The new month brings forth fresh data to gauge the health of the US economy. But no one expects the patient to wake from his coma just yet.
Indeed, the deluge of depressing data will likely prompt the Fed to cut the Fed Funds target at least 50bp, although it is not obvious that anyone believes further cuts will have any practical impact at this point. As the Fed repeatedly proves, the action is on the balance sheet side of policy. And even there, monetary policymakers are now fighting a rearguard action, simply trying to prevent the financial tailspin from taking the economy further into the abyss.
The data flow during the last two weeks of November was nothing but bleak; the numbers speak clearly of a deepening recession. If you had any doubt that the credit crunch is causing firms to shelve capital expenditure plans, you had only to look at the durable goods release.
New orders of nondefence, nonair capital goods slid 4% in October, extending what is now a three month decline. This number also likely reflects slowing export activity as the global slowdown pulls one of the last rugs out from under the US economy.
Not surprisingly, regional surveys suggest manufacturing weakness extended into November, a hypothesis that is likely to be confirmed by this morning’s ISM report. The question is not whether the report will be bad; it is how bad it will be.
The underpinnings of consumer spending continued to deteriorate as well. Via the Case-Shiller numbers, we learned what most suspected - housing prices continue to decline seemingly unabated in September, a decline that likely reflects only the early stages of the most recent phase of the credit crunch.
The Fed made an attempt to lean against this trend, announcing a plan to purchase agency debt in an effort to pull down mortgage rates. This will provide some marginal support to housing, if at a minimum by raising affordability slightly, but I doubt anyone expects it to work miracles. A larger impact is likely to come through the reported wave of refinancing the Fed’s action triggered – support for those who are not underwater on their mortgages.
Still, any refinancing gains, which extend the boost from lower gas prices, will be fighting against rising joblessness. Indeed, jumping initial claims in November foreshadow a dismal employment report Friday. The weight of the deteriorating labor market is revealed by the October Personal income and Outlays report; revised figures on private wage and salary disbursements revealed stagnant income growth. The multiple weights on consumers – housing markets, inflation in the first half of the year, declining equity markets, higher unemployment, and reduced access to credit – finally broke the fabled US consumer, with personal consumption expenditures now down for five consecutive months.
As household balance sheets deleverage, saving rates are edging up, rising from 0.6% in August to 2.4% in October. Ultimately, a sustained rise in household saving rates works to the benefits of households, providing an economic cushion, etc. In the short run, however, it plays havoc with the economy, especially if firms too are postponing spending.
A simple, yet powerful argument for fiscal stimulus – the credit crunch in the second half of the year has opened a gap in activity that the federal government can reasonably fill. Being a deficit hawk is unproductive now ; if the stimulus is too much, financial markets will send the appropriate signal via higher interest rates. Policymakers just need to listen; in theory, policy should be able to pull back if necessary.
If one were inclined to be optimistic, an argument could be made that the consumer really wants to spend more, and will do so when they realize the world is not going to end and they have money burning a hole in their pocket. In other words, the rise in saving rates is a temporary phenomenon.
For my part, I am not so optimistic; households are in the process of deleveraging, a process that is likely to continue until their balance sheets can be supported by their cash flow (income). I doubt this process can be easily reversed, especially as creditors are fundamentally reevaluating underwriting conditions. For a more pessimistic take, Rebecca Wilder sees signs that the deleveraging process has yet to even begin, at least with respect to credit cards.
In any event, we will have a month of debate on the resiliency of the US consumers, as we shift through what will certainly be daily, if not hourly stories, covering the all important holiday shopping season. Expect stories of hope and stories of despair. The truth will be somewhere in between.
The flow of data will put pressure on the Federal Reserve to ease further, although the exact nature of easing remains in doubt. While a policy target remains for the fed funds rate, endless debates over to what extent the Fed can lower rates below 1% represents nothing more than lost productivity. The Fed’s attention is elsewhere, focused on replacing dormant sections of financial markets, such as last week’s move by the Federal Reserve to support mortgage and consumer lending markets via $800 billion of new initiatives.
Indeed, Fed officials appear to believe that they have shifted to a policy of quantitative easing, but the exact policy target remains ephemeral. Is it nonborrowed reserves? Is it a target on long-dated Treasuries? Is it a money supply target?
These are what I would consider an explicit policy of quantitative easing. Or, as I suspect, the Fed believes that crisis management obviates the necessity of policy targets. The policy is simply to do whatever is needed on any given day to support the economy. These policies entail an expansion of the Fed’s balance sheet, which became defined as quantitative easing for lack of a better term.
For my part, I would like the next FOMC statement to explicitly define their policy of quantitative easing, but I suspect I will have to settle for their commitment to do “whatever is necessary” to support economic activity. I don’t see, however, how the Fed can actually move to a zero target rate without having an explicit quantitative easing alternative in place. Otherwise, policy simply wanders aimlessly from one lending facility to the next.
In any event, the Fed’s primary battle (in conjunction with Treasury) to prevent a recession has already been lost. Brad DeLong traces the loss back to essentially two policies' errors. The first was allowing Lehman Brothers (LEH) to fail, and the second (largely in Treasury’s court) was avoiding a partial or even full nationalization of the banking system as the Lehman collapse reverberated throughout the financial system.
With those decisions now irrevocable, attention is turned away from monetary policy to the previously mentioned fiscal stimulus. Of course, it is premature to completely divorce these two policy options – the Fed can provide support to fiscal stimulus by, for example, setting explicit targets for bond yields and then purchasing unlimited quantity of those bonds until the target is reached. Quantitative easing with a specific target…something that maybe just needs to wait until the next Administration is in place.
In short, incoming data will confirm that the US economy is locked in the throes of recession, placing pressure on the Fed to ease further. But as they are near or at the limits of traditional monetary policy, Bernanke & Co. will have to choose between defining explicit targets for quantitative easing, or leaving market participants guessing about the nature of the next lending facility. Policymakers are likely to opt for the former; ideas are floated by Federal Reserve Chairman Ben Bernanke here. We are left waiting for the details.