I read the detailed minutes of the December 15-16, 2009 (pdf) Federal Reserves Federal Open Market Committee (FOMC) meeting. We know the FOMC made no changes in policy based on their meeting statement released last year - but the justification of their decision process is not revealed until the meeting minutes are issued.
What strikes me about the FOMC minutes is that they are basing their outlook on a normal credit driven recovery:
Market participants largely anticipated the decisions by the Federal Open Market Committee at the November meeting to keep the target range for the federal funds rate unchanged and to retain the “extended period” language in the accompanying statement. However, market participants took note of the Committee’s explicit enumeration of the factors that were expected to continue to warrant this policy stance, and Eurodollar futures rates fell a bit on the release. In contrast, the announcement that the Federal Reserve would purchase only about $175 billion of agency debt securities had not been generally anticipated. Spreads on those securities widened a few basis points following the release, but declined, on net, over the intermeeting period. Incoming economic data, while somewhat better than expected, seemed to have little net effect on interest rate expectations. Indeed, the expected path of the federal funds rate shifted down somewhat over the intermeeting period. Consistent with the decrease in short-term interest rates, yields on 2-year nominal off-the-run Treasury securities declined slightly, on net, over the intermeeting period. In contrast, yields on nominal 10-year Treasury securities edged higher on balance. Inflation compensation based on 5-year Treasury inflation-protected securities (TIPS) increased, apparently owing in part to an announcement by the Treasury of a smaller-than-expected amount of issuance of TIPS next year. Five-year inflation compensation five years ahead also rose, and was near the upper end of its range in recent years.
You get the drift. The discussion on cost of money consumes many pages of this eleven page document.
All these FOMC members are looking at each other without a clue how to fire up the economy - except to make sure low cost lending windows are open. They are pretty sure it should fire up by itself – it always has before, but they do not see any evidence of it yet:
Though the near-term outlook remains uncertain, participants generally thought the most likely outcome was that economic growth would gradually strengthen over the next two years as financial conditions improved further, leading to more-substantial increases in resource utilization.
Does this sound reassuring?
The issue is real economic expansion - not a banker’s or economist’s view, but a view of main street business. Small business specifically is the driver of jobs and REAL driver for economic expansion.
William C. Dunkelberg, chief economist for the National Federation of Independent Business (NFIB) issued the following statement in advance of its monthly economic survey that will be released on Tuesday, January 12:
Despite the holiday season, December didn't put small business owners in a hiring mood. Last month, small business owners reported a decline in average employment per firm of 0.5 workers reported during the prior three months, not much of an improvement from November’s loss of 0.58 workers per firm.
Ten percent of the owners increased employment by an average of 4.2 workers per firm, but 22 percent reduced employment an average of 3.5 workers per firm (seasonally adjusted). Growth from new firms will provide a positive nudge to the macro BLS numbers. But overall, the job-generating machine remains in reverse.
Flying in under the radar as it was released on the same day as the jobs report, consumer credit decreased at an annual rate of 8.5% in November 2009(pdf). Revolving credit decreased at an annual rate of 18.5%, and nonrevolving credit decreased at an annual rate of 3%. (Click charts to enlarge)
An interesting perspective from The Big Picture on this consumer credit release which was the largest decline in consumer credit ever:
To put the last decade of credit growth into perspective, nominal personal consumption rose 55% (same increase as overall GDP) while consumer credit rose 61% over the same period. Thus, highlighting how dependent on credit the US became rather than on savings in generating growth.
I continue to search for signs that an economic expansion is underway. I can build a good case that indicators are pointing to expansion – but there is no evidence that an expansion is yet occurring.
This week the Railfax report on rail movements added to my discomfort. We are rapidly approaching the transport levels of the darkest days of the recession.
What we consume must be transported. The economy cannot be improving if transport levels continue to decline.
According to Bank of Tokyo – Mitsubishi, chain store sales rose 2.4% YoY in December 2009. Yes, better is better. Here are unadjusted sales to understand just how bad 2008 sales were – and that the YoY comparison does not say much. Christmas sales in 2009 were almost equal to those of 2005 even though the population has grown over 5% and we have had price inflation over this reporting period.
Jobs
No question the jobs situation at the end of 2009 is significantly better than the beginning of 2009. Non-governmental data sources such as Challenger and ADP are still witnessing job contraction – but now at an ever slowing rate. This is good, but it does not mean there is an economic expansion underway.
Challenger reports on their part of the job universe – and does not try to build an overall picture. This is to be taken with other data you receive. Their statement:
Just 11 months after reaching a seven-year high, job-cut announcements fell to their lowest level since the beginning of the recession in December, as employers announced plans to eliminate only 45,094 jobs during the month.
The December total was the lowest since December 2007, when 44,416 job cuts. It was down 73 percent from the 166,348 job cuts recorded the same month a year ago. It was 10 percent lower than November’s 50,349, marking the fifth consecutive decline in monthly layoffs. Since July, announced layoffs have dropped by an average of 14 percent each month.
ADP’s kick at the cat:
The decline in December was the smallest since March of 2008. Employment losses are now rapidly diminishing and, if recent trends continue, private employment will begin rising within the next few months.
December’s ADP Report estimates nonfarm private employment in the service-providing sector increased by 12,000, the first increase since March of 2008. However, this employment growth was not enough to offset continued losses in the goods-producing sector. Employment in the goods-producing sector declined 96,000, with employment in the manufacturing sector dropping 43,000.
The weekly initial unemployment claims for the week ending January 2, 2009 hit the magic 450,000 button where under historical circumstances we should start seeing jobs growth. A word of caution that data collected over the holiday season is suspect – and I would wait for a few more weeks before breaking out the champagne glasses.
I agree with ADP, the data shows we are really close to equilibrium on jobs. Too bad population expansion alone needs 250,000 jobs created every month. Until we hit that rate of jobs expansion, you, your kid, or your grandkid will only be able to get a job through dead man’s shoes.
Last and least accurate indicator of America’s job situation is the government’s job’s report. This piece of crap report: is an assault on my intelligence. It sticks up like a sore thumb running contrary to every other set of government and non-government data – not to mention it is inconsistent within itself.
The December 2009 headline unemployment rate of 10% is determined by a household survey which must be contracted out to ACORN. The all-in U-6 unemployment rate which includes people taking part-time work when they want full time rose 0.1% to 17.3%. No one who spends any time reviewing jobs data believes the real unemployment rate is under 13% - and could easily be close to 20% depending on your definition of unemployment.
At the end of a recession seasonal adjustment factors are inaccurate. This is due to recession related and stimulus related issues interfering with the historical monthly movements. The BLS has admitted this in the past. But this month please pay attention to the unadjusted numbers which shows non-farm payrolls dropping over 400,000:
Some will point out that the average hours worked this month remained constant. True, the adjusted hours did, but look at the unadjusted hours.
Housing
The National Association of Realtors released its November 2009 pending home sales report which shows a 16% decline, but is 15.5% higher than November 2008. Lawrence Yun, NAR chief economist, said:
It will be at least early spring before we see notable gains in sales activity as home buyers respond to the recently extended and expanded tax credit. The fact that pending home sales are comfortably above year-ago levels show the market has gained sufficient momentum on its own. We expect another surge in the spring as more home buyers take advantage of affordable housing conditions before the tax credit expires.
My friends at NAR headline with seasonally adjusted data – as the unadjusted data has declined over 27% MoM (but is over 19% better than November 2008). The NAR must continually alter their seasonal adjustment methodology.
Your take from this data is that there will be a fall of home sales through the winter (which also should suppress housing prices).
The weekly Mortgage Bankers Association new mortgage application data for the weeks ending 23 December & 01 January fell to literally half of the level of earlier this year using seasonally adjusted data. Do you hear alarm bells, gentle reader?
This mortgage data confirms the pending home sales warning of a home sales contraction. The 30 year fixed mortgage rate rose 16 basis points to 5.08%.
Over the New Year weekend, Fed Chairman Ben Bernanke spoke on the housing bubble. His conclusion:
My objective today has been to review the evidence on the link between monetary policy in the early part of the past decade and the rapid rise in house prices that occurred at roughly the same time. The direct linkages, at least, are weak. Because monetary policy works with a lag, policymakers' response to changes in inflation and other economic variables should depend on whether those changes are expected to be temporary or longer-lasting. When that point is taken into account, policy during that period--though certainly accommodative--does not appear to have been inappropriate, given the state of the economy and policymakers' medium-term objectives. House prices began to rise in the late 1990s, and although the most rapid price increases occurred when short-term interest rates were at their lowest levels, the magnitude of house price gains seems too large to be readily explainable by the stance of monetary policy alone. Moreover, cross-country evidence shows no significant relationship between monetary policies and the pace of house price increases.
What policy implications should we draw? I noted earlier that the most important source of lower initial monthly payments, which allowed more people to enter the housing market and bid for properties, was not the general level of short-term interest rates, but the increasing use of more exotic types of mortgages and the associated decline of underwriting standards. That conclusion suggests that the best response to the housing bubble would have been regulatory, not monetary. Stronger regulation and supervision aimed at problems with underwriting practices and lenders' risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates. Moreover, regulators, supervisors, and the private sector could have more effectively addressed building risk concentrations and inadequate risk-management practices without necessarily having had to make a judgment about the sustainability of house price increases.
The Federal Reserve and other agencies did make efforts to address poor mortgage underwriting practices. In 2005, we worked with other banking regulators to develop guidance for banks on nontraditional mortgages, notably interest-only and option-ARM products. In March 2007, we issued interagency guidance on subprime lending, which was finalized in June. After a series of hearings that began in June 2006, we used authority granted us under the Truth in Lending Act to issue rules that apply to all high-cost mortgage lenders, not just banks. However, these efforts came too late or were insufficient to stop the decline in underwriting standards and effectively constrain the housing bubble.
The lesson I take from this experience is not that financial regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter. The Federal Reserve is working not only to improve our ability to identify and correct problems in financial institutions, but also to move from an institution-by-institution supervisory approach to one that is attentive to the stability of the financial system as a whole. Toward that end, we are supplementing reviews of individual firms with comparative evaluations across firms and with analyses of the interactions among firms and markets. We have further strengthened our commitment to consumer protection. And we have strongly advocated financial regulatory reforms, such as the creation of a systemic risk council, that will reorient the country's overall regulatory structure toward a more systemic approach. The crisis has shown us that indicators such as leverage and liquidity must be evaluated from a systemwide perspective as well as at the level of individual firms.
Is there any role for monetary policy in addressing bubbles? Economists have pointed out the practical problems with using monetary policy to pop asset price bubbles, and many of these were illustrated by the recent episode. Although the house price bubble appears obvious in retrospect--all bubbles appear obvious in retrospect--in its earlier stages, economists differed considerably about whether the increase in house prices was sustainable; or, if it was a bubble, whether the bubble was national or confined to a few local markets. Monetary policy is also a blunt tool, and interest rate increases in 2003 or 2004 sufficient to constrain the bubble could have seriously weakened the economy at just the time when the recovery from the previous recession was becoming established.
That said, having experienced the damage that asset price bubbles can cause, we must be especially vigilant in ensuring that the recent experiences are not repeated. All efforts should be made to strengthen our regulatory system to prevent a recurrence of the crisis, and to cushion the effects if another crisis occurs. However, if adequate reforms are not made, or if they are made but prove insufficient to prevent dangerous buildups of financial risks, we must remain open to using monetary policy as a supplementary tool for addressing those risks--proceeding cautiously and always keeping in mind the inherent difficulties of that approach. Clearly, we still have much to learn about how best to make monetary policy and to meet threats to financial stability in this new era. Maintaining flexibility and an open mind will be essential for successful policymaking as we feel our way forward.
This reminds me of the old joke where the surgeon walks into the waiting room and proudly announces that the operation was successful but the patient is dead.
Good discussions of the Taylor rule which Chairman Bernanke uses as the prime evidence to justify the Federal Reserve's response to the housing bubble can be found in Baum Makes Mincemeat of Bernanke's Twisted Logic and Taylor Disputes Bernanke. The Fed should have known the bubble was growing.
The role of the Federal Reserve is to manage the economy. If something is happening which is outside their control which is damaging or will damage the economy (say something like uncontrolled increase in government spending) - then they sound the alarm.
The bottom line is that there was a housing bubble, and the Federal Reserve cannot escape that it was their job either to prevent the bubble or sound the alarm that the bubble was growing. All I expect the Fed to do is say they were responsible for the housing bubble, and say they will do their best not to let it happen again.
Manufacturing
According to the government:
New orders for manufactured goods in November 2009 increased a seasonally adjusted 1.1% to $365.3 billion. Shipments rose 1.0%, unfilled orders declined 0.7% and inventories increased 0.2% from October 2009.
They were using seasonally adjusted data. The chart below using the government's unadjusted data comparing YoY. Do you see 1.1% improvement?
In 2006 and 2007, new orders remained relatively constant MoM in the second half of the year. In 2005, new orders grew pretty much all year long. What seasonal adjustment is necessary?
My take on this data is that it has a slight negative bias still. I continue to be concerned over the falling order backlog. New orders are down almost 20% while backlog is only down 10%. I see nothing green growing overall in manufacturing except in autos.
Saving the best for last, I bring you the December 2009 Institute of Supply Management (ISM) survey for Manufacturing and Non-Manufacturing. I very much dislike the methodology of this survey – but it acts like a ground hog seeing its shadow (see Economic Indicators Suggest Investing Caution).
This economic indicator seems to work well for investing, but does not correlate that well against the real economy. The reason I do not use the non-manufacturing survey is that it is a relatively new survey and it cannot be back tested.
Here are the words of the ISM:
The manufacturing sector grew for the fifth consecutive month in December as the PMI rose to 55.9%, its highest reading since April 2006 when it registered 56%. This month's report is quite strong as both the New Orders and Production Indexes are above 60%.
The NMI (Non-Manufacturing Index) registered 50.1% in December, 1.4% higher than the 48.7% registered in November, indicating growth in the non-manufacturing sector for three out of the last four months.
My take is that this survey does not indicate an economic expansion is occurring – it is simply numeric hocus pocus. Within one month we will see the real data. However, the hard data for November 2009 did show signs of economic improvement.
Additional Economic Data this Week
The November 2009 wholesale sales and inventory data was released this week showing sales up 3.3%, inventories up 1.5%, and sales to inventory ratios falling. I will cover this topic next week with manufacturing and retail. Because of the seasonal adjustment factors being used at the end of a recession, I would not take this data too seriously, and US Census says it best in this report: “The Census Bureau does not have sufficient statistical evidence to conclude that the actual change is different from zero.”
Construction spending was $900.1 billion in November 2009, 0.6% below October’s estimate and 13.2% below November 2008. These are seasonally adjusted numbers with significant margin of error factors, and your take should be that there is no expansion yet occurring in this sector.
Bankruptcies this week: International Aluminum, Mesa Air Group, FirstFed Financial. In 2009 the total bankruptcy count was 207 public companies.
Economic Forecasts Published this Past Week
The Economic Cycle Research Institute (ECRI) released their Weekly Leading Index which its yearly growth rate slipped slightly – but the WLI is still setting new highs. Lakshman Achuthan, Managing Director at ECRI added:
It was the lowest yearly growth figure the index has seen since reaching a record high of 28.1 in early October. With the WLI climbing to a one-and-a-half-year high, the U.S. economy is firmly set to strengthen in the coming months
Disclosure: GLD, SPY, XPH, XLB, XLV, FTR, IOO, HYG, KSWS, PIN, XHB, WMT, GDX, Physical Gold - as well as numerous puts and calls which comprise less than 3% of my portfolio
