The LMCI Index Says The Fed Is Late AgainIn May of 2014, the Federal Reserve began discussing a newly designed labor market index to help support their claim that employment conditions in the U.S were improving. This was an important facility for the Fed which needed support to raise interest rates. My good friend Doug Short has a complete discussion on the LMCI, which is worth reading for context. As he defines:
"The Labor Market Conditions Index (LMCI) is a relatively recent indicator developed by Federal Reserve economists to assess changes in the labor market conditions. It is a dynamic factor model of labor market indicators, essentially a diffusion index subject to extensive revisions based on nineteen underlying indicators in nine broad categories.
The indicator, designed to illustrate expansion and contraction of labor market conditions, was initially announced in May 2014, but the data series was constructed back to August 1976."
Unfortunately for the Federal Reserve, the index has not supported the Fed's claims that employment is growing at a rate strong enough to withstand a tightening of monetary policy. In fact, as shown in the chart below, the LMCI index (smoothed with a 12-month average) has been a leading indicator of future weakness in employment. The recent downturn in the LMCI suggests that employment gains may more muted in the months ahead.
Retail Sales DeclineWhile the weakness in the LMCI is suggesting more disappointing employment growth ahead, retail sales are suggesting that the economy is likely much weaker than headlines suggest.
Given all the massaging of data through seasonal adjustments, the chart below using the NON-seasonally adjusted data smoothed with a simple 12-month average. This gives a much more realistic look at what is actually happening with retail sales in the economy that makes up roughly 40% of total personal consumption expenditures. I have also provided the SA adjusted data to show the correlation between the two series.
The chart below shows the annual rate of change in "control purchases" which is more closely related to the actual activity of average consumers. I have overlaid the analysis with a simplistic economic cycle. Again, as shown above, control purchases are also suggesting that the economic environment is, in fact, very weak.
What Inflation? PPI Declines AgainOf course, let me once more remind you why the Fed raises interest rates - to SLOW economic growth and QUELL inflationary pressures in a potentially OVERHEATING economic environment.
With Q3 economic growth rates closer to 1% than 2%, there is little danger of an overheating economy currently. Furthermore, as shown in the composite inflation index below (average of both PPI and CPI), there is absolutely no worry about spiking inflationary pressures.
For investors, the deflationary decline will erode corporate profitability and ultimately stock prices. As shown in the chart below, sharp declines in inflation have generally been associated with negative annual rates of growth in the financial markets.
The Federal Reserve is quickly becoming trapped by its own "data-dependent" analysis. Despite ongoing commentary of improving labor markets and economic growth, their own indicators are suggesting something very different.
As I have stated previously, while the Federal Reserve may hike interest rates simply to "save face," there is indeed little real support for them doing so. Tightening monetary policy further will simply accelerate the time frame to the onset of the next recession. Of course, the Fed knows this which is why they recently floated the idea of "negative interest rates" out into the markets. In other words, they already likely realize they are screwed.