Viewpoints

State labor markets in December were essentially unchanged from November. West Virginia was the only state to report a statistically significant change in payrolls (a 1.4 percent drop). Texas had the largest (not statistically significant) increase: 29,500. Over the last 12 months, 42 states had significant increases, with Texas leading the way in both numbers and percentage (650,100 and 5.0, respectively). There were no point declines.

Unemployment rates rose significantly in 7 states and dropped in 5. Nevada’s .3 percentage point increase and Maryland’s .3 percent point decline were the largest moves. Utah’s 2.2 percent was the lowest rate, and Nevada’s 5.2 percent was the highest. The Dakota’s were the only other states with unemployment under 2.5 percent. Illinois and DC both had 4.7 percetn unemployment rates. In sum, 46 states had unemployment rates no more than 1 percentage point different than the national average of 3.5 percent.

Puerto Rico’s job count edged down 1,500. Yet again there was insufficient information to compute the (seasonally-adjusted) unemployment rate on the island.

The inverted Treasury yield curve has raised concern over the risk of recession in 2023, and for a good reason. An inverted yield curve has occurred before the past eight recessions. Yet, something is awry. Banks are not restricting credit as they typically would with an inverted yield curve, and businesses and consumers are borrowing at banks at the fastest rate in fifteen years. What's up?

The thinking behind the inverted yield curve is that banks slow and eventually stop lending when bank funding costs exceed what banks can earn by lending. Yet, bank credit has been accelerating throughout 2022. The latest data for November shows bank lending to businesses, real estate, and consumers rising 11.8% over the comparable period one year earlier. That's the fastest annual growth since 2007.

Why are banks lending so much with an inverted yield curve? Banks' total costs of funds are not determined solely by the rate of federal funds. Customer deposits account for half of the funding costs for many big banks. And with customer deposit earning (or costing) less than 70 basis points, the bank's all-in funding costs remain relatively low. So it's still profitable to lend nowadays.

That raises questions about the recessionary signal from an inverted yield curve because, in previous periods of inverted yield curves, bank lending slowed sharply, often contracting (see chart). Can the inverted yield curve signal be trusted if bank credit is accelerating, not slowing, or contracting as in previous periods? I would think not.

Also, why are businesses and consumers still borrowing briskly after the Fed substantially raised official rates? Because the federal funds rate is not crushingly high, at least not yet. In the past, the federal funds rate proved restrictive when its level equaled or exceeded the growth in gross income and output (see chart). In other words, to slow domestic demand, the Fed had to raise rates equal to or above the increase in gross income and output.

At the end of the third quarter of 2022, the growth in GDP exceeded the Fed funds rate by almost 600 basis points. That's huge, indicating the economy is far from one of the conditions in place before prior recessions. Even if the Fed median forecasts of higher official rates and markedly slower nominal growth are on the mark, the GDP-Fed funds' gap will not be closed before mid-year 2023. A recession beginning around mid-year runs counter to the bullish forecasts of a strong half for 2023.

Many believe an inversion in the market yield curve, or the spread between the yield on three-month Treasury bills and the 10-year treasury, is a robust forecasting tool due to its consistent and reliable track record. Yet, yield curve inversion, by itself, is not a sufficient condition for an economic recession. Slowing or contracting credit growth and official rate levels equal to or exceeding income growth are also necessary conditions. Those conditions are not present, so until they are, the yield-curve recession signal will remain a forecast, not a reality.

The Federal Reserve Bank of Philadelphia’s state coincident indexes in November, showed softness, but on balance no more so, and arguably less, than in October. The indexes in 14 states dropped from October (little more than half the number that had one-month declines in the initial October results), all less than .5 percent. At the three-month horizon 12 states saw their index decline from August to November, but only 4 small-population ones (Vermont, Montana, Maine, and Rhode Island) clocked drops of more than .5 percent. However, large gains were also rare over these three months; a fairly moderate number (10) had gains of more than 1 percent (this group did include New York and Florida), with Hawaii’s 2.62 percent far and away the best. Over the past 12 months, 13 states (including California, New York, and Florida) had increase of at least 5 percent, but this count is also down from the first October results. 4 states (Arizona, Montana, Mississippi, and Oklahoma) had increases under 2 percent.

in November the independently estimated national figures of growth over the last 3 (.78 percent) and 12 (4.29 percent) months do not appear terribly out of line with the state figures.

All states have set new peaks in this series in this expansion. Connecticut had been the last holdout, but the revised dataset shows that the Nutmeg state exceeded the old mark in July.

State real GDP growth ranged from Alaska's 8.7 percent annual rate to Mississippi's -0.7 percent. States in the West grew more rapidly, while softness was more evident in the central part of the nation. In general, energy-producing states like Alaska fared best--Texas's number 2 8.2 percent growth rate was nearly half the result of increased mining output—while farm-oriented states were weaker. The Dakotas are the real exemplars of this effect: ex-mining, North Dakota's 5.2 percent growth rate would have been close to South Dakota-s -0.5 percent rate of decline. ranged widely in 2022: Q2.

Looking at industry contributions, major sources of declines were construction, nondurable goods manufacturing, and wholesale trade (all three down in every state). A large pickup in accommodations and food services was arithmetically responsible for Hawaii being one of the few states with a real GDP increase.

State personal income growth ran the gamut from Colorado's 14.2 percent growth rate to Indiana's 1.9 percent. Maine and New Mexico, along with Colorado, saw astonishing rates of growth in transfer payments, while Indiana was held down by a drop in that income category. “Net earnings” (employee compensation plus proprietors' income) was much evener, with Texas's growth rate of 8.5 percent at the top and Indiana's 3.2 percent the lowest.

Last week the numbers on 2021 nominal and real personal consumption and real personal income by state were issued. The high for real spending growth was Utah's 12.5 percent, while West Virginia's 2.0 percent was the low. Numbers of states in the Rocky Mountains had growth exceeding 10 percent, as did Massachusetts, New Jersey, and Florida. West Virginia and Alaska (3.1 percent) were considerable outliers on the low side: no other state was under 5 percent.

The availability of both nominal and real consumer spending figures allows for the computation of state consumption price deflators and their growth. The range of growth went from Vermont's 0.5 percent to West Virginia's 8.1. Other New England states—Maine, New Hampshire, Massachusetts, and Connecticut—also saw deflator growth under 2 percent., while Arizona Nevada, and New Mexico were also on the low side. Other high growth states included Alaska and South Carolina (North Carolina was also high). Differences in state deflators, and their growth, would largely reflect differences in service costs (as one would expect, Alaska and Hawaii have the largest divergence in good price levels), especially housing, but also utilities. Thus, it isn't surprising that there is some regional theme to divergences.

It is almost December 23rd and that means that Festivus is nearly upon us. (Actually, Festivus is floating holiday that can be observed whenever one chooses to.) It is traditional on Festivus to air one’s grievances. Among the many, one of my grievances this year with the Fed is that it talks too much – talks too much about things of which it does not know. By talking too much, the Fed adds unnecessary volatility to the global financial markets.

It was not always this way. In fact, there was a time when I believe the Fed talked too little. In 1986, I transitioned from being an economist at the Chicago Fed to becoming a so-called Fed-watcher at The Northern Trust Company. Back then, about the only thing the Fed publicly announced about current and future monetary policy was the dates of its Federal Open Market Committee (FOMC) meetings. If the FOMC decided at a meeting to change the desired level of the federal funds rate, it did not reveal this to the public. One of the tasks of a Fed-watcher was to divine whether the FOMC had changed its target federal funds rate. If the federal funds rate were trading somewhat above its pre-FOMC-meeting level in the days following the meeting, how did the New York Fed trading desk respond? Did it execute overnight repurchase agreements, term repurchase agreements, outright open market purchases of securities, do nothing or exercise the “nuclear” option, by executing a matched-sale-purchase agreement (today known as a reverse repurchase agreement). These different open market operations might, or might not, have different implications regarding the FOMC’s federal funds rate decision at its latest meeting. It might take several days for us Fed-watchers to determine the FOMC’s decision. And sometimes we, collectively, got it wrong. Similar to a tree falling in a forest without anyone hearing it, what if the FOMC changed its target level of the federal funds rate and Fed-watchers did not discover it? I always thought that this unnecessary secretiveness on the part of the Fed was a Fed tool to provide full employment for economists. Finally, beginning in 1994, the FOMC began announcing changes in its policy stance, and in 1995 it began to explicitly state its target level for the federal funds rate. Miraculously, many of us Fed-watchers managed to stay employed. We could now devote more of our time to trying to discern the implications of the FOMC’s latest change in the federal funds rate for the behavior of the future behavior of the economy, both in real and nominal terms, of future interest rate levels and of future foreign exchange rates. Even with the extra time available for this, we were not very good at this. But most of us continued to stay employed in our chosen profession!

Now, the chairperson of the Fed holds a press conference immediately after the adjourning of an FOMC meeting. The chairperson talks about all manner of things entering into the FOMC’s policy decision. Not only does the chairperson announce the FOMC’s current target federal funds rate level, but also the FOMC’s expected future path of the federal funds rate. I believe it is a Herculean task to identify the “correct” current level of the federal funds rate, much less the “correct” future level of the federal funds rate. In between FOMC meetings, there can be as many as 19 Fed officials – 7 Fed Board governors and 12 Fed District Bank presidents – commenting on current and expected future monetary policy decisions, not all of whom are singing from the same hymn sheet. The current surfeit of Fedspeak brings to my mind the 1960 pop tune performed and co-written by Joe Jones, “You Talk Too Much” (check it out on YouTube). With apologies to Joe Jones and Reginald Hall, I have substituted my lyrics with Fed references to their song below.

The Fed Talks Too Much Lyrics by Paul Kasriel To the melody of “You Talk Too Much”

You talk too much. You worry markets to death. You talk too much. Why don’t you save your breath?

You just taw-aw-aw-aw-aw-awk, Talk too much!

You talk about a neutral rate That you don’t know. You talk about a soft landing Wherever you go.

You just taw-aw-aw-aw-aw-awk, Talk too much!

You talk about max employment That you can’t define. You talk about a terminal rate That changes all the time.

You just taw-aw-aw-aw-aw-awk, You talk too much.

You talk about transitory inflation And then your views shift. You talk about anchored expectations And then they begin to drift.

You talk too much. You worry markets to death. You talk too much. Why don’t you save your breath?

You just taw-aw-aw-aw-aw-awk, Talk too much!

Well, I have brought the aluminum Festivus pole up from the basement. It is made of aluminum because of its high strength-to-weight ratio. And the clock in the bag is hung on the wall. Why is a clock in a bag hung on a wall? No one really knows. It’s just an ancient Festivus tradition. So, it is time to gather around the pole, lift a glass of single-malt scotch, (Lagavulin, if you are thinking of a present for me) and join in the singing of “O Festivus”. Remember, Festivus is not over until Chairman Powell pins me.

O’ Festivus Lyrics by Katy Kasriel To the melody of O’ Tannenbaum

O’ Festivus, O’ Festivus, This one’s for all the rest of us. The worst of us, the best of us, The shabby and well-dressed of us. We gather ‘round the ‘luminum pole, Air grievances that bare the soul. No slights too small to be expressed, It’s good to get things off our chest. It’s time now for the wrestling tests, Feel free to pin both kin and guests, O’Festivus, O’ Festivus, The holiday for the rest of us.

And a contentious Festivus 2022 to all.

Note: I asked ChatGPT to write lyrics for “The Fed Talks Too Much” and “O’Festivus”. In my opinion, the results fell short of versions written by lyricists Katy and Paul Kasriel. But why don’t you give ChatGPT it a try and judge for yourself?

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

State labor market results in November continue to show lessened improvement and, in some measures, some softening. Eight states had statistically significant increases in payrolls. West Virginia saw a 1 percent gain, and New Hampshire’s .6 percent was the only other gain higher than ½ percent. Florida saw the largest numerical increase. Its 28,100 is fairly small compared to earlier months, where the leaders generally with state pickups of more than 50,000 Over the last 12 months, every state (and DC) saw a gain in payrolls, but in six cases (as well as in DC) the increases were not seen as statistically significant. Texas’s 5.1 percent gain over this period was the largest.

12 states saw statistically significant increases in their unemployment rates from October to November, but none larger and .3 percentage point. Three states, and DC, had statistically significant declines, none greater than .2 percentage point. Nevada’s 4.9 percent rate was the nation’s highest, with DC and Illinois also posting rates above 4.5 percent; Utah’s 2.2 percent the lowest, with Minnesota and both Dakotas the other ones with rates under 2.5 percent (in October seven states had rates of 2.4 percent or lower).

Puerto Rico's job count rose by more than 4,000, but once again there was insufficient information to compute the (seasonally-adjusted) unemployment rate on the island.

"It ain't over until it's over," quoting Yogi Berra, but this has been a "painless" tightening cycle for companies. According to the profit data for nonfinancial companies, profit margins (adjusted for inflation) for the first three quarters of 2022 have averaged 15.6%, essentially matching last year's figure, which was the highest in 60 years.

In previous Fed tightening cycles aimed at slowing and reversing cyclical inflation forces, real profit margins declined, and by a lot. Declines of 200 to 500 basis points in real profit margins occurred during the tightening cycles of 1980, the 1990s, and the 2000s.

What makes this period different? For one, the rise in official rates, while significant in scale, up 400 basis points from the start of the year, is still far below the 6.3% rate of core inflation for the twelve months ending in October. And the nominal level of federal funds at 4% is still 500 basis points below the 9.2% growth in nominal GDP for the year ending in Q3 2022.

In short, the price increases have exceeded total unit costs for nonfinancial companies (including labor, materials, and credit borrowing). A 'pain-free" tightening cycle is not how inflation cycles end. In previous tightening cycles, companies felt the "pain" of higher interest rates, resulting in layoffs and cutbacks in spending.

In comments at the Brookings Institution, Fed Powell said, "my colleagues and I do not want to over-tighten... that's why we're slowing down and going to try to find our way to what is the right level is". As Yogi Berra said, "You've got to be very careful if you don't know where you are going because you might not get there." Since the Fed does not know where they are going, how should investors know? Investors should expect a volatile 2023.