Notes From Underground: The Jobs Picture Is Robust, But Where Is the Wage Increase?

This is a rhetorical question of course, for the lack of wage growth is to be found in the vast amount of money chasing a global labor pool.

It is capital that had benefited from the last 30 years of the unleashing workers after the fall of the Soviet Empire and the black/white cat policies of Deng in pursuing growth in China. Now that other emerging economies are attracting capital in an effort to create jobs, there still remains a great deal of downward pressure on wages. Even the movement of supply chains out of China will act as a drag on global earnings as manufacturers will act to hold down wages as way of remaining attractive to foreign direct investment. The world has been watching as Chinese earnings growth has accelerated over the last 10 years but one of the outcomes from the Trump tariffs will be to force a slowdown in China’s wage inflation.

I was having a conversation with Robert from Germany in the Whitewave Trading room (I strongly urge you to participate), the wise AGCO worker made the salient point that the Social Democratic Party (SPD) was pivoting left because the social contract of Chancellor Schroeder was beginning to unravel. The Hartz IV agreement slowed wage growth in Germany. The unions agreed to lower wages in an effort to keep factories in Germany rather than exporting jobs to Eastern Europe to take advantage of a cheap, well trained work force freed from the shackles of Soviet economic fallacies. It appears that inflation has risen far faster than wages so some German workers are moving to lower cost of living countries to work at jobs similar to Germany’s.

This is something to be mindful of as more data becomes available. (Green AB, I await your input.) The bottom line for the U.S. debt markets is that the FED will remain on hold until wages begin to ACCELERATE for Chairman Powell has suggested that the bottom 20% of wage earners need to have gains to make up for the tepid growth of the last three decades. This is more of the symmetric nature of the 2% inflation TARGET.

The issue of MATERIAL REASSESSMENT will evidently be determined by the outcome of trade discussions. China released its trade data over the weekend, which revealed a continued slowing in the Chinese trade balance. Some analysts believe this weakening will push the Chinese to more quickly end the trade dispute. History suggests that the Chinese are not eager negotiators from a position of weakness.

The tweet machine will be in full force but we all must recognize that the trade crisis has been playing out for far too long. The most important outcome is that President Trump exacted three interest rate cuts and a new round of “QE” from the FED. Yes, in the span of a year the central bank has from gone from shrinking its balance sheet to expanding it by roughly $300 billion, an increase that pushed the aggregate size to more than $4 trillion. The drawn-out trade war has allowed Trump to trap the FED. Now, where will wage increases be found?

***On Thursday, the Financial Time ran an important story titled, “How the Euro Has Become ‘The World’s New Carry Trade.” The significance of the carry trade is that investors and borrowers wish to borrow because it’s so cheap. If the interest rate differential is great enough the borrower may invest the borrowed money in a richer interest rate return. (An example: Borrowing EUROS at a NEGATIVE 30 BASIS POINTS and buying U.S. 2-year Treasuries at 1.60%.) It works well as long as the currency levels stay steady or the EURO is hedged preventing against a DOLLAR depreciation or EURO appreciation.

But if the borrowed currency is HEDGED, the cost of borrowing a low interest rate vehicle may be eroded by the cost of the HEDGE. In 2015, when the Swiss National Bank broke the EUR/CHF PEG at 1.20, borrowers in Swiss francs got destroyed as the currency rapidly appreciated and the unhedged borrowers in Swiss francs were forced to cover what was in essence a short Swiss franc position. That resulted in BILLIONS of losses. These are still be settled as unsuspecting borrowers sued banks that sold the Swiss franc-denominated mortgages to many Eastern European borrowers.

The FT story notes that the EURO has become like the YEN “the currency everyone wants to borrow–but no one wants to own.” The article cites the research of George Saravelos, noting that the EURO has experienced huge investment flows that OUGHT to have seen the currency appreciate. Because Europe’s banks have been lending out vast amounts to non-European borrowers the outflow has resulted in a weakened currency. According to Deutsche Bank, two-thirds of the 455 euro balance of payments surplus of the last 12 months has been lent out on a carry-trade basis.

The trade works as long as the DOLLAR remains stable but if the world’s FX markets begin to sense U.S. Dollar weakness there is a huge amount of money susceptible to losses. The current low volatility, low interest rate environment has left many positions UNHEDGED. This is a situation to be watched closely as we enter political election cycles in the U.S. Also, if ECB President Lagarde is successful in achieving a robust European fiscal package with a EUROBOND to finance it, money will flow into EUROPEAN assets. Be aware of the potential prairie fires in the forex market.

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24 Responses to “Notes From Underground: The Jobs Picture Is Robust, But Where Is the Wage Increase?”

  1. rony schlapfer Says:

    brilliant analysis

  2. Judd Hirschberg Says:

    Yra it’s always a pleasure and a privilege to have you in the room. Your insights have led to some monster gains this year in the Metals, country specific ETF’s and the U.S Indices.
    “The better the discourse the better the trade setups” Yra

  3. ShockedToFindGambling Says:

    Yra….. good article

    I never understood borrowing in a low interest currency and investing in a high interest rate currency.

    In USD/EURO, the 2% annual pickup can be lost in 2 days of EURO rally.

    If you hedge out all the currency risk, there is no or minuscule interest rate pickup (depending on whether the forwards are out of line).

    If I were so smart, that I knew when the EURO was going to rally (which you must know to do this carry trade unhedged), I could just trade the EURO and make many multiples of 2%,.

    • David Richards Says:

      That carry trade, borrowing EUR to buy USD, was profitable for some years when EURUSD was falling, US short-term yields were rising and relatively high instead of collapsing and low, and collapsing, and it was very cheap to hedge the borrowed EUR because market participants expected EUR to fall.

      That flipped months ago, as no foreigners wanted unhedged exposure to USD anymore and foreign purchases of UST dried up, as hedged exposure became uneconomic. Thus that carry trade died, and more importantly, US money markets and repo blew up as the reality of bankrupt US finances hit home. IMHO, repo is about global funds flow and US gov’t bankruptcy that requires Weimar-style funding of the gov’t by the Fed. They *want* you to instead think it’s just technical or stimulus, in order to restore confidence and preclude panic. Hiding the reality that it’s symptomatic of insolvency and a systemic financial crisis bigger than twelve years ago.

      Sadly, masses are hiding in bonds denominated in US dollars.

      • ShockedToFindGambling Says:

        David…..good points

        However, you said…….it was very cheap to hedge the borrowed EUR because market participants expected EUR to fall.

        The price of currency forwards, are mostly determined by interest rate differentials, and only slightly by expectations of where a currency is headed…….the forwards are held in line by interest rate arbitrage, unless there is a crisis, and credit/repo lines dry up.

        The interest rate pickup for an investor, after hedging costs would be minuscule (if any), barring a financial crisis……not worth the trouble considering the currency hedge required.

        A bank or hedge fund, could theoretically make some real money by leveraging the trade many times, if the forwards get out of whack (cheap to buy back the Euro).

      • David Richards Says:

        Shocked, of course you’re right altho I think it’s the other side of the same coin as currency expectations are linked to expectations for interest rate differentials. So when US interest differentials and USD were both rising, it was cheap to hedge EUR and great to use EUR to fund a carry trade long UST’s (or some foreign buyers of UST simply bought them FX-unhedged). Those days are gone and were a precipitating factor, in my view, of the repo crisis which isn’t over as far as I can tell; something’s very wrong with the financial system and a bigger financial crisis lurks ahead. Cheers.

      • ShockedToFindGambling Says:

        David…pretty much agree.

        My view on the Repo crisis is that there is a shortage of cash in the banking system because the big money is afraid to leave their money in banks, because there is only $250,000 of FDIC insurance, so they go into T-Bills, short term Govts., which cannot default (at least in theory).

  4. Judd Hirschberg Says:

    We welcome Notes readers to join the live interactive conversation.
    Send us a note @ and you’ll be sent a link to the room when Yra comes in for a chat.

  5. kevinwaspi Says:

    None of the ‘enlightened leaders’ should be surprised that wages have not kept up with the “no inflation” environment these central bankers have created. When the cost of capital is zero, it will be substituted for labor infinitely. The part that really rags me though is the ” hedonic quality adjustment” magic that passes as economics.
    Does anyone outside of the castle walls really believe that we need to raise the PCE to 2% or more?
    THIS nonsense more than any will destroy fiat currencies faster than you or I can remain current in our obligations!

    • David Richards Says:

      Kevinwaspi, indeed. Grant’s printed a wonderful public Memoriam for Paul Volcker, part of which I cut-n-paste below because there’s no url link to it:

      As his post-Fed career proceeded in tandem with decades of rising bond prices and waning price inflation, Volcker remained a steadfast voice for clarity of purpose at the central bank. At the spring 2006 Grant’s conference, an attendee asked the former chairman about the increasing emphasis on “core” inflation (i.e., excluding food and gas prices) as opposed to the broader headline metric. Volcker responded:

      “I share the suspicions implicit in your question. A great mantra of central bankers these days is ‘inflation targeting.’ I don’t understand that nomenclature. I didn’t think central bankers were in the business of targeting inflation. I thought we were supposed to be targeting stability. We all say we are in favor of stability. You hear these speeches, [then Fed chair] Bernanke saying, ‘We are in favor of stability. That is why we target inflation.’ There is a certain semantic problem for me in that connection.”

      Indeed, the nearly four-decade decline in interest rates which followed Volcker’s term has fostered a philosophical shift regarding the erosion of purchasing power. The Financial Times reported Dec. 2 that the Fed may soon implement so-called symmetrical inflation targeting, i.e., actively seeking a measured rise in prices of more than 2% to “make up” for past shortfalls. That policy change has garnered broad support, as both chairman Jerome Powell and New York Fed President John Williams have referenced a “symmetrical 2% inflation target” in recent speeches.

      The shifting inflation mandate assumed by the Fed bears decreasing resemblance to the law which governs the central bank. As historian Alex J. Pollock noted in the July 13, 2018 edition of Grant’s Interest Rate Observer, “The Federal Reserve Reform Act of 1977, for one, does not say ‘price stability.’ It does in particular not say ‘a stable rate of inflation.’ It says, ‘stable prices.”

      For his part, Volcker had this to say about inflation mission-creep from the Grant’s speaker’s podium in 2006:

      “I can remember my old professors at Harvard, in 1951 or so, saying a little inflation is a good thing. ‘We don’t want very much, but 2% is good.’ Of course, 2% is OK or even good, 3% isn’t so bad, but if you get into a little problem, do you even worry about 4% or 5%, or do you redefine the index and take out everything that is rising?”

  6. Chicken Says:

    Thought provoking to say the least.

    Central banks are defined by their litany of compounded felonies.

  7. Recoba Says:

    Repo Crisis: Shocked, the whole reason Repo market was created is due to inadequacy of FDIC insurance for large depositers. Large depositers deposit their cash at banks and brokers dealers, receive the repo rate, but also receive Treasuries as collateral in case the bank goes bust. While their is some risk due to volatility of treasuries and costs to liquidate, the haircut&collateral in theory protects large depositers from losing their cash in case of bank failure.

    • ShockedToFindGambling Says:

      Recoba…..safer and easier to buy Treasuries than deposit cash and do Repos……there have been problems……look at the work of Manmohan Singh, before you decide to trust the Repo market.

      i was once told by a bank that that can change the ownership of specific collateral 20 times per second…..makes you think.

      After Lehman went down, my recollection is that people were fighting over the Repo collateral for years…… don’t want to have your Repos at a bank that goes under.

      Also, I believe that when doing an overnight Repo (where most of the volume is), the Repo loan is converted back to cash in a bank account, until the next night’s repo is arranged and confirmed, so there would be some time period that you are sitting in cash at the bank.

      Tri-party repos should be safer.

    • David Richards Says:

      Some good comments. Also look at the work of global capital flows expert Martin Armstrong for a perspective on repo and the coming “mother of all financial crises” due to unserviceable sovereign debts worldwide (cue Jerome Powell: we have a printing press).

      What happens when for various reasons, UST’s are no longer accepted as full collateral? Like with foreigners who are returning their UST’s “back to sender”? And increasingly seeing USTs discounted abroad for collateral purposes. Simultaneously the US flooded the market with USTs to fund the spendthrift but insolvent US gov’t. And US repo went ka-BOOM!! Exactly as some bright ppl (not me) said would happen months earlier.

      Fed was forced to step in or see US interest rates soar, which the insolvent US gov’t can’t tolerate. The escape valve has been the value of USD, which has been falling since shortly after US repo broke, after an initial brief move higher in a kneejerk false move typical of markets. I’m just surprised the broad-based USD weakness this autumn hasn’t been worse. So I’m expecting more USD weakness in the coming months or so – we’ll see.

      IMO there’s a consequence. Don’t own dollars or govt bonds. Like many retail investors do, bigly. Who could take a huge haircut again as they have twice already since the turn of the century.

      • ShockedToFindGambling Says:

        Dave….good analysis.

        The ominous fact, being mostly swept under the rug, is that in what almost everyone says is a pretty good U.S. economy, the Federal deficit is increasing

        It should be falling, at this stage in the business cycle.

        Should we get a decent recession, most of believe the deficit will explode……so what happens then?

      • David Richards Says:

        Shocked – Agreed on all that. Except, no worries because, to quote Jerome Powell, “they have a printing press”. LOL.

      • David Richards Says:

        Shocked – About that rising deficit at this pt in the cycle, one thing DC agrees on nowadays is that US deficits don’t matter anymore, which is ironic, because, as is evident from events discussed above, deficits have indeed begun mattering now more than before when foreigners were willing to fund US deficits (as they no longer are).

        Thing is, by the time government finally comes to a consensus on something, it’s usually the sign to start going the other way.

        So indeed, I agree the rising deficits now are “very ominous”.

        And so is the “inflation is Dead” cover on The Economist with the picture of the dinosaur. A classic contrary indicator. Gov’t and MMT proponents have seized on this “no inflation” paradigm. But, history shows that in thousands of years of societies rising and falling, not one of them turned to deflation to resolve the big debt problem they all inevitably created – it has ALWAYS been inflation instead. With memories of the 1930’s still prevailing in the US, can anyone expect the gov’t policymakers to turn to debt deflation instead of debt inflation?… I don’t think so… Powell’s and Williams’ ““symmetrical 2% inflation target” speeches recently show policymakers are determined to ramp inflation. Having worked & lived in the 1970s, I’d say good luck shoving that inflation genie back in the bottle after she gets out.

        I’d bet the gov’t is WRONG on both. Deficits DO matter. And inflation is far from dead. Stagflation and malaise ahead. We’ll see.

      • ShockedToFindGambling Says:

        Dave…..agree with everything you said.

        My guess is that we get a deflationary recession (or worse), followed by massive QE, NIRP, ZIRP, followed by high inflation (due to money printing, not real demand for goods and services).

        I believe the Japanese started QE, and when Bernanke went all in on it, he set in motion a financial Doomsday Machine, with no good way out.

        With all that education, you would think Bernanke could have come up with his own bad ideas.

      • yraharris Says:

        David–what is BIGLY

  8. kevinwaspi Says:

    David, Excellent of you to post the tribute to PV from Grant’s.

  9. yraharris Says:

    Shocked—-let us not forget that the JAPANESE actually had REAL DEFLATION so that when yields on JGBS dropped to 20 basis and 97% 0f JGB owned by domestic investors the real return was a positive 150 basis points of real yield—no other place can claim that outcome and it is a huge factor which the others fail to acknowledge .I know the bernanke/liesman coountefactual bubble machine would claim they prevented it from taking place in the US—-must be on the Casey Jones express

    • ShockedToFindGambling Says:

      Yra…..I’ve said this before on NFU..

      2009-2019 is 2002-2008, on steroids.

      Why would you expect a better outcome?

      • yraharris Says:

        Shocked —yes this has been discussed over the last ten years as it was 12/17/09 that NFU was first published—ten long years
        Thank you and the last two BLOGS with the wonderful discussions has been a labor worthwhile

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