Last week's economic data continued the trend of deceleration from the uptick in growth we experienced in the second half of 2013. Following weak payroll growth, mortgage applications showed a big decline in purchase activity, retail sales declined to the lowest growth rate of the recovery, and manufacturing capacity utilization showed a steep drop. Economic bulls are quick to cite bad weather as the culprit for the slowdown while economic bears continue to mock the bad-weather excuse.
I don't think there is any question that bad weather can impact short-term economic data, however, one must understand that the weather is a known variable and economic estimates are calculated ex post. For instance, the retail sales that missed expectations had been made after many of the nation's large retailers had already issued Q1 profit warnings based on weak January sales. These numbers weren't just weaker due to weather; they were weaker than what were already low expectations.
(NYSE:WMT), the nation's largest retailer, issued a sales warning on January 31 following a weak holiday sales report from the nation's largest online retailer Amazon
(NASDAQ:AMZN). The following is from Reuters
The retailer now expects to report a decline in fourth-quarter sales at stores open at least a year for Walmart US and Sam's Club. It had previously expected same-store sales to be relatively unchanged at Walmart US and flat to up 2% , without fuel, at Sam`s Club.
Walmart joins a long list of US retailers that in recent weeks cut their outlooks, laid off workers, and closed stores. Faced with shoppers worried about their job prospects and modest economic growth, retailers offered more discounts during the holiday season than a year earlier.
Amazon.com, the world's largest online chain, on Thursday missed Wall Street estimates for the holiday season and warned investors about a possible operating loss.
There was no mention by Walmart of weather hurting sales, and Amazon -- which is immune from weather -- saw its holiday sales increase at the slowest growth rate since 2008.
Auto sales were one of the especially weak spots in the retail sales report:
Autos pulled down the total. Motor vehicle & parts declined 2.1%, following a decrease of 1.8% in December .
Analysts seemed to underestimate the weakness in the auto market, but just a couple weeks earlier at the Detroit Auto Show, AutoNation
(NYSE:AN) CEO Mike Jackson warned of excess auto inventories. The following is from the Wall Street Journal
on January 14:
US dealers have about $100 billion worth of unsold cars and trucks sitting on their lots, Mr. Jackson said. That level is striking given that car makers have pledged not to overstock dealers the way they did in the run up to the financial crisis and the auto-sales collapse of 2008-2009, Mr. Jackson said.
In addition, there is no mention of weather from AutoNation, and in fact Jackson's inventory observation is not specific to just the auto sector. The following is from a Wall Street Journal
article on Saturday (Feb. 15) following Friday's weak Industrial Production number:
Economists are divided over whether the recovery is being slowed by harsh winter weather or whether the acceleration in the second half of 2013 -- when growth topped a 3% pace -- was the anomaly.
Inventories Vs. Retail Sales
Businesses stocking shelves drove part of the gains late last year. With consumer demand easing recently, factories might need to slow assembly lines. "Production was going to have to adjust whether it snowed a little or a lot," said Pierpont Securities economist Stephen Stanley.
Inventories soared last year to the highest level of the recovery and were mostly responsible for the uptick in GDP in the second half of 2013. It's unclear if this inventory build was a function of perceived increase in demand that didn't materialize or whether producers were forced to purchase goods to maintain contractual agreements.
Regardless, inventory builds in the face of decelerating demand is a potentially troubling economic development. It's been a long time since we experienced an inventory recession, but prior to the past two financial market-induced recessions, inventory recessions were the more common cause of economic contraction.
Retail Sales Year-Over-Year Vs. NGDP
Does it look like the weak retail-sales number is a weather-induced anomaly or the continuation of a declining trend? It would seem this January data is more consistent with the nature of the weak recovery than it is a weather-related aberration amid an acceleration of growth. But don't take it from me. Instead of trying to force an economic square peg into a round hole, allow the market discount to provide guidance.
Long-term investors don't care about short-term deviations in the economic cycle, and long-term interest rates don't calibrate the discount to reflect these deviations. Thus if there was material upward pressure on aggregate demand because of an increase in economic velocity, it should be exerting upward pressure on long-term interest rates. However, throughout the second half of 2013, both the 10-year and the 30-year Treasury yields have been trading sideways, and this week are in the exact same spot reached on the July 5 peak.
Ten-Year and 30-Year Yields
If the recent deceleration in this growth was all weather related, then long-term interest rates should be rising in anticipation of a reacceleration of growth once the weather improves. However, the bond market is acting like the GDP uptick was the transitory event, not the subsequent deceleration.
The long end of the curve is ultimately going to anchor around the long-term structural growth rate in aggregate demand as measured by the year-over-year growth in nominal GDP plus an inflation risk premium. In the 1990s this growth rate averaged 5.5% and the average 10-year and 30-year yields were 6.6% and 6.96% respectively. In the 2000s this nominal growth rate had decelerated to a 4.1% average, and the average 10-year and 30-year yields also dropped to 4.35% and 4.85% respectively. Since 2010 the growth rate has averaged 3.9%, with the last quarter's big economic uptick that got everyone excited a mere 4.2%.
The bond market works, and the long end of the yield curve is perhaps the most efficient of all asset classes. The volatility in long-term interest rates is typically a function of an inflation premium predicated on the relative impact of monetary policy. When monetary policy is too loose (tight) relative to demand, the inflation premium in the curve is steep (low). Nominal growth has been remarkably stable over the past 30 years. Monetary policy and inflation risk, not so much.
Ten-Year Vs. 30-Year Over 10-Year/30-Year
It's not a coincidence that the unconventional Fed policy since the financial crisis has produced record steepness in the yield curve, and more specifically, the spread between 10-year/30-year Treasuries. However, with the Fed exiting quantitative easing, these massive inflation premiums are being reduced and the curve is returning to normal discounts that will become more a function of long-term structural aggregate demand. In an environment whereby the Fed is reducing inflation risk in the context of a 4.0% growth in aggregate demand, the 30-year yield at 3.75%-4.25% is a reasonable discount of this reality.
The next few months will be critical for the bond market. If this recovery is for real, interest rates in the long end should be responding, weather slowdown or not. It's clear economic bulls are anticipating pent-up demand for housing and other consumer durables to reemerge when the weather improves. If the economy doesn't thaw along with the weather then elevated inventories are going to weigh on aggregate demand and long-term interest rates. Ultimately we may find that the long end of the curve is much closer to fair value than many presume and has properly discounted the long-term structural growth rate in aggregate demand.