Economic Trends and Risks

Count Your Blessings

Year end leaves some time for perspective and a broader view for the year ahead.

The recent economic news continues to be grim.  Consumer confidence reached a new record low in December (since 1967 start), home sales and prices haven't shown any lift and the weekly data on unemployment claims is the highest in over a quarter century.  

However, the new year brings a new president and administration to lead the U.S. come late January.  The size of the discussed stimulative package makes clear the weight of the economic task as new leadership is hoped to bring a rise in optimism.  The Fed's 2008 policy easing will be better reflected by a stronger economy in the new year. 

The Fed expects the economy to emerge from recession in 2009 despite a continued rise in unemployment as inflation falls off.   The consensus among economists is the same.  And while the economic/financial downturn has been severe it comes far short of the depression it's too often compared to.

                     Federal Reserve Economic Projections (October 2008)

                                      2009                  2010                  2011

  Real GDP               -0.2% to 1.1%      2.3% to 3.2%     2.8% to 3.6%

  Unemployment       7.1% to 7.6%      6.5% to 7.3%     5.5% to 6.6%

  PCE Inflation           1.3% to 2.0%      1.4% to 1.8%     1.4% to 1.7%

The outlook is for a brighter 2009.  Take time to count your blessings (yes, good fortune) as 2008 hopefully didn't have the same effect on your life as it did on the players in the headline stories (e.g.  Lehman's bankruptcy, Madoff's victims and others). 

Happy New Year !!

2009 Outlook

The 2009 economic outlook depends largely on the 2009 fiscal stimulative package which remains undefined.  The outlook presumes an extremely large package (upwards of $800 bln) but its make up will provide more detail on when the weight of the government spending hits the economy. 

Fed policy easing has pushed the policy rate down to a record low 0% to 0.25% range.  The central bank will continue to ease policy through programs aimed at providing needed liquidity in an effort to tighten interest rate spreads and loosen the credit crunch. 

Overall economic growth, as seen through GDP, is expected to show a tremendous -5.5% to - 6% drop in the fourth quarter of 2008 with lighter declines expected over the first half of 2009.  Obviously the make up of the stimulus package weighs in heavy here given an expected start up soon after Obama's January inauguration.   The stimulative boost should leave modest GDP gains over the second half of the year.  If the economic decline continues through April the duration of the current recession will be the longest since the Great Depression. 

As noted there are large risks to any economic outlook right now as the poor fundamentals add to a severely injured financial market which has tightened up lending -- an engine of growth and the payoff of low interest rates. 

The rough outline offered for the 2009 fiscal stimulative includes tax cuts for the lower and middle class.  These cuts will have a far larger effect than the "refunds" offered in 2008.  A permanent rise in take-home income carries more punch than a single government check.  The election talk of higher tax rates on the top income brackets are expected to be delayed as will any upward shift in capital gains taxes. 

Obama plans on significant spending on infrastructure which has a delayed effect given the longer period needed to start up projects on highways and bridges.  However, the projects will provide a longer flow of payments and provide a boost to job creation.  The New American Jobs Tax Credit will also accelerate job creation by awarding businesses a tax credit for employee hiring.

Huge fiscal spending, dead low interest rates and the massive liquidity provided by the Fed should pull the economy out of recession near mid 2009.  But the path will be filled with plenty of ugly reports on the economy.

The unemployment rate may peak in the mid 8% range and deflation fears (remember inflation fears just 6 months ago) will be heard as the drop in energy prices adds to the intensifying price concessions the recession is bringing.  The massive Fed easing through money creation won't stop the worries on Wall Street.

The risks to the recovery are numerous.  The tight credit conditions continue to slow business and consumer investment as housing foreclosures follow (and lead?) the downward path of home prices.  Rising unemployment, falling home values and the plunge in the stock market have turned consumer spending to declines over the second half of 2008 with no expectation for an intermediate term turn in those leading indicators.  The financial markets remain at a tipping point with more negative surprises likely (can they top the $50 bln Ponzi scheme?). 

Drastically lower energy prices provide a lift as the outlook swings on the timing and composition of Obama's fiscal stimulus.   It's a tremendous test as the new president settles in to the Oval office. 

2008: Recession and Fear

I'm starting a 2-piece article on the economic outlook with a review of the 2008 economy as the 2009 outlook comes next week.  Charts tell the economic story pretty well, the text  highlights key details.

GDP -- gross domestic production and the big Kahuna of economic indicators -- edged lower in Q4 2007 and started off the recession in December of last year.  Foreign demand and fiscal stimulus provided a boost over the first half of 2008.  The GDP decline in the third quarter will pale in comparison to what we now see as a -4% drop in Q4. Inflation was elevated in the first half due to a run up energy prices which turned lower with astounding force over the second half.

Housing started off the economic downturn as new home sales stand at a 18 year low and prices have fallen -17% from the early 2007 peak.  Abysmal mortgage lending was worsened by falling prices which still leave a huge supply of foreclosures and poor underlying conditions.  The unknowns behind the mortgage backed securities which include the ugly debt spawned financial fears in almost everything which wasn't government backed.  The credit crisis has deepened the recession and will slow its end.

Payroll employment showed declines throughout 2008 as the unemploymentrate accelerated higher.  Accumulated payroll declines are now larger than during the last two recessions after the mammoth -533K plunge in November.

Rising unemployment, falling home prices and equity values as well as a laundry list of other consumer concerns left consumer confidence at a record low in October as weak consumer spending is a key concern given its force in the economy.   Consumer spending has been on the decline since July as real (inflation-adjusted) spending in Q4 may rival the nearly -4% annualized decline in Q3. 

Fiscal and monetary policyhave been quite active but unable to revive the economy.  Another fiscal stimulative package (near $600 bln !) is expected in early 2009 after the brief pop from the smaller 2008 package.  The 12 month budget deficit is currently more than $700 bln with a trillion dollar deficit ($1,000,000,000,000) roughly expected over the current fiscal year.

The Fed policy rate has been pushed to a 0% to 0.25% range -- the lowest in history.  The Fed has been quite active with extremely large, nontraditional operations aimed at backing up risky debt and providing needed liquidity. 

 

Its been a very ugly year.  Raise a glass to a better 2009 and the year end holidays!

Zero Interest Rate Policy Stimulus

The Fed continued easing policy rates at today's policy meeting by setting a target range for the overnight federal funds policy rate of 0 to 1/4% rather than a specific rate target.  The range allows for some modest volatility as large reserve flows provide some swing to the daily policy rate.  The policy rate is now the lowest on record.  With the policy rate near (at?) zero what does the Fed do stimulate policy from here?

The advent of near zero interest rate policy really began even before the policy meeting as the vast non-traditional stimulus to add liquidity and support the credit markets has left short term interest rates knocking at 0% floor.  In fact, last Wednesday the funds policy rate averaged just 0.11% as 1- and 3-month Treasury bills traded at 0%. 

Just how the Fed will ease policy from here out gets far less clear as "quantitative" easing rather than traditional interest rate easing is forced by extremely low rates.  Quantitative easing simply means that the Fed expands its balance sheet by adding reserves into the banking system without adjusting the policy rates.  We"ve already seen a massive increase in Fed assets to $2.3 trillion in the latest week from less than $1 trillion in mid-September.  We ran over these numerous programs in anOctober 9 post titled Everything but the Kitchen Sink. 

The policy statement noted that "the focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level.  As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant.  The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities.  Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses.  The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity."

Holiday Cheer -- Lower Energy Prices

The headlines still bring frightening economic news.  Today's unemployment benefit claims rocketed higher as the Treasury budget deficit rose to over $700 bln over the last 12 months given the '08 tax rebates and the early TARP (Troubled Asset Relief Program) spending.

There is a whisper of holiday cheer underlying much of the data though its offset by evil grinchs elsewhere.  Tomorrow's producer price index (PPI) will reflect the tremendous drop in oil prices which also frees up spending/savings, boosts business investment, narrows the trade deficit, lifts confidence and supplies very needed aid to economic growth.

 

From the early July peak oil prices has fallen over $100 or 70%.  That's tremendous!  We saw some of the effect in today's import prices and trade deficit.  November import prices are now -4% lower from a year ago compared to the 21% year ago rise in July -- thank energy prices.   And while the trade deficit is little changed its based on large petroleum imports which will slow with the weak economy (demand) and lower oil prices. 

The abrupt turn in inflation concerns comes from the drastically lower energy costs (as well as the recession) and allows the Fed to ease overnight rates below 1% at the next FOMC meeting in mid-December.  The drop in gasoline prices provide some offset against the extremely depressed consumer confidence indices.  And while the lower prices provide the ability to spend more on other items, the immediate effect is the drop in gasoline stations sales which tomorrow's retail sales data should show to be about $12 bln lower from the July peak.

The thumbnail estimates argue that for each sustained $10 fall in oil prices the economy is boosted by 0.3%-0.5% and inflation is trimmed by 1%.  However, sustained is a key word in that sentence as OPEC and the economy have the power to vastly swing oil prices.  I don't expect to see crude oil prices below $60 /bbl in a year. 

Credit Crunch

While we all hear about the current credit crunch, few know where to turn to see the effects on consumer and business borrowing.  We've summed up a few sources in today's column.

Consumer credit was released Friday and was pushed aside by the horrid news in the employment report.  Declines in monthly household non-mortgage loans are infrequent but came in both August and October.  Over the last three months consumer credit has fallen -$4 bln compared to the $25 bln average rise over the last five Aug-Oct periods.  The declines have been heavier in the non-revolving component weighed down by reduced auto loans given the quarter century lows in sales.  Annual growth has slowed to just 3%, the lowest in fifteen years.

Business loans, commercial and industrial (C&I) loans, are a bit tougher to understand.  Most of the confusion is tied to the switch from high priced commercial paper toward bank lending for many companies.  The Fed's weekly report shows that C&I loans have risen 10% in 2008, below the stunning 22% rise in 2007 but hardly as flat (or negative) as one would believe given all the talk of a severe credit crunch.

The severity of the credit crunch is better presented in the Fed's Senior Loan Officer Survey which showed that 84% of banks tightened C&I lending standards in the fourth quarter -- above the peaks of both of the last two recessions.  Despite tighter standards the tough financial market is still bringing in the lending as the self-financed method (commercial paper) is proving too costly.

The Fed's report also noted reduced demand for business loans given the slower pace of the economy.  Commercial real estate borrowing was also tightened up by 85% of banks.  Residential real estate lending -- on prime, nontraditional and subprime -- fell to 70% of banks tightening lending standards from a larger 75% in the prior quarter.  60% of banks reported tightening standards on personal credit card loans while 65% reported tighter standards for other consumer loans.

The credit market provides the means to spend or invest when cash isn't available.  The continued tightening of lending standards for both business and consumers helps leave private domestic demand on the decline after a -4% drop in the third quarter.

Employment Plunges Over a Half Million

The November employment report really drove home the depth of the current recession.  Payrolls fell by more than a half million workers (-533K) as downward revisions to the prior two months added another -200K to the reported declines.  The November decline is the largest in over three decades as employers have shed 1.3 million workers over just the last three months. 

The effect on the unemployment rate was less severe with an 0.2% rise to 6.7% after the 0.4% gain in October. 

Comparing the current recession with the last two shows a worsening as the duration has already exceeded the 8 month declines during the 1990 and 2001 economic downturns.  Both the growth in the unemployment rate and the number of lost jobs have exceeded the movement in both of the prior recessions.

 

As one would imagine given the size of the November payroll decline, it was broad based leaving only the education and health services with a significant gain.   Professional and business services was the biggest loser given the sharp decline in temporary help.  Retailers shed 91K (at the start of the holiday malling) as construction and manufacturing each gave up more than 80K.

The workweek shortened to 33.5 hours as hourly earnings growth edged higher to 3.7% from a year ago -- somewhat encouraging given the sharp rise in unemployment.

Growing unemployment carries right in to further declines in consumer spending given the resulting drop in income growth.  Yesterday's report on factory orders showed a 3 month decline of -12% and argues for a stronger fourth quarter decline in business investment.  Those and the deeply depressed residential investment make up private domestic demand -- the heart of economic growth.

Recession Startdate Confirmed, Already Longest in 1/4 Century

The startdate of the current recession was finally confirmed as December 2007, in synch with my expectations outlined in earlier Oct 21 and Jun 19 posts.  The recession is already a year old and longer than the two previous recessions (both 8 months) and to date the longest since the 1981 downturn.  All the recessions since the Great Depression held to 16 months or shorter as current conditions argue that the current recession may show the longest duration in 80 years.

The Fed will continue to fight off the recession with both policy easing and unconventional methods.  I expect the December 16 FOMC meeting to end with a 50 basis point (1/2 %) ease to leave just an 0.5% overnight policy rate.  Based on our monthly data the federal funds policy rate has never been so low.

The unconventional tools include more of the lending and excess reserve creation seen for over a year as further steps may include buying up longer term Treasury securities in an effort to push longer term rates lower as well.  The end result is lower mortgage and business borrowing rates which help stimulate economic activity.  The Fed lending continues to cushion a liquidity crunch worsened by reduced credit availability.

Further fiscal stimulus is also expected.  Estimates near $500 bln are being tossed around as the wait for Obama's inauguration is required if bipartisan efforts can't pull it together before mid January.

Recent Releases

Since our last post the economic news shows a continued slowing in activity.  Durable goods orders (read business capital goods demand) fell -6% in October.  The third consecutive decline leaves a -12% fall over the last three months.  The -1% plunge in October personal spending more than triples the size of the September decline and threatens an even larger fourth quarter decline than in the third quarter.  New home sales continued to a lower 18 year low, down a massive -70% from its peak.  

Yesterday's report from the ISM on manufacturing was below the quarter century low of October as was new orders.  Manufacturing input prices fell to a 60 year low from a 30 year high just five months earlier in June.