The Fed Has Been Tightening For 22 Months, Which is Why the Next Cycle Downturn Is Now Just Around the Corner
This week we thought we'd do something a little different and look at the relationship between claims and Fed funds. The chart below looks at Fed Funds (inverted) on the left hand side and initial claims on the secondary y-axis. What's interesting is how different this cycle appears to be versus prior cycles. First, let's establish a reference point for measuring where we are in the cycle based on the number of months elapsed at a sub-330k level of initial claims. As the chart below shows, by this point in previous cycles (we're now 20 months into sub-330k) the Fed was already well underway raising rates.
While everyone knows that rates have been low for a long time, it's not obvious just how long until you look at the chart and compare it with the last four cycles.
A bull might look at this chart and argue that it was the increase in rates that was the proximate cause of the downturns in the last four cycles and without that spark this cycle could live on for a while yet, especially with no emergent signs of inflation.
A bear could argue that the cycle is already long in the tooth and the fact that the Fed hasn't yet raised rates is indicative of just how weak the underlying fundamentals of the current cycle are.
A further argument (and the one we think is the most apt description of what's really going on) would be something along the lines of this: The Fed has already hiked simply by removing QE. As a reminder, the Fed began slowing its $85bn/month asset purchases by $10bn/month back in December 2013 and ceased those purchases altogether by October, 2014. In other words, the Fed began tightening policy ~22 months ago, which is about in-line with the start of previous cycle rate hikes when benchmarked against the 330k claims index level. Translation: this cycle actually looks very similar to recent cycles when viewed through this lens - it just appears different because most investors don't treat the slowing and cessation of QE as the equivalent to rising Fed Funds.
Our framework for thinking about the Fed is this latter scenario, and this is why we keep emphasizing the relevance of the the last three cycles duration within the context of initial claims. The last 3 cycles saw claims stay below 330k for 24, 45 and 31 months before the economy entered recession. The average duration of those three cycles was 33 months (max: 45, min: 24). With claims having just started their 20th month of strong, sub-330k claims, we are now 4 months from the min, 13 months from the average and 25 months from the max.
By the Way, Dont' Forget about Energy
Separately, claims in energy states rose faster than claims in the U.S. as a whole during the week ending October 10. The spread between the two series in the chart below widened week over week from 19 to 20. What's interesting here is that energy companies are largely hedged through ~YE15. As such, we expect to see energy claims rise steadily over the next 6 months as those hedged roll off and energy employers begin to find other ways to right size the P&L. The chart below suggests that this theme is beginning to play out.
Prior to revision, initial jobless claims rose 4k to 259k from 255k WoW, as the prior week's number was revised up by 1k to 256k.
The headline (unrevised) number shows claims were higher by 3k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -2k WoW to 263.25k.
The 4-week rolling average of NSA claims, another way of evaluating the data, was -8.2% lower YoY, which is a sequential improvement versus the previous week's YoY change of -8.1%
The 2-10 spread fell -1 basis points WoW to 140 bps. 4Q15TD, the 2-10 spread is averaging 143 bps, which is lower by -10 bps relative to 3Q15.
Joshua Steiner, CFA
Jonathan Casteleyn, CFA, CMT