The Fed Radar Detects Uncertainty

Richard Moody is the chief economist at Regions Financial Corp. We spoke with him a few days after the March meeting of the Federal Reserve Bank’s Federal Open Market Committee — one of those periodic gatherings that markets keep an eye on for changes in interest rates. The stock market rallied after interest rates were kept at virtual zero. But the economic forecast was not so cheery.  

What really surprised people out of this (March) meeting was that they softened their path to the funds rate versus December, which was the last time they issued projections. The Fed was conveying to the market that they’re not certain about the path of the economy. Their forecast for growth is still showing trend growth, but there’s greater uncertainty right now. They were saying they don’t need to be in a hurry to raise the funds rate, given how low inflation is and given there is still significant slack in the labor market.

The economy is improving, there is no doubt about that, but the question is how much slack is there in the labor market, and is 5.5 percent unemployment an accurate measure of the degree of slack? The Fed’s point is that it’s not, because there are a lot of people who are not working or are working part-time for economic reasons that are not captured in that headline unemployment rate.

For about the last four years, average hourly earnings have been stuck at about the 2 percent growth rate, and that would be an argument that the Fed would make to say the unemployment rate is a misleading signal of how weak the labor market actually is. At 5.5 percent, we should have seen wage growth accelerate by now, had that been a true measure of the slack in the labor market.

Some people compare the rate of consumer spending now to spending before the recession, and that’s not a really valid comparison, because, before the recession, you had significant growth in household debt. Consumers are still working to pare down debt. Only in recent months have we seen a tick up of the rate of growth in labor earnings.

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The employment gains have been in low-paying jobs in the earlier stages of the recovery, but in the last year and a half or so, you’ve seen more job growth in the higher skill occupations. There is very much a premium attached to skilled labor, and the skilled occupations are seeing wage growth; whereas, the lesser skilled occupations are not. Up until this point, there had been an ample amount of labor to fill these more skilled jobs, so there was no upward pressure on earnings. 

Housing starts have declined significantly in Q1, but that really had to do with weather. The declines came in the Midwest and Northeast, which were the two areas of the country that had record cold and precipitation for the month of February.

The more telling figure is that building permits continued to rise, so the underlying trends remain favorable. The thing about the housing market that a lot of people seem to have gotten wrong is that they expected a much more rapid recovery in the single-family segment of the market; whereas, it’s really been the multifamily segment that’s been seeing the most gains.

Up until this point, income growth has not been strong enough to unleash a lot of new demand for new home purchases, although that has been changing over the course of this year. There are also demographic factors. A lot of the increase in household formation that you’re seeing right now is coming among young adults, and people under the age of 34 have historically been renters not buyers.

The thing that is surprising me is how aggressive some of the forecasts have been this year for single-family growth. They must be assuming a much more rapid adjustment in the housing market than I see taking place. I could be wrong, but so far we’ve been closer to the mark, and so far we’re still comfortable with our more low-end estimate.

One thing that does concern me is that the rate at which multifamily units are being completed is significantly behind the rate at which new multifamily homes are being started. Typically, for large apartment complexes, there’s about a 9- to 12-month lag between start and finish. What we are getting concerned about is that if all these units that are in the construction process, if they all start to come on line — which we think will be late this year or early next year — then there are going to be some markets that quickly find themselves with too much supply. I wouldn’t use the term “bubble” right now, but there are some concerns about overbuilding.

The stronger dollar is helping price U.S. exports out of a lot of foreign markets, so that’s taking a pretty significant toll on corporate earnings, at least for those corporations who are exposed to foreign trade.

The whole global growth environment is fairly soft. You couple that with a stronger U.S. dollar and there’s a significant downside risk for the growth of U.S. exports. China’s economy is in the midst of a structural transition, trying to move away from an export-dominated economy to more of a services and domestic-consumption economy. And Japan’s economy has been fairly weak. 

Europe is teetering on the brink of what would be their third recession in eight years. Some of the data are stabilizing, so I don’t think things will get any worse. But I don’t think anybody expects them to get better at any kind of a rapid pace. 

We in the U.S. banking system were badly undercapitalized coming out of the Great Recession, but we’ve resolved that down. Europe has taken very few steps to do so. It wasn’t until this month that the European Central Bank embarked on the kind of quantitative easing that our central bank and others around the globe did years ago. So they’re years behind in terms of their policy response, and they have ongoing structural issues, and they also have pretty abysmal demographic trends across much of the eurozone. 

And then you have the ongoing situation with Greece and the whole question of whether they are going to be able to stay in the eurozone. That’s unsettling the financial markets as well. The reality is that Greece is such a small share of not only the eurozone but of the global economy, the impacts would be localized. But my concern would be the mentality of the financial markets. We don’t want another global liquidity crisis like we had back in 2008. Whether or not that would be enough to set one off, it’s an open question, but it’s a question that I think no one really wants to know the answer to. 

Chris McFadyen is the editorial director of Business Alabama.

Interview by Chris McFadyen

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