Tuesday, June 9, 2009

Consumer deleveraging spiral still getting worse

A lot has been written about the difficult state the US consumer finds itself in: overindebted and undersaving for quite some time. And besides the falling house prices, also the deteriorating labour market is making things worse, much worse. A lot has been written about the employment data and lately the focus has turned on the development of aggregate weekly hours as a potential signal to call a bottom in the economy. To quote Jeffrey Frankel, a member of the NBER Business Cycle Dating Committee (http://content.ksg.harvard.edu/blog/jeff_frankels_weblog/2009/06/08/the-labor-market-has-not-yet-signaled-a-turning-point/): "Total hours worked is equal to the total number of workers employed multiplied by the average length of the workweek for the average worker. The length of the workweek tends to respond at turning points faster than does the number of jobs. When demand is slowing, firms tend to cut back on overtime, and then switch to part-time workers or in some cases cut workers back to partial workweeks, before they lay them off."
Unsurprisingly the amount of aggregate weekly hours worked in the US economy has fallen significantly during the current recession (one indicator of the "unused capacity") and the outlook suggests that this will remain the case for at least another few months.
There are several points to make:
a) over the medium term aggregate weekly hours in the US economy and the S&P500 index exhibit a strong co-movement (I have used the natural logarithm of the S&P500 given it is exhibiting stronger growth over the longer term):
b) the Fed does not seem to start hiking rates while aggregate weekly hours are still falling:
c) What I find most interesting is the development of the index of aggregate weekly hours multiplied by the average weekly nominal hourly earnings. This can be interpreted as an index of aggregate weekly nominal earnings (of total private nonfarm payrolls). The chart also highlights the NBER-dated recessions:

The drop in this nominal earnings index is unprecedented since the data is available (January 1964). This is further underpinned if we look at the yoy %-change of this index:
Never over the past 45 years have nominal aggregate weekly earnings been dropping for such a long time and to such an extent. The chart below compares this change with the development of US CPI (again yoy change). This time, however, nominal earnings are lagged by 18 months. The strong co-movement between the two time series suggests that CPI only tends to rise (fall) subsequent to a rise (fall) in aggregate nominal weekly earnings with the lead time of the earnings time series being roughly 18 months. Even during the strongly inflationary 70s, inflation rates fell subsequent a significant drop in aggregate nominal earnings.

In short, the medium term outlook for the US economy remains subdued and a self-sustained recovery is very far off. Furthermore the talk about sharply rising inflation rates seems premature as well (this is not to deny that current monetary and fiscal policy will have significant inflationary pressures over the longer term if not reversed). The yoy growth rate of aggregate nominal earnings is 10% below the rate at the start of 2008 and negative. This is one element of the deflationary deleveraging spiral which is still getting worse ...

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