Friday, June 13, 2014

What does the Beveridge curve tell us about US labor market slack?

A few days ago we the Job Openings and Labor Turnover Survey (JOLTS) report was released for the month of april. This indicator lags some other employment data, but still can give us useful information. During April, the unemployment rate felt 4/10 of a percentage point to 6.3%, creating skepticism about how much of the drop could be attributed to a structural or cyclical component.

By using the JOLTS report and relating it to the unemployment rate we can see two things in the next chart.

First, the JOLTS report (given the linear relationship using data after the crisis) is consistent with an unemployment rate of 6.3%, suggesting that labor market slack is less compared with market assumption. Secondly, by comparing the constant term in both regressions (using data before and after the crisis), the NAIRU could have increased more than 1.0% (1.5% using this analysis). If the NAIRU was estimated at 5.0-5.5% before Lehman, the unemployment rate could be very close to its natural level of unemployment. Given how complascent markets have been about US monetary policy, we could see a shift in the months to come. Hopefully the FED will bring us some volatility.
Below you will find a couple of papers that supports this comment.

A New Measure of Resource Utilization in the Labor Market:

Middle-Skill Jobs Lost in U.S. Labor Market Polarization:


Thursday, May 1, 2014

Is Mr. Draghi bluffing again? Let see if we wins the hand of poker again.

During the last few months, inflation has been a trending topic, especially for economies such as the eurozone, where inflation has been running steadily below the explicit objective of two percent. The ECB (European Central Bank) has expressed its concern, especially during its last monetary policy decision. In later speeches, Draghi has explicitly stated the three main events that could trigger a move from the ECB.

"With our forward guidance, we aim to give guidance on the expected level of future interest rates, and to remove uncertainty about that level by strengthening communication on our reaction function. We have also further simplified our reaction function by laying out some contingencies that would warrant a monetary policy reaction. These are, first, an unwarranted tightening of monetary policy stance (from developments in short-term money markets, global bond markets or foreign exchange markets) that could be tackled through more conventional measures. Second, a further impairment in the transmission of our stance, in particular via the bank lending channel, for which a targeted LTRO or an ABS purchase programme might be the right response. Third, a worsening of the medium-term outlook for inflation, which would warrant a more broad-based asset purchase programme. The Governing Council is committed – unanimously – to using both unconventional and conventional instruments to deal effectively with the risks of a too prolonged period of low inflation."

In this post, I just want to focus on the third event, which is related to a worsening of medium term outlook for inflation, that could be related, at some point, with how well anchored inflation expectations are in the Eurozone.

The ECB research staff just released a paper in which they compare how well anchored inflation expectations are in the eurozone compared to the US, and they conclude that "Overall, inflation expectations are anchored somewhat more firmly in the euro area than in the United States."

I am just curious about this conclusions and would like to dig further into their arguments.

The paper states:

"One method to assess the degree of anchoring is by analysing the reactions of medium- to longer-term inflation expectations when new information on inflation and economic indicators is brought to the market. If they are reacting strongly to releases of conjunctural information, it suggests that economic agents do not expect the central bank to react credibly and fast to changing economic conditions. Similarly, when medium- to longer-term inflation expectations are not influenced by economic news releases, it indicates that market participants are confident that monetary policy will be adjusted to counter any risk to the inflation objective of the central bank (see, e.g., Clarida, Gal´ı, and Gertler (2000)).

Theoretically and intuitively, this make sense, but the reaction function of both Central Banks has been very different, and it has been clear during the last years that the Federal Reserve has been way more proactive than the ECB, wich has maybe a more complex problem (because of the differences in the monetary transmission channels). Furthermore, the ECB does not enjoy the same flexibility as the FED in order to act in a timely manner to counteract shocks that could affect inflation expectations.

Maybe the ECB is trying to justify its lack of reaction, but what is true, is that even if it is not obvious that deflation is a real threat in the immediate future, on my perspective, they are overconfident about their view. If they are wrong and deflation becomes real, that could be very costly. 

Regarding markets, it is very probable that  the market is going to test ECB patience and will drive the EUR to above 1.40 toward the 1.45 mark in the next few months. Let see if Draghi wins the hand of poker again.

Tuesday, April 22, 2014

Have we gotten the first signal that gold is just about to collapse?

In early posts, I have explained myself why I like to be long USD in general, so I dont want to waste your time again.
What I would like to highlight is the technical picture in Gold. After breaking the trendline coming from Oct 2012 (because of geopolitical tensions between Ukraine and Russia), Gold has re-established its downward trend, and it is sitting just above its 100 day MA that coincides with the lows seen at the beginning of April (1277 USD per ounce). Furthermore, we just got bearish signals from the MACD and Stochastics indicators (although not very strong).
I would recommend to wait for a break of 1275 USD (on close) to initiate short positions, targeting 1200 in the next 3 months.

Thursday, March 13, 2014

From Quantitative to Qualitative Guidance

“Participants agreed that, with the unemployment rate approaching 6.5 percent, it would soon be appropriate for the Committee to change its forward guidance in order to provide information about its decisions regarding the federal funds rate after that threshold was crossed.” - January FOMC minutes

During the last few months/years, the unemployment rate in the US has come down significantly, now nearing the 6.5% mark that the FED said would be a threshold (not a trigger) to revise its monetary policy stance. Additionally, they have argued that even if the unemployment rate is the best SINGLE measure of the "healthiness" of the job market, it only shows a partial picture of the whole market. 

In the coming months, the FED will be twisting its language to incorporate a wider range of indicators to assess the improvement in the labor market conditions. Stealing this chart from the Quarterly Inflation Report of the BoE (Bank of England), we replicated the next chart using indicators for the US, where, as shown below, the general condition of the labor market has substantially improved in the last year. The chart shows the z-score of each indicator compared to its mean from 2000 to 2007. As we can see, all of the indicators have shown a meaningful improvement, except for the unemployment and underemployment rate, for which there is some evidence that a structural change is going through.

One of the indicators that I would like to highlight, is the wage growth during the last months. Even if the pace at which salaries are growing is still below historical norms, we are just about to experience a sustained pick up in the income for american workers that, unlike others, is going to have an effect in the inflation figures during the next several months. Everything points to a normalization of the monetary policy as the FED expects, and points a risk to a faster tightening in the monetary conditions compared to market expectations. The curve in the US should flatten again and the USD should recover its gains vs G5 currencies. Equity market seems to be the one that will trade in a range, for the next few months.

Tuesday, February 25, 2014

Go Big or Go Home - Long DXY at 80.10, Target: 82, stop @ 79.46

The DXY is sitting just above a big trendline coming from mid 2011, and given how worried the market is about a potential slowdown in the US economy (more likely it is just about weather effects), the risk reward looks attractive. On the other hand, EUR is more than 50% of the Index, and being the case that the ECB is very behind the curve, especially because medium-term inflation expectations have been coming down (5 year inflation swaps are trading at multi-years low), the currency should find a hard time breaking the 1.3800-50 level. Finally, positioning in the currency looks relatively clean, specially vs low yielding currencies (most of which are in the DXY).

I am targeting 82 as a possible level in the near-medium term, with a stop around 79.46 level. (almost 4:1 risk reward)

Tuesday, February 4, 2014

Volatility is finally moving

During the last few weeks, we have had some developments that have pushed volatility higher (as shown in VIX in the chart below) including the mini crisis in EM, deceleration in China, and doubts about the strenght of the recovery in the US. Even if it would be difficult to see volatility much higher, everything points to a season of bigger moves in all of the asset classes.

I would stay long USD vs EUR and CAD.

Thursday, January 30, 2014

5 year Inflation swaps in the EZ touching multi-year lows

Inflation expectations measured by the 5 year inflation swaps in the EZ are at levels not seen since the burst of the 2008 financial crisis. Draghi has mentioned that Inflation Expectations are well anchored, and this chart suggest just the opposite. Should Draghi be worried?