Mortgage

Look for Fed to tighten before it sees the whites of inflation’s eyes

Strong employment numbers should give Central Bank confidence to take action

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Surprise, surprise: November employment data released today were off-the-chart strong.

Estimates for November payrolls had called for a gain a little over 200,000 jobs, but at 6:30 a.m. New York time, screens all over the world flashed NOV PAYROLLS PLUS 321,000 and jaws dropped onto keyboards.

Markets are struggling to evaluate and price the news. It’s possible there’s some distortion from seasonal adjustments, so for the moment there’s some skepticism about the report.

There’s more reaction among politicians and economists than investors. The White House is preening alongside anyone who has had an optimistic forecast and been frustrated during the last five years. There’s also much chatter about the report’s effect on the Fed.

More important than the payroll gain: Average hourly wages at last had a good month, up nine cents to $24.66 an hour. That’s an annualized gain of 4.4 percent, more than double the trend going in.

To evaluate the report, study other brand-new news from November for confirmation.

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In the first week of each month we get two surveys taken by the Institute for Supply Management. The November results were red hot: The manufacturing ISM arrived at 58.7, and the service-sector twin at 59.3, both a couple of points over forecast. Breakeven is 50, and results near 60 historically have triggered quick and unwelcome attention from the Fed.

There is no future in quibbling with those numbers. Hot is hot.

However, quibble anyway! There is plenty of that going on inside the Fed today. How hot can our economy run before incomes rise enough to risk inflation? The wage gain in the payroll report could be a sudden trend-change, but looks like an outlier.

The Bureau of Labor Statistics also studies unit labor costs, which track compensation and productivity separately from its employment reports. This week the BLS revised down second-quarter compensation to negative 1.5 percent. Third quarter rose only 1.3 percent — on net, dead flat for the middle six months of 2014.

Do I believe something huge has changed since the end of September? Uh-uh.

There is no change in consumer behavior to reflect suddenly improving incomes. We’ll argue about holiday retail sales until January, but initial reports are tepid.

Mortgage rates have fallen close to 4 percent for most borrowers, but there’s been no corresponding jump in purchase applications (remember all that BS about housing slowing because mortgage rates had jumped to 4.5 percent?).

How can we run so hot without rising incomes? The left says rapacious behavior by the 1 percent and business; the right blames all on government.

Both wrong: The outside world is in a disinflationary spiral, the endgame of foolishness in both Europe and Japan, and 20 years of China trying to hold its production costs under downward-spiraling incomes elsewhere.

The entire world outside the U.S. is trying now to improve its competitive position by devaluing currency, which will push down the cost of everything we import, but will also push down the incomes of anyone here in the U.S. trying to compete with production over there.

So, in a disinflationary world (if not deflating outright), why is the Fed the only central bank insistent on raising the cost of money soon?

  • Everything in the Fed’s history says it must be pre-emptive. It must begin to tighten a year or more before we can see the whites of inflation’s eyes.
  • Reports like today’s give the Fed confidence that an eentsy-teentsy tightening runs a low risk of aborting recovery.
  • Risks here matter more than anything over there. Thus the damage done over there by an overstrong dollar … tough.
  • The Fed has been at zero for SIX years. Long time. Especially after having missed the credit bubble, 2002-2007, the Fed fears imbalances that it cannot see. Like a patrol in some God-forsaken village in Mesopotamia, sometimes it’s wise to toss a grenade over a wall just to see if hazard has crept close without notice.

Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.