Guest Post: Third Quarter Economic Commentary by Dorothy Jaworski

The Bond Guru Switches Teams

The surprise of September was the abrupt departure of the Bond Guru, Bill Gross, from PIMCO, the company that he helped found forty years ago.  Shock went through the bond markets, especially at

PIMCO, who found out about Gross’ exit along with the rest of us.  Between the September 26^th surprise announcement and October 2^nd, investors pulled nearly $24 billion from PIMCO funds and ETFs.  There is no way to know exactly how much money will ultimately move and land with Bill at Janus Capital, his new home.  And he doesn’t even have to stray far from the beautiful beaches and leisurely lifestyle of Newport Beach, California, because Denver-based Janus is opening an office in Newport Beach, California.  How about that?

She’s Getting Better at Press Conferences, But…

The Federal Reserve has let the talk of rising interest rates hang over the markets like a fog.  We have seen several restless Fed governors, who keep dissenting to the Fed’s statements on policy to keep rates low for a “considerable time.”   Many in the markets thought that the Fed would drop these words from the September statement because they act like a promise to the markets, but the Fed retained them.  Following the meeting, Janet Yellen gave her press conference.  She was repeatedly asked about the words and their meaning and she kept saying over and over again that the Fed’s moves are “data dependent.”  She was not very convincing.  She could have said that returning to “normal” is taking longer than expected and the market projections that rates will rise in the middle of 2015 is about as good as any right now.  Markets build in assumptions for short term rates and this impacts long term rates, of course along with inflationary expectations.  She could have used some coaching to reassure investors.

Growth and Inflation

One would have to question a Fed that would raise rates when the US economy is the only one of the four largest world economies that is displaying any growth, albeit at a very slow 2%.  China, Japan, and Europe are all struggling.  Remember that we are five years in this recovery and we are only managing 2.2% average growth, compared to 4.6% after the prior ten economic recoveries.  Inflation is falling along with many commodity prices (except for gas prices, but I digress).  In China, consumer price inflation is -2.0%, in Europe, it is +1.0%, and here in the US, it is +1.7%.  It would not be unprecedented for the Fed to raise rates with falling inflation, as happened in 1994, but it would be unusual and fairly shocking.

Geopolitical tensions abound in the Russia-Ukraine conflict, Syria, Iraq and a US led group of allies fighting against the evil that is ISIS, and the Israel-Palestinian fighting.  The threat of the spread of Ebola is increasing tensions as well.  This is not an environment that screams for rates to rise; reality may be quite the contrary.

The Unemployment Rate

Much of the fear of Fed tightening springs from the decline in the unemployment rate to the Fed’s “goal.”  For the month of September, the unemployment rate fell to 5.9%, within the NAIRU band quoted by Fed Chair Yellen in her press conference.  NAIRU, or the non-accelerating inflation rate of unemployment, is the unemployment rate below which inflation will rise.  Oh, Phillips curvers, where have you been?

I have a couple comments when I look at the drop in the unemployment rate over the past two years.  First, the drop has been caused more by workers dropping out of the labor force than from job creation.  Job growth has established itself at an average above 200,000 per month, which is fairly good, but well below the pace of other recoveries when the economy was so much smaller.  The labor force participation rate has dropped to 62.7%, the lowest since 1978.  It is not just retirees lowering the rate, but it is young people, too.  Those Not in the Labor Force now total 92.6 million, which is a record.  Many of the jobs created are lower level or part-time, so wages are not rising dramatically.  I cannot believe that productivity will benefit from the structural shifts that we are seeing in employment and I believe we will continue to see sub-par growth in GDP.  I saw this quote on Bloomberg in September and it resonates:  “The economy always appears stronger if you ignore the weakness.”

Cybercrime

Speaking of productivity, we are in the midst of another period where we will pour trillions of dollars of our precious earnings into protecting our computer systems and networks from the scourge of hacking.  I have listed this as a risk to the economy in the past but I didn’t realize the extent to which cybercrime would reach new heights.  The evidence was revealed by JP Morgan in the first week of October.  Hackers got into their bank systems and stole names, addresses, and email addresses (but supposedly not account data) of 76 million households and 7 million businesses.  No system is sacred anymore.   Witness the Acme announcement of a major hack at their stores recently.  We are just getting over Home Depot’s admission of 60 million credit and debit card numbers being stolen over the course of months, eclipsing Target’s data breach.  So, nothing is sacred online.  The complete waste of time and money is an ever-increasing drag on GDP.  Add this to the purported estimates of regulatory costs of $1.86 trillion on our economy, and 2% growth seems like a gift.

Our Bank’s Senior Vice President of Deposit Operations and Information Technology, Karen Shinn, knows all too well the risk and costs of these breaches to banks.  She works continuously with our vendors and has implemented fraud detection tools to protect our customers’ debit cards.  But customers can work closely with the Bank, too, by being vigilant about their personal information and by notifying us right away about any unusual activity.  Hacking prevention and network protection expenses will continue to filter into the costs of every company.  Maybe this will be the inflation that the Fed and ECB so desperately desire.

Last Word

Dr. Charles Plosser, President of the Philadelphia Federal Reserve, recently announced his retirement as of March, 2015.  Thank you for all that you have done for our Philadelphia region over your years here!

Thanks for reading!  10/09/14



Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with First Federal of Bucks County since November, 2004. She is the author of Just Another Good Soldier, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure.

Guest Post: First Quarter Economic Review by Dorothy Jaworski

Spring-At Last

We are all thankful to leave the brutal winter of 2014 behind, especially the polar vortex! The constant barrage of snowstorms was mind numbing. The ice storm that hit our region (Philadelphia Region) with damage and over 700,0000 power outages was perhaps the worst storm. I missed being on the eastbound Pennsylvania Turnpike by 30 minutes on February 14th. For that, I am truly thankful. The lost productivity cost our local economy greatly. and the lasting legacy of potholes will keep drivers on their guard for months!

But it is pring and a new beginning. The equity markets are reaching new highs, expecting the economy to emerge from the deep freeze in the first quarter. GDP is expected to rebound from 1% to 1.5% in the first quarter to its "normal" mediocre growth rate of 2% to 2.5% in the second quarter.

Long term interest rates remain near their highs of last year, with the 10 year Treasury trading around 2.75%, as a result of the Federal Reserve tapering of their QE bond buying program. The bond markets unwound the benefits of QE during 2013, so it quickly became apparent to the Fed to reduce it. Rates would be much higher today if the economy was expected to grow more than the rates I indicated here. Markets are ignoring would events, such as Russia's annexation of Crimea, further unrest in Ukraine, earthquakes, and the missing Malaysian Airlines Flight 370.

We have a new beginning at the Federal Reserve, too.  Janet Yellen was sworn in as the first female Fed Chairwoman and she is expected to rule an empire in the same traditions as her two predecessors, the Maestro and Big Ben.  She worked for both men and is a fan of each.  She is a proponent of studying the data and is not fooled by numbers that do not provide the full picture of economic health, such as the unemployment rate.  She learned her first lesson at her first press conference.  When asked to define “considerable time,” she blurted out “six months or that type of thing” without thinking.  What?  “Considerable” is that short?  Bernanke always implied it was years!  Bond markets quickly adjusted to rate hikes sooner than expected.  I don’t think she meant that at all.  Nearly five years into our “recovery,” she knows that she must keep short term rates low to improve employment and prevent inflation from getting too low.  She knows if she tightens too soon, economic growth could stall.

Cautious Growth for 2014

We still expect that GDP growth for 2014 will be between 2% and 2.5% nationally.  Once the country recovers from the brutal winter in most parts of the US, growth will resume but uncertainty will remain, as businesses and consumers adjust to the new healthcare laws, regulatory burden, and general discomfort with the economic outlook.  Many of our bank customers remain reluctant to borrow and spend on large projects.

The Federal Reserve released their updated economic projections on March 19, 2014.  Generally, they lowered their GDP projections for this year and the next two slightly, kept their inflation forecasts about the same- still at 2% or below, and lowered their unemployment rate projections due to structural problems with the rate falling from persons exiting the labor force and lower paying jobs being added.  They slightly raised their Fed Funds projections, including an earlier increase of the Fed Funds rate from the prior December projections.  The market interpreted this as tightening sooner than had been built into the term structure.  Janet Yellen, when asked directly about this change in the scatterplot, stated that we should “ignore” it and pay attention to Fed statements released after their meetings.  Here we are- back to the good old days when everything the Fed says is vague!

Fed QE Programs

I am of the opinion that the QE bond buying programs served to reduce long term rates and were initially successful.  During 2012 and 2013, long term interest rates, including mortgage rates, fell and contributed to an improvement in the housing markets, allowing home price increases to gain some momentum and prompt the new construction markets to improve.  Then, the Fed mishandled their message on QE early in 2013 and the markets abruptly removed its favorable impact, sending long term rates soaring over 100 basis points.  This type of increase is very rare in a declining inflationary environment, but we live with it.  With the markets having removed the benefits of QE, the Fed began “tapering” the program, which started at $85 billion per month last year and is now at $55 billion per month.  Markets expect the Fed to continue reducing purchases by $10 billion per month until it is down to zero- in October or November, 2014.  So our question to Janet is:  What will you do if the economy stalls and you need to ease?  Her answer:  More QE!

By the way, Europe is about the start up a QE bond buying program for the first time- to the tune of $1 trillion Euro to help the struggling economies, where growth turned positive, but only by about +.5%.  Mario Draghi, the head of the European Central Bank, is revealing his plans to the International Monetary Fund for buying sovereign debt, or maybe even private debt!  Later, he will make a public announcement.  The European markets are abuzz with speculation, but it will not be the first time Draghi has proposed something big and not followed through on it.  Yeah, like negative interest rates, Mario!  Stay tuned!

Discovery of the Waves

Albert Einstein predicted in 1915, in the general theory of relativity, that the universe contained gravitational waves, left over from the Big Bang billions of years ago.  A second theory developed in the 1980s predicted these waves as part of a process known as cosmic inflation.  An instant after the Big Bang occurred 13.8 billion years ago, the universe expanded exponentially, inflating in size trillions and trillions of times.

An announcement by the Harvard-Smithsonian Center for Astrophysics in Massachusetts on March 18, 2014 stated that researchers have discovered the gravitational waves, confirming both theories, by looking through telescopes on the South Pole.  This is another monumental breakthrough in understanding the universe, after the discovery of the “God particle” by the Large Hadron Collider team in Switzerland last year.  Yeah, now we know!  Now, if we could only predict interest rates!

Thanks for reading and Happy Spring!  DJ 04/07/14

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with First Federal of Bucks County since November, 2004.