Lower Income Group Leveraging Up

Central Bankers Flip Flop

It appears that President Trump will pick Powell in the next few days as there’s an 86% chance on the PredictIt website. While the decision is known, the chart below provides context to how it may have been made. As you can see, the chart shows the policy positions of each potential candidate. Many of the candidates moved in the dovish direction. This is clearly an estimate because these candidates don’t take tests to determine their exact position. When I describe their positions, I can only look at quotes and analysis. I can’t predict when they might change their opinions on policy. Some positions like Warsh’s steadfast opposition to QE probably won’t change. As you can see, Yellen has been fairly consistent in her positioning. Powell has fluctuated more, but ends near the same place as Yellen. That’s different from other research which says he’s very dovish. This analysis is a preview of what’s to come in Powell’s first speech as chair. Yellen’s press conference in December will be her chance to leave her mark on monetary policy just like Jackson Hole except at this one everyone will know she’s leaving.

Leverage by Income

The inequality gap is important to measure because it shows the strength of the middle and lower income consumer, which is important to GDP growth. According to the Gallup survey, there were gains in middle income and lower income people when asked about how much they’d spend on Christmas gifts. The chart below is breakdown of the leverage among consumers by income group. It’s only updated to reflect 2016 data, but it’s still valuable to review. As you can see, the bottom 20 percentile group has the highest median leverage ratio compared to other years. Having more leverage than 2007 is hugely problematic as that year was prior to the financial crisis. To be clear, this doesn’t mean a recession is coming; it’s reflective of the inequality trend continuing. The richest 10 percent is doing the best in 2016 as compared to the other years as this expansion has allowed those people to deleverage. This all adds up to the overall number showing 2016 to have the 3^rd most leverage out of the few years shown as the rich somewhat makeup for the leverage the lower income people have taken up. Tying this together with the Gallup poll, it’s possible some poor people are ready to spend more money by taking out debt.

Wage Growth Slowing?

The chart below adds to the information about how the lower income group hasn’t had an easy time in this expansion. As you can see, production and non-supervisory employees only saw sustainable real weekly earnings growth from 2014 to 2016. Just as the economy started to give these low-mid wage employees a raise, the manufacturing and energy recession hit the economy, bringing down growth. The growth rate rebounded in late 2016 has stalled this year. It might be a case of tough year over year comparisons. The Atlanta Fed wage growth tracker has similar findings as growth peaked in November 2016 at 3.9%. However, in September growth was 3.6%, so the decline isn’t as dramatic.

The chart below is the actual metric the BEA reports on wage and salary disbursement growth. We like to look at breakdowns of the report by the Atlanta Fed, tax withholdings, and growth of non-supervisor salaries, but here is the actual chart showing what’s happening. As you can see, growth has been more volatile this cycle than the last one. It only touched 7.5% for a brief moment and has at times fallen below 2.5% growth a few times. Keep in mind, this takes into account wage growth and the growth in jobs created. The most recent data in the chart shows a rebound in growth in the past two months, possibly driven by the manufacturing sector which has created a lot of jobs this year. The most recent results differ from the chart above possibly indicating the chart above is delayed by a couple months. Either way, the data from August and September are compromised by the weather effects, so we’ll have to wait until the non-farm payrolls report on Friday to get uncompromised results.

Economic Leverage Overview

We reviewed the leverage by median income. Now let’s look at total economic leverage. The chart below has a lot of information as it fits in 9 metrics. Let’s start from the top. As you can see, the financial leverage, government leverage, household leverage, corporate leverage, and the Federal Reserve Balance sheet are reviewed. The household debt has declined because the housing debt fell. Financial debt also fell in relation to GDP since the financial crisis. The two groups which have increased leverage are government and corporations. The corporations will be fine unless there’s a change in the credit cycle. The government always seems to increase its debt load; it hasn’t been a major problem yet, but it could be a long term drag on the economy

That brings us to the bottom half of the chart. It shows the natural rate of interest compared to the Fed funds rate. It’s not clear how to calculate this rate, but the chart below shows it right about where the current Fed funds rate is, indicating a neutral policy. This is after 9 years of policy that was too loose. It’s disconcerting to see this period in comparison to the 2002-2005 loose period because of how long it was. The obvious question to ask is what will happen when policy gets too tight in this cycle if the last time it happened, there was a financial crisis. It’s possible that this thinking is too simplistic because there were other factors that led to the housing bubble, such as the government actively encouraging people to buy homes and banks lowering their lending standards. Clearly there isn’t a housing bubble now; that counters to fear this chart promotes.

Conclusion

These charts on the health of the low wage to medium wage consumer give us some pause over the other reports which show strength in the labor market and the consumer about to have a good holiday season. This all makes the non-farm payrolls report on Friday that much more important. In terms of the headline number, I expect a return to solid growth, but the devil is always in the details. It will be the first report without major distortions from the hurricanes.