Economic Trends and Risks

Bernanke, Debt and Housing

I've just returned from a week in isolation on a small Maine island.  The economic news while I was away piled up.  The highlights include positive comments from Fed Chairman Bernanke as well as his presidential nomination to another four year term.  The CBO came out with its latest estimate for a $9 Trillion budget deficit over the next 10 years -- as a percent of GDP its equal to the cumulative deficit of the last 23 years.  A number of housing statistics continue to show an improving sector which showed the most dramatic decline during the (past?) recession.

The annual Federal Reserve meeting in Jackson Hole, Wyoming brought encouraging words from the Fed Chairman regarding the "leveling out" of the economy and prospects for positive growth in the near term (current quarter?).  Moreover, the improving economy, financial markets and possibly the fear of negative market reaction to the CBO estimates pulled President Obama from his family vacation to announce the nomination of Bernanke for a second term as Federal Reserve Chairman.

The bi-partisan Congressional Budget Office (CBO) released an estimate for a $1.6 trillion budget deficit during the current fiscal year "slimming" to $1.4 trillion in FY10 and $921 bln in FY11.  The $9 trillion sum over the next ten years almost doubles the cumulative deficits of the last 30 years.  We've heard how the President plans to better that outlook though taxation and the rationing of health care benefits.  Thankfully, the public is making its opinions equally clear. 

 

The CBO estimates included a 2010 GDP estimate of 2.8% (4th quarter to 4th quarter), a PCE price index of just 1.1%, unemployment just above 10% and low interest rates of 0.6% for 3-month T-bills (the start of Fed tightening) and 4.1% for the 10-year T-notes.

The upward trend in housing statistics also requires note.  Today's report showed July new home sales jumping 9.6% after a 9.1% hop in June and stand 32% above the January record low.  Existing home sales also showed a fourth consecutive gain with a 7.2% July gain to leave the strongest pace in two years.  Single family housing starts have been on the rise since January as total housing starts are 21% above the April low.  Even some of the home price data is encouraging as the Case-Shiller 20 city price report rose 1.4% in June -- the largest gain in four years!

 

Fundamental Drags on Consumer Spending

Despite the efforts of fiscal and monetary economic stimulus the consumer will be under the weight of large fundamental drags for quite a while.  The powerful effects of a high unemployment rate are also seen in negative income growth, restricting the ability to spend.  Lower equity and home prices have dragged wealth sharply lower.  Tighter bank credit adds another significant weight. 

Today's report of a small -0.1% decline in July retail sales came as the market looked for a gain just shy of 1%.  Excluding autos sales, retail sales fell -0.6% to leave annual declines larger than  -8% for both measures. 

 

The July surprise was the lack of a stronger lift from vehicle sales.  The Cash-for-Clunkers government program started at $1 bln as the Senate noted its huge success in driving buyers back in to the showrooms and boosted the program another $2 bln. 

While, like everything, the nay sayers have been criticizing the program wondering why the government doesn't cultivate sales of other products (like drugs where tax benefits seem to be now outweighing government caution), it certainly will help jump start growth.  The benefit to current quarter GDP could be more than 0.5%.  The program began at the turn of the month so expectations are that the car sales that didn't show up in July will appear in the August data.

Unit auto sales (as opposed to the dollar amount seen in retail sales) jumped 16% in July from June as the retail figure showed just a 2.4% gain.  Domestic car sales surged 26% as light trucks rose 9%.  With the extension of the program and an already lean inventory supply we're likely to see a significant boost from autos pull tomorrow's industrial production measure higher after showing only one gain in the last year and a half.

 

Although the July industrial production gain should be skewed by the strong (and temporary) rise in autos, the gain will provide another welcome boost to confidence.  The turn to a gain in industrial production is consistent with the ISM manufacturing survey which shows outright gains in manufacturing production over June and July.  The recession may have quietly ended though official reporting of the event is delayed.

 

Forecasting Payroll Growth

The market hand-wringing has begun as the important employment report looms Friday and carries the potential to shift sentiment and market direction.  There are plenty of early employment indicators but none with the ability to really tie down expectations.  A -300,000 market estimate for July payrolls comes with a wide 185,000 range (-375,00 to -190,000) owed to its volatility.  However, improvement is clear since the January low as the rise in the unemployment rate is slowing as well. 

 

The ADP estimate of private (non-government) payrolls carries attention as the company has a first hand view in its payroll check writing business.  The -371,000 ADP estimate for July is the smallest since October.  While above market expectations, the 90,000 average miss over the last three months provides a wide range for a miss. 

 

The weekly figures for those claiming unemployment benefits also shows improvement.  Normal seasonal swings from the July auto retooling clouded the effects from the tremendous layoffs the auto industry is going through.  The July payroll survey week showed initial claims (i.e. layoffs) -80,000 lower than the June survey week.  Continued claims (those unemployed) fell -460,000 possibly arguing for a dip in the unemployment rate.  The weekly numbers are volatile.

 

The ISM survey employment indexes showed continued strengthening in manufacturing as the service sectors showed the second decline over the last 5 months.  These measures have always had a loose correlation with the payroll data.

 

An important final note is that employment gains follow the end of the recession.  The timing of the eventual gains is uncertain but both of the last two recessions (which were far tamer than this one) showed gains well after the recovery started.  Current expectations for job growth are likely to make the "job-less" recovery of 2001-02 look relatively good given the weak pace of economic growth anticipated later this year and next.