Fed Chair Yellen Paints Overly Optimistic Picture of Job Prospects Post Graduation

Janet Yellen, Chair of the Board of Governors of the Federal Reserve System, delivered a Commencement Address at the University of Baltimore's 2016 mid-year commencement.  The first half of her address was focused entirely on the job prospects of recent graduates as they attempt to break into their chosen careers.  Commencement addresses, by their very nature, are extremely optimistic, and Ms. Yellen's was no exception.  Unfortunately, reality is much closer to Thornton Mellon's view than Janet Yellen's.  (You may remember that classic commencement address in "Back to School" in which Mellon advises the class, "It’s a jungle out there.  You gotta look out for number one.  But don’t step in number two.  And so, to all you graduates, as you go out into the world, my advice to you is … Don’t go! It’s rough out there! Stay in school!")

Ms. Yellen opened her address by telling the graduates, "I believe, for two reasons, that the job prospects and career opportunities for new graduates at this time are very good. First, after years of a slow economic recovery, you are entering the strongest job market in nearly a decade. The unemployment rate, at 4.6 percent, is near what it was before the recession."

Followers of this blog are already aware of how little respect I have for that U-3 figure of 4.6%.  Rather, the number on which I place the most significance is the Labor Force Participation Rate which is currently sitting at a dismal 62.7%.  The current rate is en par with the levels last seen in 1978 and those levels tell us nearly 95 million Americans are out of work.  It's a far cry from the rosy picture painted by that 4.6% U-3 number.  Worse yet, it's not improving.



There are numerous causes for the decline that we've experienced since the turn of the century, however recession isn't one of them. Look at the strong upward slope of that chart right through 1990.  While the labor force participation was improving dramatically, we experienced three recessions.

• 1973 to 1975.  GDP: -3.2%
• 1980.  GDP: -2.7%
• 1990 to 1991.  GDP: -1.1%

According to the Fed Chair, the layoff rate is low and job openings are up over the past couple of years.  That, however, is at odds with what we're seeing in the workforce, especially in the higher paid fields.  The "job openings" statements are especially troubling since they only consider whether or not a company is hiring. What they do not consider is where they are hiring and if those hires will be Americans or will come from the hoards of H1b visa holders that are flooding the US job market at the expense of Americans that are routinely put out of work.

Lest their be any doubt that Americans are not being hired for high paid positions, take a look at the 2016 Green Card Report listed by job title.  The 2016 H1b Visa Report tells an equally dismal story.  The bottom line is, if you're considering a career in technology, you're living in the wrong country.  The opportunities for any highly skilled software developer in the US are dwindling fast, and that is not likely to change in the time it will take for anyone currently in the school system to see any benefit.

In fact, those prospects will get decidedly worse before they get better.  The latest craze whenever business leaders talk about technology is "cloud computing."  Few of them know what it means or why they want it, but you can bet that "moving to the cloud" is in everyone's road map. Of course, the fine print on those cloud services is all too often ignored until it's too late, but it will be a decade or more before businesses learn that they've been duped and the cloud solutions have cost them far more than any perceived realized benefits.  In the meantime, that move towards Software as a Service (Saas), Infrastructure as a Service (IaaS), or any of the other "as a Service" offerings with which companies are being inundated today will continue to drain the industry of skilled technology jobs.  Well, at least in the US.  India, on the other hand, is the prime benefactor.  The number of foreign applicants coming from India outnumber their nearest competitor (China) 7 to 1.  As I said, if you want a career in technology, you're living in the wrong country.  "But we are quite certain that a college diploma or an advanced degree is a key to economic success.Those with a college degree are more likely to find a job, keep a job,have higher job satisfaction, and earn a higher salary."

She's correct in the need for a college degree, although not necessarily for the reasons she mentions or for the reasons graduates may think.  A college undergraduate degree has one purpose: assist you in procuring your first job in a career field.  Once that job is secured, the rest is up to you.  The Fed Chair correctly notes that the need for a college degree is higher than ever.  What she did not mention, however, is the reason for that, and it has little to do with the complexity of today's jobs.

Obtaining less than a 4-year college degree has become too easy and, as a result, its value has diminished.  When I entered the workforce, the level of education that was the differentiator was a 2-year Associate's Degree.  Prior to that, it was a high school diploma. Today, it's a 4-year Bachelor's Degree.  The dirty little secret is that the differentiator will always be the level of education that weeds out the vast majority of potential applicants.  The degree is not so much a job requirement as it is a method of reducing the number of resumes to a manageable level.

That, in fact, is my primary reason for opposing free college education programs.  By increasing the number of 4-year degrees on the market, all that will be accomplished is to raise the minimum requirement one level higher, to a master's degree.  The net number of people eligible for a position will not change, despite an increase in the number that have a fancy undergraduate diploma that has suddenly become worthless.  

Ms. Yellen briefly touched on student debt, however she didn't go far enough nor offer any advice beyond a subtle hint that it's okay to take on that debt.  She couldn't be more wrong in that regard.  The best advice I've read recently is to not incur more total student loan debt than you can reasonably expect to earn in your first year after graduation.  What solid advice!  The fact is, education has grown absurdly expensive, and the primary reason it has grown out of proportion is the ease with which students are able to obtain loans.  The supply and demand dynamic that should result in the price of an education no longer applies, and as a result, the cost is allowed to skyrocket out of control.  With the exception of very few professions, there's no justification for it.  What's important is the degree itself, not the name of the college on that degree (again, with very few exceptions.)  All that diploma is doing is getting you into the job interview.  How you conduct yourself at that point is what determines if you get the job.  Yes, the cost of education is absurd, today, and it must be fixed.  The solutions, however, do not include transferring the cost away from the student and onto the taxpayer since that simply skews the supply and demand equation even further.

Finally, the major problems today's students will face in the workforce are coming from globalization and increased automation.  The Fed Chair stated, Like technological change, globalization has reinforced the shift away from lower-skilled jobs that require less education to higher-skilled jobs that require college and advanced degrees. 

What she neglected to mention is that the purpose of increased automation is not to simply increase the productivity of the workforce.  Rather, it's purpose is to completely eliminate the workforce. It is not just low-income unskilled jobs that are being eliminated.  It includes highly skilled high wage jobs.  Again, this is seen daily in the technology fields where automation and offshoring are the daily mantras.  Where "institutional knowledge" was once considered a key asset, it is today considered a major liability that inhibits the misconception that technology resources are interchangeable commodities that can be sourced elsewhere for a fraction of US labor costs.

So yes, I do believe Ms. Yellen painted an overly optimistic of job prospects to yesterday's graduates.  They face the worst job prospects I've seen in my lifetime, and they are likely to worsen over the coming decade.  Until "globalization" becomes a dirty word, the American worker will consistently lose to their foreign counterparts in countries without decent wage standards, environmental protections, or industry regulations.  Unfortunately, as the American worker finds it increasingly difficult to establish a career in a high paying field, that standard of living Ms. Yellen touted will begin to decline.  The point of equilibrium in this new world of "globalization" is not a point at which most Americans will want to live.  Without a bit of protectionism inserted into a world view, however, that decline is inevitable.

Key Points to Watch in Wednesday's FOMC Announcement

As of today's market close, the 30-day Fed Funds Futures have factored in a 95.4% probability of a .25 bps increase in interest rates when the Federal Open Markets Committee (FOMC) releases their December announcement at 14:00 EST on Wednesday.  This would mark the first rate hike since December of last year, and it would raise the Fed Funds rate to a target range of 0.50% to 0.75%.  The market would then settle rates around 0.63%, up from the current 0.38%.  The equities market expects the rate increase and has largely included it in stock prices. 

The actual monetary policy move is of little substance, tomorrow.  What traders and investors will be watching is the tone of the monetary policy announcement coupled with the statements and responses Janet Yellen provides in the post-announcement press conference.  That tone and her responses may significantly move the market heading into tomorrow's close.  Here are some points that we are watching.

• Commentary regarding unemployment.  The most popular number watched by the press and typically referenced by Yellen is the U-3 number which currently sits at 4.6%.  We know that she will reference that number and will likely cite it as an indication that the nation is at "full employment."  In past conferences, however, she has also made passing reference to both the U-6 number (9.3%) and to the Civilian Labor Force Participation Rate (62.7%.)  Those numbers paint a less rosy picture of the employment situation and we'll be watching how Yellen presents either of them in her commentary.
• The next major number we expect the Fed Chair to reference is the Inflation number.  It currently sits at 1.64%, slightly below the Fed target of 2.0%.  Since changes to monetary policy typically take approximately 6-months to have and effect, it's no surprise that the Fed will move ahead of their target.  It's like turning an ocean liner - it takes time to get the behemoth pointing in the right direction.  What we will be watching, however, is her assessment on the rate at which she expects inflation to increase.  This will offer some guidance as to how quickly rates will be increased in 2017.
• We anticipate some commentary, at least in the press conference, regarding potential tax and regulatory changes from the incoming Congress and Administration.  A somewhat adversarial relationship is developing between the President-Elect and the Fed Chair, and the latter has expressed concern in recent weeks over the possible inflationary impact the theoretical domestic policy changes will have on our overall economy. How she references this and the tone she takes will provide more clues into how swiftly the Fed believes they must move in raising interest rates.
• Some reference to "global economic headwinds" will likely be made, and that will most likely occur in both the announcement and in the press conference.  What we will be watching is whether those headwinds are perceived to be holding steady, increasing, or decreasing.  She may put this in the perspective of Brexit as well as the recent ECB announcement.  In the past, the economic conditions in Europe have caused the Fed to take a more cautious approach domestically.  Any improvement in the Fed's perception of those conditions will potentially signal a more hawkish economic policy in the US.
• We must pay careful attention to the phrasing of certain terms.  Once we have the announcement in hand, we need to compare the exact wording with the prior announcement.  Dropping a single word in a phrase can signal a fundamental shift in outlook, so we will need to scrutinize any changes to prior announcement specific to the rate at which the economy is expected to grow.

Current market expectations are for two rate increases in 2017.  These will most likely come in June and December.  At least, that's what the Fed Funds Futures have currently factored into pricing.  From a trading perspective, that is what we are attempting to anticipate.  A more aggressive monetary policy may signal a potential rate increase in the February or March time-frame, and we'll see stocks react accordingly.  Given the current inflation and unemployment levels, it's highly unlikely that the Fed will signal a slower rate of increase, although that more aggressive posture is a distinct possibility.

The final major consideration is something that will not be referenced in tomorrow's announcement, however it's something the markets will have to factor into pricing over the course of the next month.  There are currently two vacancies on the Fed's Board.  These will be filled by the President-Elect, and he will have the ability to make those appointments immediately following his inauguration.  Given that he has already expressed displeasure with the dovish policies set forth by Yellen, it's almost a given that his two appointments will have a hawkish outlook.  Their presence on the board will increase the likelihood of a more rapid normalization of interest rates than we've experienced thus far.  Expect this to be factored into market pricing the closer we get to the inauguration.

Happy Trading.     

Jobs Report Mostly Positive But LFPR and Earnings Decline

The much anticipated November Employment Situation Report was released by the Bureau of Labor Statistics, this morning. The "jobs report" is issued monthly and has a major impact on financial markets worldwide.

This morning's report offered mixed news, however.  The key takeaways are:

• Unemployment declined to 4.6%. That's below the 4.9% consensus estimate.
• The Civilian Labor Force Participation Rate declined to 62.7%.  
• Number of people employed part time for economic reasons is unchanged at 5.7 million.
• Number of people marginally attached to the labor force increased by 215,000.
• Number of discouraged workers remains unchanged at 591,000.
• Total NonFarm Payroll Employment rose by 178,000 versus a 170,000 consensus estimate.
• Professional and Business Services rose 63,000.
• Health Care Employment rose 28,000.
• Construction Employment rose 19,000.
• Employment in other major industries remains unchanged.
• The average workweek for all employees was unchanged at 34.4 hours.
• The average hourly earnings for all employees declined by 3 cents to $25.89.

Despite the drop in Labor Force Participation Rate and the drop in Hourly Earnings, the report was primarily mostly positive.  As we've stated numerous times, we prefer to focus on the LFPR instead of the published Unemployment Rate since the LFPR more accurately reflects the number of Americans currently out of work.

The rise in Professional and Business Services, Health Care, and Construction are marginally encouraging, however the increase of only 178,000 across all industries was well below the whisper numbers circulating yesterday.  Job growth, while gradually increasing in 2016, is still well below the pace needed to sustain GDP growth in the 3% to 4% range.

The average hourly earnings survey did drop by 3 cents for all employees, however it increased by 2 cents for all private sector production and non-supervisory employees.  For the year, hour earnings is still up 2.5%.

What all this indicates is that the US economy continues to grow, however that growth remains slow.  With regards to the FOMC decision in two weeks, this report is unlikely to influence them in either direction, although from a PR perspective, I would not be surprised to see Fed Chair Janet Yellen latch onto the 4.6% number in her post-meeting announcement.  A "5%" target was oft cited in 2015 as part of the criteria used by the Fed in setting interest rate policy.

Since this morning's announcement, the Dow, Nasdaq, and S&P futures have all fallen into negative territory, although not by any significant margin.  The open, today, looks to be flat to slightly down, however there appears to be nothing in the Jobs Report to unnecessarily either spook or excite traders heading into this weekend.

Next up in the major news cycle is the Italy Constitutional Referendum set for this Sunday, followed by next Thursday's ECB meeting.  Keep an eye on both as they have the potential to rock international markets.

Happy Trading.

Complexities Abound in Trade Deficit Discussion

The US Census Bureau released advanced October trade deficit numbers on Friday, signaling a 9.6% increase in the International Trade imbalance.  Similarly, both wholesale and retail inventories declined by 0.4% month over month. (Seeking Alpha: International Trade.)

Historically, a trade deficit is not necessarily a problem, and economists have split over the years on the actual impact of a trade imbalance either way.  Traditionally, countries with strong, growing economies achieve a trade deficit as compared to countries with stagnant or declining economies. We see this today when we compare the trade deficits between the US and Japan, for example.  This makes sense in the context of healthy economies placing higher demand for goods and services than can be satisfied internally, thus the imbalance on imports.  Similarly, a country in recession cannot afford to import, thus their imbalance on the side of exports.

The other positive aspect of the trade imbalance comes in the form of investment.  Typically, the nation with the trade deficit has the healthier economy and thus enjoys an influx of investments from foreign sources.  These investments boost the Treasury bond markets, corporate and municipal bonds, equities, and Forex. It's most obvious when there is negative news overseas and the US markets experience a surge in Treasury bond and Utilities Sector investments as foreign traders seek a flight to safety.

Beginning in the mid-1980s, however, there was a subtle but not insignificant shift in the causes and impacts of the trade deficit as viewed from the US side of the ledger.  With the relaxation of trade restrictions with China, Russia, and other Eastern Bloc nations came a wave of technology exports that, initially, were extremely beneficial to numerous US industrial sectors.  This was followed by a slew of increasingly permissive free trade agreements intended to further lubricate the flow of goods and services in both directions.

What the latter actually created, however, was a means by which entire industries could circumvent US labor, environmental, and safety laws.  The results were goods that could be produced in third world countries at a fraction of the cost of that same production in the US since those third world countries bore none of the financial burdens imposed by US regulations and US labor requirements.  Little has changed in that regard, today.

With the restrictions on technology trade lifted, these same third world countries were able to improve the quality of the product they produced to the point where they were either en par or surpassed the quality of the same product produced in the US.  No longer was "Made in Japan" a symbol of "junk" but rather it became a symbol of high quality as evidenced by the dominance in the 1990s of brand names such as Sony or Toyota.  We see the same surge coming out of the Korean peninsula today with the rise of Samsung (current problems notwithstanding) and Hyundai.

The situation on the service side is equally grim.  US customer service and call centers now abound in the Philippines, Costa Rica, and India. The reason is simple: labor costs.  High paid technology resources - resources that would command a $150,000 per year salary (plus another 30% in benefits) in the US - are now outsourced to companies in India, Bangladesh, Costa Rica, the Philippines, and a host of former Soviet Bloc nations simply because they can be paid less than 1/3 that salary and not receive benefits.  In many companies the mantra is clear - if it can be off-shored, then it will be off-shored.

The regulatory imbalances and the labor law imbalances remain, however.  The developed world is effectively turning a blind eye towards sweatshop labor and environmental disaster, provided the third world continues to ship inexpensive yet high quality products.  This is coming at a severe economic cost.

On top of this loss of critical jobs to overseas subsidiaries, there is also the rapid march towards automation.  Self-service checkout lines, unattended gas stations, self-service airline check-in, and even the full automation of large warehouses such as those run by Amazon are all adding to significant job loss across the nation.  (Bloomberg: How Amazon Triggered a Robot Arms Race.)

The October 2016 Labor Force Participation Rate as reported by the U.S. Bureau of Labor Statistics was 62.8%.  This rate measures the number of people that have jobs in the US aged 16 to 65 that are not students, disabled, in the military, or officially retired, and, in my view, is the truest measure of the employment situation we have.  What this shows is that 37.2% of the population eligible to work is not working.  That's 95 million Americans that should be working but do not have jobs.  This doesn't factor in all those that are underemployed, having part-time jobs where they want full time, or having lower skilled jobs due to jobs in their areas of proficiency being unavailable.

This is the hidden dynamic behind the trade deficit put into context in the 21st century. While we don't recommend an immediate repeal of international trade deals - the impact of that would be economically catastrophic - we do need to increase the profitability of bringing service, technology, and manufacturing jobs back into the US.  This doesn't mean the imposition of tariffs.  All trade tariffs are immediately passed on to the consumer, so a trade tariff is simply another sales tax that the consumer will ultimately pay.  Rather, the objective - and it's a very long term objective for it to be achievable - is to raise the labor standards and environmental standards in third world countries.  For US companies with overseas facilities, we can certainly consider the delta between US costs and their overseas costs to be taxable income.  The objective must be to incrementally raise the costs of the overseas holdings to the point where it's more economical to return those services to the US.  That cannot be achieved in the short term, however, and requires the cooperation of other industrial nations, cooperation that will be difficult to achieve, at best.  Still, the path we are on right now is one that leads to a very lengthy economic decline and a resetting of the standard of living we've come to enjoy in this nation.  That may still be a generation or two away, but without taking action on securing our own industrial and service viability, that destination is inevitable.

Showing Only 1.2% Growth, GDP Is Still Anemic

Is there truly an economic recovery in progress?  You'd never know it from the GDP which increased by a mere 1.2% in the quarter ending June 30th.  It continues a very sluggish trend that started in 2014 following what had looked to be a promising post-Great Recession recovery.

Quarterly GDP Growth 2012 to Present

Economists generally consider a range of 2.5% to 3.5% GDP growth to be healthy for the economy.  Lower than 2.5% and corporate profits suffer and with them, job growth also suffers.  Higher than 3.5% and the economy starts to experience inflationary pressures.  Now, that last point is significant in this case since we've been in an extended period of under-inflation.  The Fed mandate to maintain inflation at 2% needs a boost in GDP well above what we're currently experiencing before that target grows within reach.

Low inflation, in this case, translates to lower interest rates.  Following Friday's GDP report, the Fed Funds Futures market reacted sharply, reducing the probability of a September Fed interest rate hike to only 12%, and a December probability dropped to 30%.  As we discussed two days ago, interest rates will be depressed likely right through 2017.

Yesterday's announcement made mention of a slight increase in trade, saying it added about 0.2 percentage points to overall growth.  I've read some analysts point to that figure as evidence that the impact of the strong US dollar has stabilized, however I don't believe that to be the case.  Rather, what's driving the trade growth is a drop in US imports, not an increase in exports.  (Imports are subtracted from the figure, so if imports decline, it has a net positive effect on the trade number.)  Given the strength of the dollar, a reduction in imports is a very bearish signal, indicating a decrease in demand for materials and finished products.

Along those same lines, a major factor in yesterday's anemic announcement was continued reduction in inventory restocking by businesses in the US.  This is the fifth consecutive quarter in which inventory levels have dropped, and it's a further indication that there are strong downward pressures on consumer demand and on corporate sales.  Unlike analysts that are predicting a rapid end to that trend, I see just the opposite.  Until there is a healthy increase in the hourly wage statistics and a healthy increase in the Labor Force Participation Rate, I don't see any major driver for a change in inventory stocking behavior that would add anything of significance to the GDP.

When I consider the economic warnings hidden in the Schlumberger and Union Pacific earnings calls earlier this month, I begin to see a general underlying pattern of slowing growth, slowing demand for commodities and raw materials, and a potential crack in the expected rate of consumer spending over the second half of the year.  For that pattern to reverse, we need to see a weakening of the US Dollar, a dramatic reduction in the number of Americans that are out of work, and a return to a price of oil that provides healthy growth across a wide range of industries.  None of those appear to be on the short-term horizon, which leaves me pessimistic about future growth prospects in 2016 and into the first half of 2017.

Market Focus is on Tomorrow's Jobs Report

The Bureau of Labor Statistics will release the June 2016 Employment Situation report (popularly called the "Jobs Report") at 8:30 AM EDT tomorrow.  It's one of the most closely watched releases each month, and its trends have a significant impact on the Fed's monetary policy.  As you may recall, the May report issued last month stunned the financial world, showing a dismal increase of just 38,000 jobs in the Non-farm Payroll category.  When teamed with Brexit, the Italian banking crisis, and increased fears of recession in Europe - all factors Fed Chair Janet Yellen termed "headwinds" - the May report pushed any prospects of another Fed rates hike out into the distant future.  The futures market is currently projecting a near 0% chance of a rate hike in September, although it starts to climb ever-so-slightly in the fourth quarter.

Analysts do not expect such a dismal jobs report tomorrow, although the projections of 175,000 on the optimistic side to as low as 140,000 on the pessimistic side are still well under the levels needed to sustain economic growth.  The street is also expecting a slight rise in unemployment from 4.7% to 4.8%, and the expectation for hourly average earnings is an increase of 0.2%.

The June report, however, is being closely watched more as a harbinger of the economic outlook for the next twelve months.  Some analysts are now placing the risk of recession at 30% for the next year.  Given the turmoil in Europe and the impact that contagion can have in the States, I would categorize that 30% as very optimistic.  Even Janet Yellen, in the cryptic fashion typical of a Fed Chair, expressed concern last month: “Is the markedly reduced pace of hiring in April and May a harbinger of a persistent slowdown in the broader economy? Or will monthly payroll gains move up toward the solid pace they maintained earlier this year and in 2015?”  If, indeed, we see another month of anemic growth, prospects for recession will spike dramatically.

There's one important factor that will not manifest in this report, and that is the effect of Brexit on the US jobs market.  The data for the Employment Situations report closed on June 12, well before the UK vote to leave the European Union.  That vote sent shock waves through the world markets, including here in the States, and most companies are adjusting their capital plans to account for it.  Financial firms in particular are adjusting to the reality of prolonged low interest rates heading into 2017, and most companies with heavy European exposure are still trying to assess what the vote means for them and what adjustments they'll need to make in their 2017 capital plans.  Whenever there's uncertainty of that nature, companies become reluctant to add to their workforce.  None of this, however, will be reflected in this month's release.

The final data points that will be most interesting concern the Labor Force Participation Rate.  You've seen me write time and again that, in my view, this is the most accurate measure of the true employment picture, and the numbers released on June 3 were horrendous.  The rate dropped to 62.6%, setting an all-time record of 94,708,000 Americans out of work.  Analysts are expecting the rate to drop even lower in tomorrow's release.

What the report will mean for trading tomorrow is anybody's guess.  I've long since stopped trying to predict how the market will react to pre-open releases, especially when you have to factor in the contradictory effects of bad news being good for interest rate projections, but bad for future growth projections.  I've learned over the years to sit back on release days and let the market sort itself out over the first 30-60 minutes of trading.  Tomorrow will be no exception.