), inflation will likely remain in the vicinity of 6% -- pending supply shocks. And that´s good enough -- never mind the 4.5% target

Dilma’s Inflection and Cliff Walking

Good article by Cristiano Romero, Valor newspaper. Economic policy seems in fact to be in an inflection point. First the monetary policy, with the Central Bank surprising the markets with higher rates. Now the fiscal policy, with the budget contingency. My NTNBs are doing great, thanks for asking (figure with the B23). But I don’t buy it.

My theory about Dilma's Government is the “cliff walk” theory. They have all the wrong ideas but react when facing constraints (I mean popularity related constraints). Now they are moving away from the cliff to avoid falling (fiscal mess à FX depreciation, downgrade and inflation à drop in popularity). But as things get better, they will move closer to the cliff again.

BRL or CDI Steepening?

Figure is from BofA, suggesting the relative play of paying the steepening and selling USDBRL. I like both the steepening and the long USDBRL, but what I found interesting is that my intuition was in the other direction. I thought the BRL was more distorted than the CDI

Weather and Inventories on US GDP

Still working on it but, at first sight, these effects together will take only 1pp from 2014Q1 growth.
In the figure the growth contribution of change in inventories, which I used to run a simple ARMA, and got an effect of -0.5pp. The weather effect of -0.5pp is Goldman's estimation, which seems a bit exaggerated. (Perhaps those guys are so used to endogenous variables they get embarrassed when this is not the case).
Weird thing is my GDP tracking is suggesting Q1 could growth be only 1%. This is pretty low, and cannot be explained by weather and inventories. Maybe a reason to tactically reduce risk.

Strange labor mkt

Two posts back, FK said it is explanation 2.

Well, I am not so sure. Employment lost steam last year -- as he himself pointed out in the chart he stole from LCA -- but at the very same time real wages were increasing. This automatically leads us to story 1: participation rate (not sure if it is FIES fault, but anyways...)

Further, the labor demand story cannot possibly be right. I look around and all I see are gloomy entrepreneurs.

R$40bi contingency

The surprise was not the number, or the R$30.5bi discretionary, but the flattening of the di curve (Jan/23 in the picture). It’s OK that the Central Bank will use this number to slow down, but it’s not OK to believe the Gov’t will deliver the primary surplus.

Brazuca Labor Report

Figures (from LCA, no, I didn't ask for permission), show (i) unemployment, (ii) real wage, (iii) inflation, (iv) employment

Two interpretations

1)      Unemployment is falling due to participation rate which, in its turn, can be explained by the FIES (student financing program). Labor market is really getting tighter, and the real wage confirms it.

2)      Employment series indicates labor market got much softer during the last six months (now it is actually beginning to recover). Real wage dropped in mid 2013 because inflation increased, now we are seeing the reverse.

I know you like (1). But (2) is the right answer

BoE implies FED

One idea circulating (Deutsche among others) is to use the Bank of England forward guidance to guess what the Fed will do.
Rather than choosing a new threshold, the Fed would say that (i) will hike later because there are lots of idle capacity, (ii) then will raise rates very gradually, and (iii) the terminal rate will be lower than it used to be. By doing so, it would be able to lower the short, belly and long part of curve, respectively.
My take is that (i) is already happening. (ii) will never happen, as it is contrary to recent Fed thinking, concerned about the bubble making effects of too slow and predictable monetary policy. And (ii) is already in those dots, where they say fed fund in the long run will be 4%.

Fomc minute

They were optimistic about growth, but it happened in January. In the figure the US surprise index (from citi) and a vertical bar showing the date of the meeting. Also, that story about large output gap (focus on long term unemployed and part time due to economic reasons), inflation below target for long time. Didn't change my mind in any sense. Boring.

The BofA View (for the US)

Today I’ve listened to Merrill Lynch (better known as Mario Lanches) US scenario. Growth will be strong (just consensus) and inflation will be low (interesting). They believe there is large output gap, large labor idle capacity. Main data to support their view is “part time workers for economic reasons”, it seems.

Since they were too lazy to do it, I got the data, divided by the labor force and plotted against change in inflation. (I’ve also changed sign and multiplied by the Okun coefficient, to be comparable to an output gap). The result stinks. The measure loses big time against my DSGE outputgap in a Phillips competition.

Tombini´s words

I disagree with my colleagues on Tombini´s talk. I notice two new signs. First, the Governor did not say a word about “inflation persistence”, which was the main reason to keep the pace of 50 bps in Copom´s January meeting. And he hemmed and hawed about the timetable of IPCA convergence to the target of 4.5%, shedding light on an alternative CPI index --- IPC-Fipe, which shows inflation at 3.7% in February, against 5.59% of IPCA). It´s hard to imagine dovisher signs.

That said, in the absence of another adverse inflation surprise (February IPCA-15 will be published this Friday), I expect a hike of 25 bps, and a last movement of the same size at the next meeting. In other words, three alternative diagnoses and only one conclusion!  

Tombini´s talk

The BCB chairman stressed once again the lagged effects of monetary policy -- this is what FK called the usual bla -- but this time aorund he further added that inflation is converging! If it is not 25 bp, I suggest we never pay attention to him anymore and flip a coin instead.

CNT/MDA popularity poll

Government approval rate (excellent or good) dropped from 39.0% to 36.4%. Awesome!

Tombini conf. call

Most people thought was dovish. I didn’t; just the usual blah. But I think 25bps is more likely.

The Itau view

Listened to Itau guys today.

1)      Probability of energy rationing is 20%. Growth is 1.4%. Inflation is 6.3%.

2)      Contingent budget announcement will be R$40bi of which some R$15bi are just a trick (extra revenues due to a different growth hypothesis). Anyways, there is no correlation between contingent budget and real budget (the primary surplus). Primary surplus should be only 1.3% of GDP in 2014, implying increasing debt over GDP.

3)      Employment decreased and is in line with GDP. But unemployment is not. The reason is a drop in participation rate, especially of young people. In its turn, this is due to FIES, the student financing program.

Points (1) and (2) are consensual. I liked the way Aurelio articulated (3), although I have a very different view. If he is right, labor market is still very tight. And, he argues, wage growth supports this view. My personal take is that participation rate data is shitty, and should not be used to help measure labor market tightness. Supporting my view Raone (in the audience) pointed out that participation rate increased a lot in 2012. This behavior was very weird and without good explanations. About wages, later on.

US Potential Growth

Gordon’s NBER paper (w19895) contrasts with Fernald and Jones’ (w19830), but both stink.  Growth per capita may not be equal to 2% in the future (figure 1). I agree that demography (age affecting participation rates) and educational attainment will be worse (figure 2). But that’s about it.

Fernald and Jones argue that research has gains from scale (external externalities), and there will be more PhDs from China. Also that robots may increase labor supply.

Gordon complains about inequality and the tax distortions needed to fix debt sustainability. Also data-mines an innovation slowdown and claims he can predict future TFP growth. Then arrives at some crazy 0.2% per capita growth (figure 3).

I’m much better than these guys. The right calculation is to get 2%, subtract .3% from aging, .2% from education, and another .3% because I'm in a bad mood, reaching 1.2%. That’s the per capita growth. Population will be growing .6%, which implies a potential GDP growth of 1.8%.

The monetary policy gap

In a recent post, Fabio has discussed the nominal neutral interest rate in Brazil. According to him, this rate is somewhere around 11%, which means that monetary policy (MP) will get into neutral mode in the next one or two Copom´s meeting.

Based on one of the mainly BCB´s model (Samba), I got almost the same conclusion. In my exercise, I consider that, until the end of 2014, MP will target CPI at 5.5% (against the official target of 4.5%). After that, the target will smoothly converge to 4.5% in 2016. In Samba, MP evolves according to a traditional Taylor Rule, where interest rate is a function of output gap, expected inflation and the CPI target, besides its own lags and an error component (monetary shock).

Figure 1 shows observed interest rate (blue line) and a counterfactual rate that would prevail in a world where MP never deviates from Taylor Rule (dashed red line). The difference between both rates (illustrated by the green area) is what I call “monetary policy gap”, a measure that shows us if MP is on a dove or on a hawk mode (in relation to its historical behavior).

As we can see, after a very short cycle of tightening, BCB acted in an unprecedented dovish way (even taking into account all the headwinds from world economy, as the model does!). The good news is that, after seven consecutive hikes, the gap has closed in 4Q13. And comparing Samba´s projections with consensus forecast, monetary policy gap will be kept around zero until the end of 2014 (both project selic around 11.25%).

In other words, MP will not put more pressure on inflation. So, in that sense, it´s possible to say that it has become neutral. Unfortunately, this doesn´t mean that BCB´s dovish bet in the last years will have no consequences from now on. As the central bankers love to emphasize, MP works with lags, which means that the dovish adventure will impact CPI over this year. And, according to Samba, this impact is far from trivial: after accounted for 2.1 p.p of CPI in 2013, it will account for almost a full percentage point of inflation in 2014.

BCB will face two options. The first one is to became even hawker, and put monetary policy gap on positive territory. The second (and my favorite one) is to keep MP as neutral as it is today and pray against adverse shocks. I believe Tombini will give us a hint of his possible choice tomorrow.

Typology of China Crisis

As I see China problem is overaccumulation of capital, lots of investments with negative rate of return if prices were right, which are artificially profitable due to huge distortions. As prices get corrected, productivity will reflect its true value, and output will drop. Thing is, that usually this process shows up as non-performing-loans in the financial sector. And as such, the way Government deals with financial sector rupture defines the shape of the economic crisis. That’s why I’m thinking how the forthcoming crisis will be.

1)      A la Lehman. If the political system is such that bailing out banks looks bad, Government may let some big bank fail. Financial intermediation stops, lights are turned off, the economy collapses. One year of deep recession. Plus two additional years of healing. But I doubt this would happen in China.

2)      Gangnam style.  Like in Korea, Government bails out big time, quickly cleans up all banks balance sheets, finding buyers for the banks it shut down. Recession lasts for only one year, and the economy rapidly resumes growth

3)      Lost Decade. Like Japan, China opts for a slow healing. They are proud of their millennium culture and fond of very slow changes, after all. Slowly reduce credit growth. Many years to clean up banks. A decade of slow growth.

I can't decide between 2 and 3. Celso, why do ya think?

Brazuca Central Banks Economists Meeting

Was there, today. Tomatos, electric energy, primary surplus. Boring stuff, as usual. My impression is that 2014 consensus is something like: (a) 1.5% growth and, (b) 6.5% inflation (but few explicitly state their inflation forecast, and prefer to say it is around 6%)

Putting a lot of effort, I would describe three groups of people.

i)                 Those that are focusing on the unemployment series. Believe labor market is extremely tight and only becomes more tight. Impossible to grow or reduce inflation.

ii)                Those who believe low growth will create idle capacity. Gap is zero now, but will become negative and help inflation, pero no mucho

iii)               Those crazy, me included, with weird opinions. In my case, the impression that output gap is already negative, but recent employment recovery (CAGED series) suggests output gap is closing. Other fellow saying hot weather will help growth due to icecream sales. 

Tombini´s interview and the inability to recollect

Apparently, Tombini stated that the CB objective is ALWAYS 4,5%.

That seems to be untrue, to put it mildly. Average inflation since 2011 is 6%.

Moreover, he himself stated clearly that the target (missed) for 2013 was anything below 5.84%

He also said that the exchange rate was to blame. But who caused the FX to depreciate in 2012, my dear Tombini? I remember, it was you guys in the government.

I am teaching games this semestre. The models, equilibrium concepts and even the advanced N.Eq. refinements I cover all assume players have perfect recollection of their past actions.

Tombini at the Exame magazine

I think the shop in NY that appears in the picture is Uniqlo, the Japanese chain. Those ultra light coats are really cool, you can put them in a pretty small bag, which is great for travelling. I guess that is the most the relevant aspect for monetary policy I read.

Oh my NTNBs

Picture shows yields on (aprox) 5 year duration NTNBs (which I started to buy at 5.5% -  shit!). It is contrasted with the yield of Brazil Sovereign Bonds (paid in US$) minus the US breakeven inflation (Treasury vs TIPS), also 5 year duration. Both alternatives contain a premium for the Brazilian credit risk, although default in one does not imply in the other.

Scales in the two axis have the same size, but different levels. NTNBs always paid more. However, now that the real exchange rate seems fair, I don’t see any good reason for it. Notice also that during the last 6 months the NTNB continue to deteriorate but the sovereign stopped.

Half of Emerging Market Crisis is Gone

I’ve just look at the screen. The S&P and Treasuries are telling me the half of price movements that happened over January has already reversed. I guess the other half will happen over the next couple of weeks. It doesn’t make sense to believe EM will hurt the US, I think.

Mrs. Yell

I wish she yelled at the congress, or did something more fun. Reminds me when Lula got elected, and we had to get used to his bearded frog speeches. So much more better if Laurencio were there. And her accent, annoying. We, the jewish from Brooklyn, are very disappointed.

DSGE forecasts for US

These are outputs from BLUES, my wonderful DSGE model estimated for the US economy, which systematically beat those usual egregious houses. In words, growth is going to be great, output gap is close to zero. The reasons for are (i) end of fiscal drag, (ii) easy monetary policy, (iii) end of political uncertainty, (iv) no oil shock, and(v) housing and capital stocks still too low

Yellen

Said unemployment at 6.6.% is far from ideal.
Now, the F.Guidance threshold is 6.5%
Seems then that Yellen is telling us to disregard the FG threshold for U...
But then, Mrs, if you want to guide, put sth in its place!

Fatso at Valor

He said fiscal policy management should be improved. He said inflation is persistently high

So far, so good.

But then he said industrial sector weakness is due to many years of appreciated currency. The funny thing is: the new matrix depreciated currency is with us for some time now, but seems not to have helped the industrial sector. Then one needs to explain why the effect is assymetric -- hurts in one direction but doesnt help in the other.

Of course, one can invoke lags; it is always useful to resort to lags when u are desperate. Or if you are really really desperate, you can argue that was it not for the new matrix, things would be much much worse.

Sakano at Valor

Tuesday I usually check what the Fatso wrote at Valor. But today Sakano stole the scene. Our many jabuticabas and the underperformance can be explained, he claims, by the way interest rates are set by the Central Bank. Untie this Gordian knot (lower the Selic) and we move to a good equilibrium. Two points to remember:

1)      Nakano will push this idea to Dilma. She also listens to Beloser, who says the evil markets are holding the Government hostage. And to Fatso, who never speaks his mind.

2)      If the last couple of years were not enough to convince Sakano otherwise, nothing will

Natura´s IEDI guy: a reason to be optimistic about Brazil

Read his interview yesterday in the Big State.

I guess it is the first time a guy from the industrial sector argues in favor of openness to trade; this may be a sign mindsets are finally changing in Brazil.

And he also said confidence in government has broken down and this in tunr explains dismal investment by the private sector.

Brazuca January CPI - take 2

Differently from CESG I thought it was good. Check it out the Services component (3mo moving avg, seas adjusted), coming from more than 10% to less than 7% over the last 6 months.

CPI - Jan

My read was not optimistic.
The unexpected fall was due to one major item, transports. And diffusion was above 70%, which is very high.
BCB should not lower its guard, but it will.

A story I heard

EM governments have been accumulating reserves and running down their hard currency liabilities for a decade. This dimished currency mismatch is healthy and provides insurance against shocks.

Now, the story I heard is this: recently, the private sector in these very same countries have been increasing its indebtness abroad, taking advantage of ultra-low interest rates in the developed world. That being true, and since I read this in a paper from the BIS it is likely to be true, the depreciation movement taking place now may mean real trouble down the road.

Tough to be optimistic about Brazil

Choose the most painful alternative:

i)                 Industrial Production.

ii)                Caffarelli as solution for the lack of credibility.

iii)               Infernal heat, and the fact that FCH’s popularity only dropped 4 pp during the 2001 energy rationing

iv)               NTNBs close to 7%

 

Size matters

I agree w/ FK that there may be some defunct chinese projects out there. Misallocation and price distortions.

But size matters in the sense that the chinese government can deploy enough resources to salvage banks.

And size matters also in the sense that China being huge and populous, there is a chance that basically any investment in infrastructure pays off (i am exaggerating a bit, but you get the point).

I wonder why, psychologically speaking, FK insists on the claim that size does not matter.

Size Doesn't Matter

(Porn is on the next blog. Here only China and other boring stuff)

Many pictures during the last weeks showing the size of Chinese Trusts and Wealth Management Products are very small compared to assets, GDP, deposits, etc. (See below a neat one, from BCA).

True, chances of banking crisis is small in China. But, as I see, bankruptcy is a signal that projects have negative rate of return. Suppose there was overaccumulation of capital and many prices were distorted (interest rates, exchange rate, commodities, pollution). Now, as prices get corrected, many previous investments become unprofitable, and the economy shows a much lower productivity. As a result, GDP drops.

I guess my point is that, even without a banking crisis, broad based trust funds problems indicate Chinese GDP could face a severe slow down.

Pay US10?

Figure shows Kim and Wright term premium and the US 10 yrs itself. Movement during January was in the premium and, in some sense, not related to the economic performance (which should change the rate expectation). Bodes well with the Emerging Market driven risk aversion increase story. But I’m not sure what to do. If movement was NOT in the term premium I would challenge it, and pay rates. I guess I’m going to take a nap instead.

Dilma's Popularity

A regression of popularity (Government considered excellent/good, source Datafolha, very similar to Ibope or Census, but longer data) in four determinants: (i) lag of popularity, (ii) GDP growth, (iii) inflation, (iv) real exchange rate.

Is unemployment irrelevant? Yes, in contrast with some specifications I saw around, which forgot to put lagged variables and had nonstationary residuals, I found unemployment to be irrelevant. I’m happy with this, as the unemployment series is total crap.

Are the regressors endogenous? Shit yeah.

In the first picture a forecast. Assuming growth at 2%, inflation at 6% and BRL at 2.40, popularity trends up to 45. Shit yeah.

In the second picture, which shows the residual of the regression, a curiosity. The effect of the “passe livre” street movement was huge, but vanished.

Hermanos Argentinos y nosotros

1 - They are heading towards economic disaster

2 - Argentina is the major foreign market for Brazil's manufactured products (1/4 of this sector exports)

3 - Brazilian industrial sector is in bad shape as of now

4 - [fill in this blank]

Euro Negative Deposit Rate

4 reasons for betting on negative deposit rate

1)      In the Picture the 3mo Euro CPI, a nervous but leading series.

2)      No theoretical reason for saving ammunition for later (only the contrary, the Central Bank should do the most before too late, especially if it’s about to run out of weapons)

3)      Draghi is somehow able to lead that messy board

4)      I’ve been so right on the Euro during the last year that it’s about time to make a mistake, so that no one thinks I have inside info

Cariocas 1 x 0 Gringos

During 2013 there was a stark contrast bw cariocas' and gringos' opinions about Brazil. Cariocas were very pessimistic, and were looking at how much Brazil got worse during the last couple years (a time series comparison). They would pay rates, sell BRL and Ibov. Gringos would say Brazil was a lot better then South Africa, Turkey, etc. (a cross section comparison). They didn't see a smoking gun, and received rates, sometimes with no FX hedge.
Prices, we know, so far supported the Cariocas. But I would say there is even more to it. My recent talks with gringos indicate they also became pessimistic with Brazil, converging and accepting Cariocas' views. Only weird thing is that they still seem to believe Dilma will become more pro-market, and do some fiscal adjustment after the election. If they keep believing this, elections should be good time to sell Brazil.

Argentina impact over Brazil

Blue curve is Argentinean GDP growth. Red. and green are respectively Brazilian exports to and imports from Argentina. For some reason I don't know exports are more affected than inports when Argentina collapses (we are talking about vehicles and parts, both ways). Forthcoming collapse should imply about $5 bi less for Brazilian trade balance, or .25 pp of GDP. This does not take into account the financial impact - I believe gringos will differentiate the risks of Brazil from those from Argentina, as they did in 2001, after all Cristina is better than Dilma

Vulnerability to EM

I liked this picture, from BCA. Even though Japan is very closed, it is a lot more exposed to EM than the US.

Confidence vanished

I thought that the concessions program going ahead -- as it is -- confidence would return, even if modestly, to the brazilian entrepreneurial sector. It did not. Investment plummeted in the second semester, and did not recover.

This suggests the government managed to do great harm to investors' animal spirits with its "new macro matrix" which came accompanied by unprecedented micro interferience (including here public credit and its attendant misallocation of capital). At this juncture, my call is that nothing other than a thorough change in command can revert this dullness.

Unfortunately, this looks unlikely.

Happy 2019!

What does Taylor say for the Selic?

Acording to Taylor,
Selic = neutral real rate + inflation target + 1.5*(expected inflation - inflation target)
I've decided to delete the output gap term because we all disagree about it.
Nowadays expected inflation is around 6%.
For the target and neutral rate, I suggest the following cases:
i) Tombini's mind: neutral rate = 4%, target = 4.5%, which implies Selic = 10.75%
i) My own mind: neutral rate = 5%, target = 5.5%, which implies Selic = 11.25%