Fed, Employment, Mistake or Correct? Munis?

Author: David R. Kotok, Post Date: May 6, 2018

Albert Einstein was, it turns out, apparently not the person who defined insanity as “doing the same thing over and over again and expecting a different result” (see https://quoteinvestigator.com/2017/03/23/same/); but it’s a good definition just the same.

The definition certainly applies in economics and financial markets when we apply regression analysis to data on the assumption that nothing has changed. Many fail to look for new or unique information or regime changes but rather remain trapped by old ways.

In a brilliant analysis, Philippa Dunne and Doug Henwood published the following insight in their May 3 TLR (formerly The Liscio Report). For information on this first-rate newsletter, which I always read as soon as it arrives, call 518-827-7094 or email Philippa directly: philippa@panix.com. We thank Philippa & Doug for permission to share their superb work with our readers. They wrote:

“Analysts enthusiastically make claims about jobless claims in historical context, but it’s important to remember this: jobless claims are around 62% of flows into unemployment, more than 20 points below the 1990–2007 average of 85%.”

That’s a terrific snippet.

So as we thought about the monthly employment report, we wanted to frame it in this context and not reiterate the headlines that painted the news flow after 8:30 AM on Friday morning.

Let’s wade deeper into TLR for details.

“Much has been made of the low level of first-time unemployment claims. They are low, no doubt about it – 0.16% of employment, a hair above March’s record low of 0.15% and well below the previous record of 0.20% set in March 2000. (You can say similar things about continuing claims.) But, as we’ve noted in the past, the record comes with an asterisk. That asterisk is the declining share of the unemployed who are eligible for benefits. When we last visited this terrain, we noted that the insured unemployment rate was close to 70% of the official rate in the early 1970s; it’s less than half that, around 32%, today. Some readers countered that this could be explained by the rising share of the long-term unemployed in the total. True enough; now, those unemployed 27 weeks or longer account for 26% of the total, which would have been worse than a depth-of-recession neighborhood in the 1970s and 1980s. But the long-termers can’t account for this: initial claims are now around 62% of the flows into unemployment, more than 20 points below the 1990–2007 average of 85%, and had never been below 74% before 2013. Looking beneath the surface, we’d say there are some labor shortages, but the job market is not as tight as claims may suggest.”

Think about that: “not as tight as claims may suggest!”

So are the Fed’s models steering the FOMC in the wrong direction? Is monetary policy succumbing to economic insanity? Do the labor force data changes cited by Philippa and Doug help explain the flattened yield curve?

Former Fed Governor and “almost Fed Chair” Kevin Warsh thinks so.

Politico reported this on May 4, 2018:

“KEVIN WARSH THINKS THE FED IS BUSTED – Former Federal Reserve Governor Kevin Warsh, who nearly became Fed Chair, sat down with a group of reporters in Palo Alto, Calif. on Thursday night for his first on-record comments since the top central bank job went to Jay Powell…. Warsh offered a fairly stark assessment of the Fed, including its reliance on antiquated data sets (including today’s jobs report) and obsession with a 2 percent inflation target that is certainly not precise to the decimal point. Had he gotten the Fed gig, Warsh said he would have harnessed the many big brains inside the central bank to find better data. Warsh: ‘The place is thirsting to be led in new directions … I have the impression … that they are waiting on the payroll number … and they think it’s filled with important insights about the economy.’ He also dismissed the idea that slightly faster wage growth should cause the Fed to panic about inflation. ‘A catch-up in wages would not tell me that “oh my goodness, inflation is coming.” I do not have a 1978 view that unions have bargaining power and that will send us on a wage-plus-price spiral that’s going to lead to inflation.’”

Terrific analysis by TLR and a clear statement from Kevin Warsh are enough to give us pause.

We still wouldn’t buy the Treasury note or long bond. We still prefer spread product in the municipal space. When a very-high-grade tax-free instrument is paying investors a higher yield than the corresponding taxable Treasury security pays, that is a screaming bargain. We will even use the tax-free instruments in taxable fixed-income accounts in lieu of traditional corporate bonds, as the yield may be higher and the cushion against a higher future interest rate is improved by the tax-free nature of the instrument. Only a repeal of the income tax code would change that approach, and we do not believe that is a remote possibility.

The muni sector is offering bargains to those who will do the hard work to find them. Those who are running from that sector are doing so way too soon.

David R Kotok
Chairman & Chief Investment Officer
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