Fed Sees Labor-Market Slack Even as It Trims Bond Purchases

The Federal Reserve said slack in the labor market persists even as the economy is picking up, and it continued to trim monthly asset purchases that have pumped up its balance sheet to a record $4.41 trillion.

“A range of labor-market indicators suggests that there remains significant underutilization of labor resources,” the Federal Open Market Committee said today in a statement in Washington. “The likelihood of inflation running persistently below 2 percent has diminished somewhat.”

Policy makers tapered monthly bond buying to $25 billion in their sixth consecutive $10-billion cut, staying on pace to end the purchase program in October.

Fed officials led by Chair Janet Yellen are stepping up a debate over when to raise interest rates for the first time since 2006 as unemployment falls faster than expected and inflation picks up toward their 2 percent goal.

The outlook brightened today with a government report showing the economy expanded more than forecast in the second quarter. At the same time, Yellen has expressed concern about persistent signs of labor-market slack, including low wages. The FOMC repeated it’s likely to reduce bond buying in “further measured steps” and to keep interest rates low for a “considerable time” after ending purchases.

Committee’s Objective

“Inflation has moved somewhat closer to the committee’s longer-run objective,” the Fed said. Its preferred inflation gauge -- the personal consumption expenditure price index -- rose 1.8 percent in May from a year earlier. Its 12-month gain was as low as 0.8 percent in February.

“They are protecting their credibility” by flagging less risk that inflation will persist below their target, said Mark Vitner, senior economist at Wells Fargo Securities LLC in Charlotte, North Carolina. “Inflation has moved from a reason for the Fed to be easier for longer to more of a neutral factor in policy.”

Stocks gained while bonds remained lower after release of the Fed announcement. The Standard & Poor’s 500 Index increased 0.1 percent to 1,971.75 at 2:38 p.m., while the yield on the 10- year Treasury note rose nine basis points to 2.55 percent.

Philadelphia Fed President Charles Plosser dissented, objecting that the guidance on the timing of a rate increase was “time dependent” and didn’t reflect “considerable economic progress.”

Bond purchases will be divided between $15 billion in Treasuries and $10 billion in mortgage-backed securities.

Achieving Goals

Since meeting in mid-June, the committee has come closer to achieving its goals for stable prices and full employment. Employers added 288,000 jobs last month, helping push down unemployment to 6.1 percent, the lowest in almost six years.

Today’s Commerce Department report showed gross domestic product expanded at a 4 percent annual pace in the second quarter, confirming the Fed’s view that a first-quarter contraction was transitory.

Consumers, whose spending accounts for 70 percent of the economy, have grown more confident as the labor market improves and rising share prices boost wealth.

The S&P 500 index is up more than 6 percent this year after jumping almost 30 percent last year, aided by easy monetary policy and rising corporate profits.

Almost 77 percent of companies in the S&P 500 have posted second-quarter results that exceeded analysts’ estimates, according to data compiled by Bloomberg.

Slow, Steady

The recovery in demand has “been slow and steady,” said Mike DeWalt, corporate controller for Peoria, Illinois-based Caterpillar Inc., the world’s biggest maker of construction and mining equipment.

Yellen told lawmakers this month that while her view of the economy has turned “more positive,” she’s concerned about signs of job-market “slack” such as low participation in the labor force.

“We need to be careful to make sure that the economy is on a solid trajectory before we consider raising interest rates,” she said in her semi-annual testimony. “There are mixed signals.”

Among them: average hourly earnings fell or were stagnant in the past four months, after adjusting for inflation.

“The most important thing is to look at what’s going on with hourly wages,” according to Brian Jacobsen, who helps oversee $232 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin.

Flat earnings will probably compel policy makers to err on the side of keeping rates low, said Ellen Zentner, a senior economist at Morgan Stanley in New York.

“This is a Fed that’s going to have to be slapped across the face with higher wage growth before they raise interest rates,” she said in a July 25 Bloomberg Radio interview. “And we just haven’t seen any kind of data that points to that yet.”

--With assistance from Tom Keene in New York.

The Two Faces of Coal

Over the past two and a half decades, a real dichotomy has emerged in the global coal markets. In the Western world, coal consumption is on the decline. If you live in the West and read news articles about coal in the West, you might think that coal consumption is on the decline globally. But you would be very wrong.

In the US, coal consumption has been flat to declining for the past 20 years. Just since 2007, US coal consumption has fallen by more than 20%. This is the primary reason the US leads all countries in reducing carbon dioxide emissions over that same time period. Last year, the US still accounted for 11.9% of the global demand of coal, but the 455.7 million metric tons of oil equivalent (Mtoe) that the US consumed was roughly the amount we consumed in 1987.

The story is the same in the European Union (EU). Since 2007, coal consumption in the EU has fallen by 12%. While the consumption decline since 2007 is not as dramatic as that in the US, the decline in EU coal consumption since the late 1980s has been greater. In 1989, US and EU coal consumption were almost identical (480.5 Mtoe for the US versus 487.6 Mtoe for the EU), but then consumption in the EU fell sharply during the 1990s. Today the EU share of the world's coal consumption is 7.5%.

The story of declining coal consumption in recent years holds true for most of the developed world. Canada, Australia, and New Zealand have all seen their coal consumption decline since 2008. Japan's coal consumption was on the decline until the 2010 Fukushima nuclear power plant accident, but has been increasing since as Japan tries to make up for the loss of nuclear power. Germany is a notable exception in the EU. It has seen coal consumption rise in three of the past four years, but there too the general trend for the past 40 years has been sharply lower coal consumption.

Consider that in 1980, the US, the EU, and Asia Pacific each consumed! some 400 to 500 Mtoe of coal. EU coal consumption never went much beyond that level before beginning to decline to the current level of 285.4 Mtoe. US coal consumption rose a little bit, but topped out at 574.2 Mtoe in 2005.

But in the developing world, coal consumption trends have been very different. In fact, coal's gains in the developing world are hard to put into perspective. This graphic should help:

In 1980 the combined coal consumption of the US and the EU was 866 Mtoe. Today, the combined coal consumption of the two is 741 Mtoe. But the increase in Asia Pacific's coal consumption since 1980 is 2196 Mtoe — nearly triple today's combined coal consumption of the US and EU.

China is the world's top consumer of coal, and was responsible for the largest share of Asia Pacific's gains since 1980. Of the 2196 Mtoe increase in coal consumption, China was responsible for 1620 Mtoe — 73.8% of the total gain.  This represents a more than six-fold increase in China's coal consumption since 1980, which is of course partially explained by the outsourcing of manufacturing from developed countries.

No other country comes close to China's coal consumption. In 2013, China consumed 1925 Mtoe, 50.3% of the global total. The US was a distant second at 456 Mtoe (11.9% of the global total), followed by India at 324 Mtoe (8.5%), Japan at 129 Mtoe (3.4%), and Russia at 93.5 Mtoe (2.4%).

China also produces the most coal. The 1840 Mtoe mined there in 2013 was 47.4% of the world's total, but not enough to satisfy China's coal demand. As with the consumption figures, the US was also a distant second in production at 500.5 Mtoe, which was more than the US consumed and 12.9% of global consumption. US coal exports are on the rise as a result. Following the US in coal p! roduction! were Australia at 269 Mtoe, Indonesia at 259 Mtoe, and India at 229 Mtoe.

Australia and Indonesia both produce far more coal than they consume, and as a result they are major exporters to Asia. In fact Australia is the world's top coal exporter, with nearly 90 percent of its exports destined for Japan, China or South Korea. US coal producers would love to expand into this market but are at a geographical disadvantage. Further, there aren't many options for US producers wishing to export coal from the west coast. As a result, most US coal exports are destined for Europe.

Nevertheless, the US has 26.6% of global proved coal reserves — the most of any country and enough to produce at its 2013 rate for 266 years. At current market prices for coal, these reserves would be valued at some $15 trillion, so there will be tremendous incentive to mine this coal.

Following the US in coal reserves are Russia with 17.6% of global reserves, China with 12.8%, Australia with 8.6%, and India with 6.8% of global reserves. Each of these countries has enough proved reserves to produce coal for at least 100 years at 2013 rates except for China, which has only enough reserves for 31 years of production at its 2013 consumption rate. Russia, on the other hand, has enough proved coal reserves to produce at its 2013 rate for over 450 years.

Conclusions

The global coal markets are the story of skyrocketing consumption in the Asia Pacific region that far more than offsets the consumption declines in the West. The US has the world's largest coal reserves, and because the US Environmental Protection Agency is attempting to phase coal out in the US, coal producers would like to grow their coal exports. However, these producers are constrained by geography and the availability of west coast coal export terminals in tapping into the growing Asia Pacific market.

The coal sector is one that I have not generally favored for several years. There are some opportunities, but pitfalls abound. Mo! re coal p! roducers are likely to end up as the James River Coal Company (OTCMKTS: JRCCQ), which was forced to declare bankruptcy and is planning to auction off its assets as a result of falling coal demand. But even in sectors with such a bleak outlook, sometimes a true bargain may appear. When it does, we will bring that to your attention in The Energy Strategist.  

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