Macro Roundup

In October 2022, the retired share of the American population was 1½ percentage points above its pre-pandemic trend. These 3.5 million workers account for essentially all of the shortfall in labor force participation rates., “…Despite some improvement in the labor force participation rate for the working-age population since the early stages of the pandemic, the LFPR in October 2022 remained nearly 1½ percentage points below its pre-pandemic, February 2020 level (after making adjustments for changes in population weights introduced from the 2020 Census). The importance of retirements in accounting for this shortfall is illustrated in Figure 1, which shows the percentage of the working-age population that is not in the labor force for different reasons (black line) relative to February 2020, based on responses to the Current Population Survey. While earlier in the pandemic, factors other than retirements were an important contributor to elevated non-participation (such as non-participation while caregiving, the orange line), the percent of the population that was not in the labor force and retired (the “retired share”) has steadily increased and in October 2022 was almost 1½ percentage points above its pre-pandemic level, representing an increase of more than 3½ million retirees and accounting for essentially all of the total shortfall in the LFPR….”

The Evidence The pre-pandemic trend, “…Even in the absence of the pandemic, the retired share would likely have risen, albeit more gradually, due to shifts in the age distribution of the population toward ages traditionally associated with higher retired shares (primarily, the movement of the Baby Boomer cohort into older ages). As one illustration of the importance of population aging, Figure 2 plots the retired share (solid line) alongside a counterfactual trend (dashed line)….”

“…. This trend is an estimate of how the retired share would have evolved in the absence of the pandemic and is derived by assuming the continuation of pre-pandemic, age-specific trends in retired shares, assuming the state of the business cycle remained similar to pre-pandemic levels, and accounting for the actual changes in the age distribution over this period (in section III, we discuss in more detail the calculation of this and other counterfactual retired shares). Over the five years prior to the pandemic, the retired share increased about 0.2 percentage point per year, and plausibly would have continued increasing at a similar pace in the absence of the pandemic. As of October 2022, the retired share remained 0.6 percentage point above the pre-pandemic expected trend, or about 1.6 million people (Figure 2). This gap between the actual and expected lines is an estimate of “excess retirements,” and the excess retirements gap remains sizeable. In fact, the retired share was slightly below trend just prior to the pandemic (about 0.2 percentage point), implying that excess retirements as a share of the population have increased by about 0.8 percentage point since February 2020, or about 2.1 million people. That increase in excess retirements explains a little more than half of the 1.4 percentage point increase the total retired share since February 2020, whereas the increasing expected retired share explains the rest (see Figure 3)….”

“…Thus, less than half of the increase in the retired share to date would likely have occurred even in the absence of the pandemic, suggesting that more than half of the current LFPR shortfall is a direct result of the pandemic on retirement….First, as discussed above, more than half of the increase in the retired share relative to February 2020 is due to an increase that would have been expected in the absence of the pandemic. Second, about two-thirds of the total increase in the excess retired share is attributable to those who were age 65 and older at the start of the pandemic, with a particularly sharp increase in excess retirements among those age 70 and older. The remaining one-third of the increase in the excess retired share is attributable to those age 55 to 64 when the pandemic began. Third, there is also substantial heterogeneity across education, race, and ethnic groups, with retired shares for those age 65 and older increasing more than expected for Whites relative to Blacks and Hispanics, and for those with a college education relative to those without….…Because the retired share has remained significantly elevated since increasing substantially at the start of the pandemic and has shown little sign of converging towards its ex-pandemic counterfactual, it may take some years for retirement behavior to normalize relative to pre-pandemic norms and for the retired share of the population to converge toward what it would be in the absence of pandemic-related influences. We view it as unlikely, however, that the retired share will fall substantially towards its pre-pandemic trend and that those who retired early will return to the labor force in large numbers, since most of the excess retirements are concentrated among people who are 65 and older who (given their age) would likely be retiring in greater numbers anyway over the next few years. That assessment is supported by the stabilization of the unretirement rate at its pre-pandemic level, well below the level it would need to reach for the retired share to fall substantially…”

Joshua Montes, Christopher Smith, and Juliana Dajon, ” “The Great Retirement Boom”: The Pandemic-Era Surge in Retirements and Implications for Future Labor Force Participation,” Federal Reserve Board, November 2022, https://www.federalreserve.gov/econres/feds/the-great-retirement-boom.htm

In Bastrain’s reconciliation of his own results with those of the Bruce Myer’s Chicago team, Bastian misattributes something on the order of 200,000 of the one-million-parent difference in predicted disemployment to married parents rather than to low-income single mothers. Relative to the Chicago team, he underestimates the disemployment of low-income single mothers by a similar amount. The evidence remains consistent with the Chicago team’s claims: a permanent expansion of the CTC that resembles the temporary child allowance created in 2021 could reduce employment among single mothers by about one million, an effect that would go a long way toward reversing the employment gains among single mothers since the policy reforms of the mid-1990s.

Bottom line, “…The evidence remains consistent with the Chicago team’s claims: a permanent expansion of the CTC that resembles the temporary child allowance created in 2021 could reduce employment among single mothers by about one million, an effect that would go a long ways toward reversing the employment gains among single mothers since the policy reforms of the mid-1990s….”

Scott notes three core flaws

“..In his reconciliation of his own results with those of the Chicago team, Bastian misattributes something on the order of 200,000 of the one-million-parent difference in predicted disemployment to married parents rather than to low-income single mothers. Relative to the Chicago team, he underestimates the disemployment of low-income single mothers by a similar amount. This is one reason why Bastian’s results suggest that Corinth et al. have overestimated disemployment effects among upper-income parents..”

“…Bastian’s assumed size for the key parameter in the child allowance debates—the participation elasticity for low-income single mothers, which describes the sensitivity of their employment to changes in the return to work—is almost surely too low. The midpoint of the range of credible elasticities for this group is higher, not lower, than assumed by the Chicago team. Indeed, that midpoint is exactly the same if we only use the elasticities implied by Bastian’s own studies. That makes the Chicago team’s disemployment effects relatively conservative. Bastian’s arguments that recent studies find lower elasticities or that the elasticity for low-income single mothers has fallen substantially over time do not stand up against his own research and that of others….”

“…Of Bastian’s other attempts to invalidate the Chicago team’s results, one suffers from Bastian’s understatement of the disemployment effect on low-income single mothers, one constitutes an illogical exercise in applying averages to subgroups to show results that seem implausible, and one is a markedly imprecise back-of-the-envelope exercise that can easily be modified to reinforce the Chicago team’s results….”

Scott Winship, “How Much Would Creating a Child Allowance Reduce Work Among Parents?,” American Enterprise Institute, December 9, 2022, https://www.aei.org/research-products/working-paper/how-much-would-creating-a-child-allowance-reduce-work-among-parents/

“…The above chart by Michael Howell of Crossborder Capital shows estimates of global new liquidity. The lines indicate the three-month annualized % growth in the monetary base. Globally [red line], growth in liquidity has ticked up very slightly after dropping to its lowest level since the global financial crisis. In the major G10 economies [grey and yellow], there is a pickup from outright negative growth that has been helped by the startling fall in the US dollar in recent weeks. As many countries use dollar financing, this has the effect of easing conditions everywhere. Last week’s balance sheet data from major central banks show policy liquidity shrinking at 5.3% in local currency terms [yellow] but rising by 2.7% in US dollar terms [grey.] Thus, it is possible that a pivot away from tighter money is already under way…”

John Authers, “The Temptation to Call the End of Inflation,” Bloomberg, December 11, 2022, https://www.bloomberg.com/opinion/articles/2022-12-12/john-authers-calling-the-end-of-inflation-and-buying-china?sref=U3dOGIDF

The Temptation to Call the End of Inflation

Lead Us Not Into Inflation

What have we got to be afraid of? The 2022 drama of the word’s fight against the return of inflation is about to reach its final act. After the US consumer price index on Tuesday, the Federal Reserve holds its last monetary policy meeting for the year on Wednesday, to be followed the next day by the European Central Bank, Bank of England, Swiss National Bank, and Norway’s Norges Bank. Then finally, with any luck, we can all enjoy the World Cup final and send the world into mothballs for the Christmas and New Year holidays.

So where do we stand? Inflation this year far exceeded any estimate, as did the monetary policy response (at the turn of the year, fed funds futures predicted the fed funds rate would hit 0.82% after this week’s meeting; now that market is braced for 4.35%). But after the ghastly surprise of 2022, markets again are coalescing around a view that price rises will imminently come under control. That is clear if we look at implied inflation rates from the swaps market (available on the terminal), which suggest that CPI will be back below 3% by next summer:

Why might they think this? We can answer that first by reference to the broader global picture, and then by looking more closely at the nitty-gritty of central banks’ provision of liquidity to the markets. For the case that it’s reasonable to expect inflation to fall next year, consider this schematic illustration from Academy Securities’ Peter Tchir:

Don’t spend any time on the precise numbers, or the way the different factors have been weighted; this is meant as an aid to thought and conjecture rather than anything precise. Inflation had many driving factors behind it. Among the most important were: The Fed’s expansive monetary policy in 2020 and 2021 (“The Fed” above); the fiscal stimulus administered to tide companies and individuals through the pandemic (“Stimulus”); stresses on global supply chains as businesses began to reopen; the war in Ukraine; and the bubbly behavior that was fostered by the brief but dramatic boom in “disruptive” stocks and cryptocurrencies. The diagram shows Tchir’s rough estimate of how important all these factors have been since the pandemic began. At this point, his model suggests that the Ukraine conflict is the only remaining factor still pushing inflation upwards. By the middle of next year, again on a very simple model, all of the previously inflationary forces will have become deflationary. Intuitively, this model does seem reasonable. It also implies, for Tchir, that the Fed has already gone too far.

If that’s concerning, we also need to look at how far the battle to tame in inflation has come. Central banks across the world have reined in liquidity this year, and the announced policy of “quantitative tightening” implies that they have much further to go, selling bonds into the market to reduce the money in circulation. However, it looks as though this may already have come to a “pivot” point. The following chart by Michael Howell of Crossborder Capital in London shows estimates of global new liquidity:

To be precise, the lines indicate the three-month annualized percentage growth in the monetary base. Globally, growth in liquidity has ticked up very slightly after dropping to its lowest level since the global financial crisis. In the major G10 economies, there is a pickup from outright negative growth that has been helped by the startling fall in the US dollar in recent weeks. As many countries use dollar financing, this has the effect of easing conditions everywhere. Last week’s balance sheet data from major central banks show policy liquidity shrinking at 5.3% in local currency terms but rising by 2.7% in US dollar terms. Thus, it is possible that a pivot away from tighter money is already under way.

The weakening of the dollar can be viewed as a response to implicit easing by the Fed, or it might also have been driven by an increasing belief that inflation really has been licked, and that tightening will soon go into reverse. By trying to anticipate this, the foreign exchange market almost delivers some degree of easier money as a self-fulfilling prophecy. Even if the Fed has already tightened too far, then, it’s possible that markets are already working to blunt the impact on the economy next year. To quote Howell of Crossborder Capital: ‘The US Federal Reserve looks to be leading the cycle once again. Having been the first to tighten starting from around this time last year, recent data suggest that the Fed’s QT cycle is close, or even already at, its nadir. Interest rates are likely to go on rising into 2023, albeit at a slower pace as upward pressure on prices abates, but quantitative policy looks to be changing direction already. The US dollar is responding. From its recent peak levels, it has lost some 14% versus sterling, around 10% against the euro and yen, and 5% versus the renminbi. While other Central Banks may lag the Fed once again, the depreciation of the US dollar will help. Its strength during 2022 has forced EM Central Banks to tighten to underpin their own currencies and has exacerbated already strong inflationary pressures in Western economies. The positive effect is already evident in aggregate policy liquidity growth expressed in US dollar terms. This is now gently expanding having been in negative territory for the last 12 months.”

A broader question concerns the pressures that sustain longer-term inflation. Many of the big global trends driving prices higher have turned, but consumers and businesses across the world have begun to growing accustomed to rising prices. What risk does this create of a self-perpetuating cycle of rising wage demands and rising prices? That’s an imponderable question, but the continuing strength of the US labor market suggests that inflation isn’t beaten yet. Last week, brought publication of the Atlanta Federal Reserve’s Wage Tracker figures for November, which are based on census data and allow a granular look at pay increases across the US.

Average hourly earnings data from the Bureau of Labor Statistics at the beginning of this month also suggest that it’s premature to call a top on rising wages:

We’re about to receive a bombardment of new information about inflation. It will all be useful, but there are longer-term trends whose destination is unclear. Even if and when the central banks reach the point of not raising rates anymore, there will be plenty more uncertainties.

Buy China?

If there’s one almost universally popular call for 2023, it’s “buy China” — not just its bonds, but even its beleaguered stocks. On any simple what-goes-down-must-come-up model, this makes ample sense. China’s stock market endured almost a perfect storm in 2022: Growing trade conflict with the US, and international outrage of corporate governance, contributed to a selloff that widespread shutdowns caused by the Covid-Zero policy would likely have caused in any case. Once Chinese stocks are in a slough of despond, all good contrarians know that it is time to buy.

However, a lot of the bounce has happened in the last two months. Chinese American Depositary Receipts, as measured by the Bank of New York’s index, and Hong Kong-quoted shares covered by the MSCI China Index have more or less caught up with the MSCI All-World index. An epochal 46% fall for the ADRs at one point is now a more manageable 18% drop for the year. Meanwhile, mainland shares represented by the CSI 300 Index have also regained much ground:

Was that the buying opportunity? What case is there for renewed excitement about China? And can we be sure of the ground we stand on? This time last year, JPMorgan Chase & Co.’s much-quoted equity strategist Marko Kolanovic said: “China was a headwind for performance of various assets this year, but we believe China growth will accelerate in 2022, which should further provide support for global equities and cyclical assets.” JPMorgan’s precise prediction was a for a 38% rise in the MSCI China. As the chart shows, that didn’t happen. It’s as well to remember this when looking at Kolanovic’s outlook for China for 2023: “We remain positive on China, due to favorable monetary conditions as well as an eventual full reopening and end of Covid.” There’s certainly a much more attractively priced entry point now than there was a year ago”

Meanwhile, Christopher Wood, a veteran analyst of Asian markets who writes as GREED & Fear for Jefferies, suggests that it’s now safe to enter the water. But it’s important than he is more confident about relative performance (because he sees US earnings and the dollar as challenged), than about absolute performance in an environment that is likely to see a big public health crisis in the next few months: “The growing evidence of further closet Covid easing this week is clearly bullish for Chinese equities and increases the chance that the emerging market asset class has made a major bottom against both the S&P500 and the MSCI World Index. This is particularly the case given the positive earnings upgrade potential for several Asian markets next year and the risk of earnings downgrades in the US in 2023. Global asset allocators should increase their allocation to emerging markets if they agree with GREED & fear’s base case, namely that monetary tightening expectations and the US dollar have peaked.”

There’s a big currency element to this. China’s yuan has enjoyed a dramatic resurgence in the last two months, driven both by lower yields in the US and hopes that post-Covid opening is real and imminent. It’s dropped below 7.0 per dollar — a level that has caused major political tensions in the past — after one of its strongest appreciations in decades:

In its own right, a rebound after a major selloff makes sense for the yuan. But all the China bulls might take note that this big shift has already happened, and might easily reverse if the post-Covid resumption does not go as hoped. It’s worth heeding these words from Marc Chandler of Bannockburn Global Forex: “The US 10-year yield premium over China topped in late October at slightly more than 150 bp. It fell to almost 50 bp last week before settling around 65 bp. Investors have been eager to believe the Covid pivot, but the risk is that they have gotten ahead of themselves. Of course, less testing will generate less detected cases but there will be other signs of rising infections and strains on the healthcare system. That said, even if one wants to accept these developments at face value, the move is too far too fast. The yuan’s surge offers an opportunity to those who are looking for an opportunity to hedge or reduce CNY exposure.”

China is plainly a more interesting investment opportunity than it was 12 months ago. But, just as then, the case might not be quite as clear as it seems.