Dressing Up for a Waltz Through the Mailbag

Topsy Curvy

We have not dipped into the mailbag in a while. Let us do so today.

I heard some tool on TV say that the Fed hiked too much. Is he right?

Highly unlikely. Tools are rarely right -- and accident is the No. 1 reason when they are. They just aren't programmed for analysis. They're built to talk, to love to hear themselves talk, and to want other people to listen. The people back in college who at the library talked and talked and talked and never really studied anything? Tools now. Every last one of them. Many migrated to markets and economics, where, owing to very low barriers to entry, their concentrations have always been especially thick; the ones who couldn't clear those hurdles became lawyers. No one who talks so incessantly about a subject can possibly know very much about it. There just aren't enough chances for actual information to seep into the pea.

The Tools are now forecasting (among other things) that the tightening cycle has ended; that growth will average just 2% during the second half of the year (compare with roughly 5% during the first); that central bankers will switch to a balanced-risks statement when they meet next month; and that the Fed will be discussing rate cuts by the end of the year.

All of those sit snugly inside the feasible set, and it's really stupid to call any forecast stupid for the simple reason that you just never know what might happen. (One of the few times your narrator messed up in a major way came in the autumn of 1998, when the Tools were insisting that the economy was set to slow seriously -- and screaming at the Feds to ease in support. "That's stupid!!" I screamed back. Very loudly. Lots of times. And then, right on cue, the Fed eased. The action had nothing to do with anything the Tools were talking about, but I ended up looking stupid because I got the result wrong. Completely wrong. Wrongwrongwrong.) Six-sigma events can and do hit.

They're also impossible to predict, which leaves us to use what we do know to figure out what's most likely. We know, for example, that the Index of Leading Economic Indicators has posted four declines during the past seven months -- and that that usually always happens prior to a recession. Yet we also know that the index also sends its share of false signals; it did so in 1993 and then again two years later. We know that the yield curve is inverted -- and that that has in the past tipped us to slower growth and rate cuts. Yet we also know that the message might not be the same this time; the piece that Brian Reynolds posted last Friday told us why.

We cannot subscribe to the notion that the Fed's tightened too much. We think it's too soon to be talking about easing -- the Fed waited until growth slowed by 2 percentage points before it finally eased up a bit in the wake of the harsh 1994 hikes; this time around, the tightening hasn't proven nearly as severe and growth has yet to show any slowing at all -- yet the disaster scenario intrigues us enough to throw it a nod. A neat little model from the New York Fed currently places the odds of a recession unfolding over the next year between 20% and 30%. That goes down as the most serious signal of the expansion.

Is there some kind of catastrophe in the works?

What's up with productivity and profit margins?

They're both rocking.

Margins, which fell to 11.7% last year from 11.9% in 1998 from 12.5% in 1997, have turned around. They clocked in at 11.9% during the first quarter of this year and then rose to 12.3% during the second.

Productivity in the nonfinancial corporate sector, which grew 4.3% last year following a 3.6% increase in 1998, was growing at a 4.8% rate during the second quarter. Unit labor costs, which grew 0.6% last year following a 1.2% increase in 1998, were falling at a 0.3% rate during the second quarter.

Why's all this good?

For, obviously if productivity growth slows, unit labor costs would rise, first pressuring profit margins, and then prices. Indeed, we cannot rule out such a process if labor productivity growth simply levels out.

The man in charge is happy when productivity increases are keeping labor costs down and margins up.

What's up with employment?

The August numbers showed that the unemployment rate rose to 4.1% in August from 4.0% in July; that the year-on-year increase in average hourly earnings slowed to 3.6% from 4.0%; that the pace of overall job creation slowed to 1.9% from 2.1%; and that the rate of service-sector job growth slowed to 2.2% from 2.3%.

And the Fed will feel no need to tighten further if employment reports keep printing like that.

Side Dish

Anyone got a recipe that involves chicken, bread crumbs, Italian dressing, and a glass baking dish (or a combo close to that)?

Let's have it if so.

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