Economic Trends and Risks

Housing Turns the Corner

The housing data have been so horrendous for so long that the market is suspect to any apparent improvement.  But as home sales move from flat line to positive growth and the price declines give way to gains the housing market is finally showing some response to the record high affordability.  The first sector to fall victim to the economic downturn is strengthening and provides more reason to believe in the economic recovery which may already have started.

Existing homes include a large supply of foreclosures so require caution when making assumptions regarding the monthly report.  However, cleaner new home sales jumped 11% in June (20%+ gains in the three regions outside the South) with gains in all of the last three months after a record low in January.

Housing affordability has reached the highest levels in its 18 year calculation.  Lower home prices and low interest rates combine with the $8,000 federal tax credit for first-time home buyers to wave on borderline buyers understandably cautious of risk.

The home prices reported are not seasonally adjusted so exaggerate the recent improvement.  The key Spring sales season typically leaves prices peaking in June (shown by the blue dots in the chart below).  But here again, the lesser seasonal movement in new home sales shows gains in three of the last six months after reaching a March low. 

 

Supporting the argument that home prices are beginning to improve is the latest report from S&P/Case-Shiller.  Its index of 20 cities home sales rose in May as 13 of the 20 metro areas showed increases.  This is the first positive return since mid 2006 and the first broad increases in prices in 34 months.  Granted, the index is down -17% from a year ago but even that is the best in 9 months as prices slowly improve and suggest that the sector worst hit is on the road to recovery.

 

 

Bernanke's Monetary Policy Testimony

Fed Chairman Bernanke made his semi-annual testimony to the House to update Congress on the current economy and the path of monetary policy. 

The testimony started with some review of what the country has gone through.  "The financial shocks that hit the global economy in September and October were the worst since the 1930s, and they helped push the global economy into the deepest recession since World War II".   But noted that "the pace of [economic] decline appears to have slowed significantly, and final demand and production have shown tentative signs of stabilization".  In fact, the FOMC participants (i.e. those officials that direct Fed policy) expect output will increase slightly over the remainder of 2009.  The "recovery is expected to be gradual in 2010 with some acceleration in activity in 2011".

The focus was on the path ahead for monetary policy.  "The FOMC believes that a highly accommodative stance of monetary policy will be appropriate for an extended period."  The eventual exit from the extraordinary measures taken to provide needed liquidity through massive traditional (interest rate) and non-traditional policy easing requires some early explanation as the market fears an inflationary result if the Fed waits too long before cutting them back.

An array of options is open to the Fed to reduce the current massive supply of reserves in the banking system.  Draining reserves through traditional reverse repurchase agreements or outright sales of security holdings are added to by the Fed's ability to adjust the rate of interest paid on reserve balances and the resulting demand for those balances.  Bernanke did not mention the ability to raise demand for reserves by boosting reserve requirements (noted in the May 11 post).  More detail and alternatives are likely ahead as the testimony noted the attention the FOMC has devoted to the exit strategy.

The testimony also included a short listing of global reform needed to protect the financial system.  They included mechanisms for dealing with emerging systemic risks and stronger capital and liquidity standards.  Overall, a tighter system of financial supervision and regulation.  See the list and the full testimony in the Monetary Policy Report.  The far longer 54 page Report to Congress  lays out more detail. 

The table below are the Fed's revised economic projections released with the June 23-24 FOMC minutes on July 15.  Included are the prior estimates made at the April FOMC meeting.  2009 estimates have been revised stronger for all four measures of growth, unemployment and inflation.

                                                2009                  2010                 2011

Change in real GDP. . . . . .   -1.5 to -1.0          2.1 to 3.3         3.8 to 4.6

       April projection. . . . . . -2.0 to -1.3          2.0 to 3.0         3.5 to 4.8

Unemployment rate. . . . .      9.8 to 10.1          9.5 to 9.8         8.4 to 8.8

       April projection. . . . . .  9.2 to 9.6            9.0 to 9.5         7.7 to 8.5

PCE inflation. . . . . . . . . . .  1.0 to 1.4            1.2 to 1.8         1.1 to 2.0

       April projection. . . . . .  0.6 to 0.9            1.0 to 1.6         1.0 to 1.9

Core PCE inflation. . . . . .     1.3 to 1.6            1.0 to 1.5         0.9 to 1.7

       April projection. . . . . .  1.0 to 1.5            0.7 to 1.3         0.8 to 1.6

Strengthening Sales Despite Reduced Credit

An 0.6% gain in June retail sales was powered by vehicles and higher gas prices but the gain now leaves six month growth back in the black after standing at (an annualized) -4% in May and -14% in March.  We've noted the retail sales improvement in recent posts but a broader measure of sales is also on the mend.

Business sales combine sales from retailers, wholesalers and manufacturing and were released with today's report on inventories.  The modest -0.1% decline in May sales was the smallest in ten months as all three recover from the Q4 plunge.

 

Despite the continued strong declines in payrolls, a turn in trend for industrial production is all that's needed before the recession is considered unofficially over.  Business sales and the tax/refund induced rise in incomes leaves only payrolls and industrial production on the short list to signal a return to growth.  The official word from the National Bureau of Economic Research will arrive well after the recovery has started, as was the official word on the start of the recession. 

Tomorrow's report on industrial production is expected to show a decline of -0.6%, the smallest of the last eight months as the stabilization seen in factory orders (see June 30 post) is passing through to steadier production. 

 

A brief note on consumer credit, which by my records is showing the weakest annual growth since WWII.  Declines in seven of the last eight months leave a -2% decline from a year ago tied to annual declines in both credit cards and non-revolving credit (other non-mortgage household lending).  Banks remain tightfisted as reduced consumer demand has a part in this as well. 

 

Outlook for 2009's Second Half

Last week's post noted the bottoming out of residential and business investment as well as consumer spending.  These components make up private domestic demand and are the key elements to returning positive growth in the second half of 2009.

Not surprisingly my estimates don't vary greatly from the latest from the Fed (provided in the  late April FOMC minutes).  The Fed's revisions in August will include the latest data which suggest a stronger decline in 2009 GDP (gross domestic output) to near 2.8% from the Fed's -2% to -1.3% estimate.  I expect a very moderate rise in the current Q3 quarter and a stronger but  modest gain near 1.5% in the final quarter of the year after the dramatic plunge at the turn of the year.  Any number of factors can alter the outlook.

Last week's reports suggest that the rise in unemployment is slowing.  Continued claims for unemployment benefits may have peaked in late May (or could be due to run off as the long term receivers reach their end dates) as June unemployment rose just 0.1% after the 0.4% average of the prior six months.  I'm holding with a year end rate just below 10% as the Fed will boost its April estimate of 9.2% to 9.6%. 

Inflation will reflect the run off of the late 2008 plunge in energy prices and end the year with an annual growth rate above 1% from the near flat level currently.  I expect core prices (less volatile non food and energy) to continue to soften and end the year in the 1% to 1.5% range the Fed noted in April.  The inflation wary may want to note that the Fed doesn't see core inflation rising above 1.6% over the three year forecast horizon.