by Calculated Risk on 4/06/2010 01:04:00 PM

Minneapolis Fed President Narayana Kocherlakota spoke today: Economic Recovery and Balance Sheet Normalization

The headline is Kocherlakota thinks the Fed should start selling a non-trivial amount of MBS each month to normalize the Fed's balance sheet.

[T]he passive approach is a slow approach that will leave the Federal Reserve holding significant amounts of MBSs for many years to come. If the Federal Reserve wants to normalize its balance sheet in the next five, 10, or even 20 years, it needs to supplement the passive approach with an active one. In plain English, it will have to sell mortgage-backed securities.
...
To pick one of many possible plans, suppose we were to commit to the public to sell 15 billion to 25 billion dollars worth per month of MBSs. This path of sales, combined with prepayments, would get the Federal Reserve out of MBSs within five years after the start of selling. The plan would also return the Federal Reserve’s balance sheet to a normal size, so that excess reserves would be normalized at their 2007 levels well before the end of the five-year period. Just as important, I feel confident that this pace of sales would be sufficiently slow that it would have little or no impact on MBS prices and long-term interest rates.

He also made some interesting comments on housing:

Let me start my outlook with the most troubling information first. Housing starts and sales remain at near historically low levels. These data are disturbing to many observers. And that’s understandable. After many past recessions, residential investment has played a significant role in the subsequent recovery. Arguing by analogy, some are concerned that we cannot have a sustainable economic recovery unless housing starts pick up dramatically from their current low levels.

CR: I think a sustainable recovery is possible, but I think it will be sluggish and choppy. I've argued it is difficult to have a robust (V-Shaped) recovery without housing.

I have to say that I’m somewhat skeptical of this thinking. Yes, the housing sector is important, but residential investment makes up just 2.8 percent of the country’s gross domestic product.

CR: This is an error in analysis. Back in 2005, several analysts argued I was wrong that a housing bust would eventually take the economy into recession - they said residential investment was only 6% of the U.S. economy! They were wrong because they didn't consider all the add on effects - and the impact of financial distress. Now residential investment is only 2.5 percent of GDP, and Kocherlakota is making the inverse faulty argument. During previous recoveries, housing played a critical role in job creation and consumer spending. It isn't the size of the sector, but the contribution during the recovery that matters - and housing is usually the largest contributor to economic growth early in a recovery.

The U.S. economy is a wonderfully diverse one, and has many possible sources of growth. We can—and I believe that we will—have significant growth in output without seeing a major turnaround in the housing market.
...
Housing starts are ... strongly affected by the general health of the economy (job growth or loss) and the stock of housing relative to demand. As I see it, the problems in the housing sector right now are largely driven by this second factor. For a number of reasons, the nation has built a lot more houses than it now needs or wants. As a result, my own prediction is that housing starts are going to remain low—possibly for several years.

What does the large supply of housing mean for the general economy? It means that resources formerly dedicated to building and outfitting homes are gradually shifting to other uses. This points out another remarkable feature of the U.S. economy: its flexibility.

I generally agree with this last section. The problem with "flexibility" is there are two key labor mismatches (as discussed last week by Atlanta Fed President Lockhart); The first is lower geographical mobility because of the inability to sell a home. Usually people can move freely in the U.S. to pursue employment, but many people are tied to an anchor (an underwater mortgage).

The second is a skills mismatch. This is because so many people went into the construction industry because it was the highest paying job. These workers may be highly skilled in their trade, but their skills are probably not transferable to the new jobs being created. It will take some time for these people to learn a new trade.

Both of these mismatches lower the "flexibility" of the economy.

by Calculated Risk on 4/06/2010 10:00:00 AM

From the BLS: Job Openings and Labor Turnover Summary

There were 2.7 million job openings on the last business day of February 2010, the U.S. Bureau of Labor Statistics reported today. The job openings rate was little changed over the month at 2.1 percent. The hires rate (3.1 percent) and the separations rate (3.1 percent) were also little changed in February.

Note: The difference between JOLTS hires and separations is similar to the CES (payroll survey) net jobs headline numbers. The CES (Current Employment Statistics, payroll survey) is for positions, the CPS (Current Population Survey, commonly called the household survey) is for people.

The following graph shows job openings (purple), hires (blue), Total separations (include layoffs, discharges and quits) (red) and Layoff, Discharges and other (yellow) from the JOLTS.

Unfortunately this is a new series and only started in December 2000.

Click on graph for larger image in new window.

Notice that hires (blue) and separations (red) are pretty close each month. This is the level of turnover each month. When the blue line is above total separations, the economy is adding net jobs, when the blue line is below total separations, the economy is losing net jobs.

According to the JOLTS report, there were 4.96 3.961 million hires in February (SA), and 3.957 million total separations, or 4 thousand net jobs gained. The comparable CES report showed a loss of 14 thousand jobs in February (after revision).

Layoffs and discharges have declined sharply from early 2009 - and that is a good sign.

However, hiring has not picked up - and even though total separations were at a series low, there were few jobs added in February (according to JOLTS). This low turnover rate is another indicator of a weak labor market.

by Calculated Risk on 4/06/2010 09:01:00 AM

Just an update ...

Market News International reported that Greece may want to cut the International Monetary Fund out of the rescue package. However an unnamed Greece official denied the report, from the WSJ Greece to Pitch Dollar Bond to U.S. Investors

"Don't expect at this point any major push by Athens to get the IMF out of the picture," the official said. "There is unhappiness with the support package because it's vague. And, yes, the involvement of the IMF is something that we could do without," the official said. "But it was us who first raised the IMF card and I don't think the Greek government will or can renegotiate the package. It will show inconsistency."

This official said Greece would like more clarity on any aid package involving the IMF, but the government doesn't plan to demand the agreement be renegotiated to exclude the IMF.

Update: Jason sent me an update from the Street on Greek bonds: "Wider by 50 on the day in the 10 years and 120 in 2 year, it is clear panic has now set in ..."

by Calculated Risk on 4/06/2010 12:07:00 AM

From Nick Timiraos at the WSJ: Apartment Rents Rise as Sector Stabilizes

Nationally, the apartment vacancy rate stayed flat at 8%, the highest level since Reis Inc., a New York research firm, began its tally in 1980.... Nationally, effective rents, which include concessions such as one month of free rent, rose 0.3% during the quarter compared with a 0.7% decline in the fourth quarter of last year and a 1.1% drop in the first quarter of 2009. ...

"Rent reductions are not over yet," said Hessam Nadji, managing director at real-estate firm Marcus & Millichap.

Note: the Reis numbers are for cities. The overall vacancy rate from the Census Bureau was at a near record 10.7% in Q4 2009.

Rents plunged in 2009 by the most in the 30 years Reis has been tracking rents - and with vacancies at record levels, the slight increase in Q1 2010 rents doesn't mean the rent declines are over.

by Calculated Risk on 4/05/2010 08:00:00 PM

Some people have argued that measured is inflation is declining mostly because of the Owners' Equivalent Rent component that is being pushed down by the record high rental vacancy rate. Economists at the San Francisco and New York Fed argue that there is "a broad pattern of subdued price increases across most consumption goods and services and [housing] is not distorting the broad downward trend in core inflation measures."

From Bart Hobijn, Stefano Eusepi, and Andrea Tambalotti: The Housing Drag on Core Inflation

Click on graph for larger image in new window.

One way to consider the effect of the price of housing on core inflation is to calculate a core PCEPI that excludes housing. This is done in Figure 1, which contains three time series. The first is 12-month growth in the core PCEPI. The second is a comparable measure of inflation for the housing component of the core PCEPI. The final time series is a core PCEPI that excludes housing expenditures.

Three things stand out in this figure. First, the standard core inflation measure shows substantial disinflationary pressures at work. ...

Second, part of the drop in measured core inflation is undoubtedly due to the deceleration in the price of housing. ...

Third, it turns out that this drag is rather small. The decrease in housing inflation only accounts for a small part of the overall disinflationary pressure on core PCEPI. ...

Consequently, the evidence in Figure 1 offers little cause for concern that the recent behavior of core inflation might be a misleading signal of the underlying inflation trend.
emphasis added

Note: The measures of housing inflation try to separate the cost of living in a home from changes in the asset price.

The Fed has a dual mandate of price stability and maximum sustainable employment. This disinflationary trend (ex-housing) is important because some people at the Fed are more concerned about possible future inflation, whereas others are more concerned with the high level of unemployment.