Mix Matters

“What kind of cookies do they sell at the airport? Plain.”

Rene Descartes - famed mathematician, creator of the Cartesian plane and bane of 7th grade math classes - enjoyed getting up late, preferring to spend the morning lying in bed thinking.  

The story goes that he invented the coordinate plane while lying in bed watching a fly crawl on the ceiling, reasoning that he could describe the exact location of the fly by knowing its distance from two perpendicular walls. 

Descartes laid in bed. Socrates engendered philosophical insight strolling the gardens. Einstein intuited and fully conceptualized his theory of relativity “during long walks on the beach” and while “lying down and gazing at the ceiling” before any math entered the equation.   

When I was in construction, I had everyone take a week off every six weeks. The path to improved morale and elevated productivity was, ironically, not working. 

In athletics (and life in general), an exceedingly effective way to hinder long-term progress and physical/mental adaptation is through over-work. 

Workout 2-3 times a day for a couple weeks and your progress will be great. Try to do that for a year straight and performance will invariably go downhill. 

A small minority of people have the genetics to sustain 12-14 hr days of focused attention. The vast majority don’t and performance, creativity and mental plasticity start to deteriorate over time under that kind of regimen. 

This is basically fact, and it’s interesting that even people who know this (myself included) still succumb to the prevailing Wall Street culture that more hours = more & better productivity.    

There is a trade-off to be sure. 

Work wins high-frequency battles and grinders generate ideas but #BigIdeas, it seems, are the product of restless but rested minds.

Mix Matters - NFIB CoD1

Back to the Global Macro Grind

A notable takeaway from last Friday’s jobs reports is that with hourly earnings growth decelerating and average hours worked per week declining, aggregate income growth will show further deceleration when the official income and spending data are released for February later this month.   

Further, unless credit growth accelerates meaningfully and/or the savings rates declines materially, consumption growth for February should follow income growth lower.

This week is light in terms domestic fundamental data flow but we did receive some incremental updates related to both wage and credit trends.

Credit | Consumption’s Wild-Card: With household debt still very much elevated and no rope left on lowering debt service costs, the capacity for debt to support consumption growth over the intermediate and longer term remains constrained.  

In the shorter-term, however, there exists some runway for accelerating credit growth to help offset slowing income growth in support of consumption. 

Yesterday’s consumer credit data for January showed total borrowing rose $10.5B, marking the slowest gain in 27-months. 

Non-revolving credit (i.e. auto’s and student loans) rose $11.6B sequentially while decelerating to +6.9% YoY – the slowest pace of growth since July 2012. Revolving credit (i.e. credit cards) dropped for the first time in a year, declining at an annualized rate of -1.4%. On a year-over-year basis, however, growth in credit card debt made a new cycle high at +5.27% YoY. 

So, credit growth appears to be moderating but remains a modest, positive support to consumption growth. Not enough to fully compensate for the deceleration in income growth but a positive offset to buttress a slowdown in aggregate consumer spending. 

Compensation Plans | Hurry Up & Wait: Keeping with the theme of wage and income growth, we got the NFIB small business confidence data for February this morning and, with it, the sub-indices tracking both actual Compensation trends and Compensation Plans. 

Economists and strategists focus on the Small Business Compensation Plans index because, historically, it has presaged actual compensation increases pretty well – typically leading growth in the ECI and reported hourly earnings by ~3 quarters. 

Indeed, and as we’ve highlighted, the strong advance in NFIB Compensation Plans over the last 39 months along with more recent strength in the Employment Cost Index (ECI) have backstopped consensus expectations for accelerating wage inflation for the better part of the past two years. 

The Data | Ruh-roh? The February data showed the Hiring Plans Index decline -1 pt, the Compensation Index decline -5pts and the Compensation Plans Index decline -3pts; all marking 9 month lows and multiple months of sequential decline (See Chart of the Day above).   

The decline off the recent peak and the failure for hourly earnings to accelerate as labor slack has diminished continues as a lead source of consternation for late-cycle labor and Phillips curve economists.

Why has the conventional relationship between unemployment and wages failed to materialize?

Mix Matters: Yesterday, the San Francisco Fed put some quant around a dynamic we’ve known was impacting the wage growth data but had yet to study intensively. 

 

Specifically, they explored the impacts exerted by labor composition and the flow of workers into and out of the labor force on reported wage inflation. 

You can read the note HERE but it’s worth reviewing the key takeaways.

 

Some of the underlying methodology is complex, but the conceptual crux of the analysis is pretty straightforward.

The analysis centers on the premise that income is generally an increasing function of age and tenure. That is, wage and salary income typically rises with experience and duration of full-time employment. 

Commonsense and empirics side with that presumption.

This logic implies that older, continuously employed full-time workers, on balance, make more than part-time or recently employed, younger full-time workers.

Now, what would the impact to average wage growth be if labor turnover evolved in an exaggerated barbell type of way that saw older, more highly compensated workers retire and be predominately replaced by new lower-wage entrants?

Suppose further that at the same time, and in addition to this secular reality, labor slack and underemployment remain a cyclical overhang on compensation growth – and disproportionately so for new, younger entrants into the labor force. 

Hidden In Plain Sight: Does the entry of younger, comparably lower-wage workers to full-time time employment and the exit of a large bolus of higher-wage retirees sound like any (Millennial-Boomer) developed market economy you know?

In other words, mix matters and when taking a composition-centric view of the labor force the protracted stagnation in reported average wage growth isn’t particularly surprising.

The implications are a few fold. 

Labor composition shifts give leash to businesses, in the aggregate, to help manage and minimize labor cost pressure. However, if new entrants are less productive then unit labor costs may actually be rising (even though it wouldn’t be showing up in the headline inflation data, to the Fed’s continued chagrin). 

Rising unit labor costs in combination with decelerating demand = incremental margin pressure for a corporate sector collectively past peak in profitability and now on the wrong side of the global growth curve.

Our immediate-term Global Macro Risk Ranges are now:

UST 10yr Yield 1.67-1.92%

SPX 1

Nikkei 157

VIX 16.37-23.49
USD 96.44-98.78
YEN 111.70-114.64
Oil (WTI) 29.86-36.98

Best of luck out there today,

Christian B. Drake

U.S. Macro Analyst

Mix Matters - Mix CoD2