This past week has again left me weak hearing all the diametrically opposing opinion on the investing and economic environment in both the short and long term.
I was amused by Matt Taibbi who took another shot at government miss-action in Wall Street's Bailout Hustle.
But it was the Federal Reserve offered the most interesting flips, back-flips and plain entertainment.
The Federal Reserves' Federal Open Market Committee (FOMC) released the minutes of their 26 and 27 January 2010 meeting. The minutes included the following statement:
The several extensions of emergency unemployment insurance benefits appeared to have raised the measured unemployment rate, relative to levels recorded in past downturns, by encouraging some who have lost their jobs to remain in the labor force.
The Fed believes that terminated people should not be considered part of the workforce once their unemployment benefits expire. This is ostrich economics. A different interpretation of the meaning of this statement was offered by Bank of Tokyo – Mitsubishi:
In the FOMC minutes, the Committee remarked that the extensions to the unemployment insurance program have encouraged a portion of job losers to remain in the labor force. This drives the unemployment rate higher because presumably there would have been a portion that..... would have taken any job available and therefore wouldn’t have been counted among the unemployed. Indeed, if we assume Congress lets the extended benefits expire on February 28th and one million of the would-be ineligible recipients drop out of the labor force, the unemployment rate would fall to around 9.0 percent.
As of January 2010, what we believe to be eight months into recovery, unemployment sat at 9.7 percent, which is 0.3 percentage points higher than what it was at the trough. In sharp contrast, eight months into recovery in July 1983 the unemployment rate sat at 9.4 percent, which was 1.4 percentage points lower than what it was at the trough. Are extended unemployment benefits, which stretch about 7 months longer today than they did in the early 80’s the reason why the unemployment rate is higher eight months into recovery? Taking this as proof that the labor market is not as slack as we think because the unemployment rate is being overstated is a slippery argument, especially when jobs loss as a share of the workforce was twice as severe this time around.
The Committee members’ views on this issue matter because the FOMC forecast for subdued inflation centers around “substantial resource slack”. If indeed things are not as slack as they seem the Committee runs the risk of acting too late to stave off inflation.
I take issue with the determination we have a potentially inflationary labor resource slack – as the manifestation would be rising prices. Read the section on “Prices” further down in this article. The FOMC minutes continued on the employment situation:
If businesses were able to continue generating large productivity gains, as in recent quarters, then firms would need to hire fewer workers in the near term to meet rising demands for their products. But if the unusually rapid productivity growth seen in recent quarters was not sustained, then job growth could pick up significantly as productivity returned to sustainable levels. The rise in employment of temporary workers in recent months appeared to be continuing; historical experience suggested that increased use of temporary help could presage a broader increase in job growth.
Too much of the FOMC meeting economic discussion was in this vein – two opposing economic forces were discussed and of course the FOMC overall conclusion was that growth was predicted.
Then the Atlanta Federal Reserve President Dennis P. Lockhart delivered a speech to the Atlanta Chamber of Commerce which confirmed this polarization of economic forces:
I see two competing narratives about how this recovery will play out. Growth in the fourth quarter of 2009 was quite strong and raises hope for a robust recovery. In this, the first narrative—that of a traditional sharp bounce-back following a deep recession—growth exceeds the underlying long-term potential of the economy and unemployment declines at an accelerating pace.
In this narrative, businesses rebuild inventory levels and resume capital expenditures in anticipation of growing sales. Consumers regain confidence, and retail spending grows briskly. You can add positive export growth as the economies of our major trading partners—especially in Asia—also show better growth.
Finally, in this narrative the banking system successfully navigates a weak commercial real estate sector and starts expanding credit to both business and consumers.
The alternative narrative entails some fundamental changes in business practices and consumer habits. In this scenario, businesses have learned from the recession that they can operate permanently at leaner inventory levels and flat or lower employee head counts. And the impressive worker productivity gains measured in recent data continue to accumulate.
Consumers, in this narrative, have assumed a quite different mind-set compared to the precrisis, prerecession "normal." Chastened by the recession and high unemployment—consumers are simply more frugal and more inclined to save. And even if consumers wanted to resume prerecession spending habits, the consumer finance industry, in this narrative, will not accommodate previous levels of consumption.
In this narrative, growth continues, but at a very modest pace, and unemployment is very slow to recede. The first narrative is a return to something resembling normal as we knew it; the second narrative describes a somewhat new and different world.
Which narrative did the Atlanta Fed President forecast the economy would follow?
In my view, we're at an uncertain juncture and must watch closely for indicators in coming months to discern which reality is playing out. Indicators will include retail sales, inventory and capital investment, and, importantly, job creation and hiring.
My team of Atlanta Fed economists and I are forecasting the second narrative. We are forecasting a lower-growth, more gradual recovery with slow progress on unemployment. Our outlook gives weight to some challenges facing the economy and the banking sector that we believe may constrain recovery.
The Kansas City Federal Reserve President Thomas M. Hoenig came out swinging this week against the growing government fiscal imbalances in a Washington speech (pdf). It is important that an independent central bank keeps sounding off about a government which makes the Federal Reserves' mandate of controlling the currency an impossible task. President Hoenig concluded:
Knowing inflation is not an acceptable alternative to strong fiscal management, a government faced with rising debt levels must provide a credible long-term plan to reestablish fiscal balance. The plan must be clear, have the force of law and its progress measurable so as to reassure markets and the public that the country has the will and ability to repay its debts in a stable currency.
You remember this Kansas City Federal Reserve Chairman is the lone dissenter in the January FOMC meeting as he wanted the option to start raising the Federal discount rate now. Here is a review of the Federal Reserves position on the discount rate:
At that FOMC meeting, the Committee left its target range for the federal funds rate at 0 to 1/4 percent and said it anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.
Then in one of the quickest reversals in Federal Reserve history, the Federal Reserve issued a statement later this week which said in part:
The changes to the discount window facilities include Board approval of requests by the boards of directors of the 12 Federal Reserve Banks to increase the primary credit rate (generally referred to as the discount rate) from 1/2 percent to 3/4 percent. This action is effective on February 19.
In addition, the Board announced that, effective on March 18, the typical maximum maturity for primary credit loans will be shortened to overnight. Primary credit is provided by Reserve Banks on a fully secured basis to depository institutions that are in generally sound condition as a backup source of funds. Finally, the Board announced that it had raised the minimum bid rate for the Term Auction Facility (TAF) by 1/4 percentage point to 1/2 percent. The final TAF auction will be on March 8, 2010.
It could be argued that a ½ to ¾ percent Is not much different than 0 to ¼ percent. However, the purpose of releasing the meeting minutes is to provide guidance to the market. So much for guidance.
Anyway, this is a clear signal from the Fed that they consider the recession over. The cycle is now beginning to normalize the lending conditions, and to begin in the near future to start drying up liquidity and disposing of their bloated balance sheet. This is a very small first step which I consider symbolic.
The day of reckoning is when the Fed begins disposing of its treasuries and securitized mortgages. Or maybe the day of reckoning is simply when the Fed stops buying securitized mortgages.
Has the economy built up enough steam to allow the Fed to withdraw from the mortgage market?
What I do know is that the coincident indicators will begin to show signs of distress if the economy begins to weaken.
The coincident indicators are still stable. They are not expanding in any measurable degree (except for manufacturing and exports) – and are on average simply moving sideways. As the economy has so much potential energy stored within, another dip of the economy would take months to manifest.
The coincident data is telling us the short term direction of the economy will range from steady to a slight upward bias. When I say short term, I mean two months maximum.
But what about the long term economic forecasts?
Here the forward indicators are beginning to indicate that the economic forces of growth are beginning to weaken.
We never saw much of a real expansion, and now ECRI is saying the party may be over as early as mid-2010.
I am an economic mongrel. Dogma is not my thing. I have some Keynesian clown beliefs grafted to my Austrian roots.
Kansas City Fed President Hoenig shares my view of the need to have a fiscally responsible plan for government spending. Without a responsible plan, the economy is not controllable. While we have no plan, chances of a stable and viable future are low.
On the other hand, I worry that no strong economic upward pressure has been built. The economy is still being held together with chewing gum and band-aids. It will not take much of a bump in the economic road to upset the apple cart. Withdrawing liquidity at this point may be premature.
Even with consensus, our economic future is never certain. Without consensus, I am sure we are in for one wild economic ride.
Manufacturing and Business
The New York Fed released their manufacturers survey for February 2010 which headlined as follows:
The Empire State Manufacturing Survey indicates that conditions for New York manufacturers improved at a healthy pace in February. The general business conditions index climbed 9 points, to 24.9. The new orders index fell, though it remained positive, and the shipments index inched downward as well.
My take is that “healthy” might be somewhat of an exaggeration. The only issues I care about in this subjective survey is new orders and unfilled orders (backlog).
The New York manufacturers do think they are seeing some growth. In periods of “healthy” expansion since 2001, the percent of manufacturers which see improvement in new orders is around 50%. The percent of manufacturers which see improvement in backlog in periods of “healthy” expansion are over 25%.
Definitely the current growth is not healthy compared to historical “healthy”.
One positive note from this NY Fed manufacturers survey is that this is the second month in a row where manufacturers who are seeing an improving backlog outnumber those who are seeing a decline. The last time manufacturers saw two months of improving backlog in a row was July 2007.
The Philly Fed issued their manufacturers survey for February 2010 and stated: Manufacturing conditions continue to improve in the region, according to firms polled for this month's Business Outlook Survey. Indexes for general activity, new orders, shipments, and employment all remained positive this month and increased from their readings in January. Firms reported a notable pickup in new orders this month. Overall, firms remain generally optimistic about growth for the manufacturing sector over the next six months.
For the Philly Fed's manufacturing survey, since 2001 – a healthy growth cycle has over 40% of manufacturers seeing increases for new orders – while periods of healthy growth for unfilled orders is above 25%.
As the general trend of the data since December 2008 has been upward, we should consider this paradox an anomaly attributed to sampling error. It is illogical that new orders would be up so strongly while backlog fell equally as strongly at this point in the economic cycle.
A general trend in improvement of unfilled orders is a positive sign the Great Recession is behind us.
Hard manufacturing data for January 2010 supports January 2010 survey data from both the Philly Fed and the NY Fed. I went through the data looking for a surprise but it was consistent with general economic news. The Federal Reserve data release stated:
Industrial production increased 0.9 percent in January following a gain of 0.7% in December. Manufacturing production rose 1.0% in January, with increases for most of its major components, while the indexes for both utilities and mining advanced 0.7%. At 101.1 percent of its 2002 average, output in January was 0.9% above its year-earlier level. The capacity utilization rate for total industry rose 0.7 percentage points to 72.6%, a rate 8.0 percentage points below its average from 1972 to 2009.
Prices
The government issued export and import price data for January 2010 and headlined:
The U.S. Import Price Index advanced 1.4 percent in January, the U.S. Bureau of Labor Statistics reported today, as fuel and nonfuel prices each increased. The rise in overall imports followed a 0.2% uptick in December. Export prices rose 0.8% in January after advancing 0.6% in December and 0.8% in November.
The Producer Price Index (PPI) which tracts price changes under below the consumer level was released for January 2010. The government's statement:
The Producer Price Index for Finished Goods rose 1.4% in January, seasonally adjusted. This increase followed a 0.4% advance in December and a 1.5% rise in November. In January, at the earlier stages of processing, prices received by manufacturers of intermediate goods climbed 1.7%, and the crude goods index jumped 9.6%. On an unadjusted basis, prices for finished goods moved up 4.6% for the 12 months ended January 2010, their third consecutive 12-month increase.
My take, stepping back from the data, is that “core” price changes at the producer level are stable, and consistent with other month's data we have been seeing during this end of recession economic turning point. However, both intermediate and crude goods prices are at the upper end of the range but not significantly above the finished goods price increase.
But the surprise was the January 2010 (pdf) consumer price index (CPI) data which did not show the price growth anticipated. The government's press release stated:
On a seasonally adjusted basis, the January Consumer Price Index for All Urban Consumers (CPI-U) rose 0.2%. Over the last 12 months, the index increased 2.6% before seasonal adjustment. The seasonally adjusted increase in the all items index was due to a rise in the energy index. An increase in the gasoline index was the main factor, and the indexes for fuel oil and natural gas rose as well, though the electricity index declined.The index for all items less food and energy fell 0.1% in January.
This decline was largely the result of decreases in the indexes for shelter, new vehicles, and airline fares. In contrast, the medical care index posted its largest increase since January 2008, and the index for used cars and trucks increased significantly for the sixth month in a row.
The food index increased in January, with the food at home component posting its largest increase since September 2008. Sharp increases in the indexes for dairy and related products and for fruits and vegetables accounted for most of the increase.
The economic picture on prices is clearly showing little upward momentum except for imported goods. The PPI and CPI is only showing moderate growth. And if we start considering MoM data, the core CPI actually declined for the first time since 1982.
We should be asking ourselves at this point, why prices are growing so mildly when we are told that an economic expansion cycle is underway. The answer of course is that there is massive overcapacity in the market place – housing, manufacturing, and labor. Add to the mix the weak consumer purchasing habits, the debt deleveraging, and the cash starved state governments – and we have the recipe for the weakest recovery cycle since WWII.
Other Data
Initial unemployment claims continue to be range bound just above 450,000 is data released for week ending 13 February 2010.
The government's new home construction data for January 2010 headline reads in part:
Privately-owned housing units authorized by building permits in January were at a seasonally adjusted annual rate of 621,000. This is 4.9% (±2.2%) below the revised December rate of 653,000, but is 16.9% (±4.0%) above the January 2009 estimate of 531,000.
Privately-owned housing starts in January were at a seasonally adjusted annual rate of 591,000. This is 2.8% (±11.5%)* above the revised December estimate of 575,000 and is 21.1% (±12.3%) above the January 2009 rate of 488,000.
Privately-owned housing completions in January were at a seasonally adjusted annual rate of 659,000. This is 12.4% (±7.8%) below the revised December estimate of 752,000 and is 15.3% (±10.5%) below the January 2009 rate of 778,000.
The unadjusted new home data tells the same story. Although there is some movement off of the depths of the Great Recession lows, new home construction remains in the toilet – and no fundamentals point to a change in this within the short term.
With hat tip to Calculated Risk, this graphic puts the big January increases into perspective.
The weekly Mortgage Bankers Association new mortgage application data for the week ending 12 February 2010 was relatively unchanged and remains about 60% of the level of early 2009 using seasonally adjusted data. The 30 year fixed mortgage rate was unchanged at 4.94%.
Our residential mortgage crisis may have peaked. According to the Mortgage Bankers Association:
We are likely seeing the beginning of the end of the unprecedented wave of mortgage delinquencies and foreclosures that started with the subprime defaults in early 2007, continued with the meltdown of the California and Florida housing markets due to overbuilding and the weak loan underwriting that supported that overbuilding, and culminated with a recession that saw 8.5 million people lose their jobs,” said Jay Brinkmann, MBA’s chief economist.
The continued and sizable drop in the 30-day delinquency rate is a concrete sign that the end may be in sight. We normally see a large spike in short-term mortgage delinquencies at the end of the year due to heating bills, Christmas expenditures and other seasonal factors. Not only did we not see that spike but the 30-day delinquencies actually fell by 16 basis points from 3.79 percent to 3.63 percent. Only three times before in the history of the MBA survey has the non-seasonally adjusted 30-day delinquency rate dropped between the third and fourth quarter and never by this magnitude. If the normal seasonal patterns hold for the first quarter, we should see an even steeper drop in the end of March data.
This drop is important because 30-day delinquencies have historically been a leading indicator of serious delinquencies and foreclosures. With fewer new loans going bad, the pool of seriously delinquent loans and foreclosures will eventually begin to shrink once the rate at which these problems are resolved exceeds the rate at which new problems come in. It also gives us growing confidence that the size of the problem now is about as bad as it will get.
The other apparent good sign is a drop in the rate of new foreclosures started. This drop may be temporary, however, because we continue to see large increases in loans 90 days or more past due.
A picture is worth a thousand words, and hat tip to Calculated Risk for a visual on the Mortgage Bankers Association statement:
What is left out of this press release and graphic is the effect of a sizeable chunk of ARM's which will reset later this year. And we cannot forget the commercial real estate market which some predict will have significant impact on the small and medium sized banks.
Bankruptcies this week: Magna Entertainment
Economic Forecasts Published this Past Week
The Economic Cycle Research Institute (ECRI) released their Weekly Leading Index declining for ten straight weeks. Lakshman Achuthan, Managing Director at ECRI added:
The pace of economic expansion will begin to ease off by mid-2010, as the yearly growth figure continued to fall from an October record high.
Lakshman believes that with the 6% GDP growth and the jobless rate having peaked back in October, that a double dip is still out of the question.
The Conference Board released their leading and coincident indicators for January 2010 with the following statement:
The Conference Board Leading Economic Index® ((LEI)) for the U.S. Increased 0.3 percent in January, following a 1.2 percent gain in December, and a 1.1 percent rise in November.
Says Ataman Ozyildirim, Economist at The Conference Board: “The U.S. LEI has risen steadily for nearly a year, led by an improvement in financial markets and a manufacturing upturn. Consumer expectations and housing permits have also contributed to these gains over this period, but to a lesser extent – especially in recent months.
Current economic conditions, as measured by The Conference Board Coincident Economic Index® (CEI), have also improved modestly since July 2009, helped by strengthening industrial production, despite continued weakness in employment.”
Adds Ken Goldstein, Economist at The Conference Board: “The cumulative change in the U.S. LEI over the past six months has been a strong 9.8 percent, annualized. This signals continued economic recovery at least through the spring.”
Disclosure: Author holds positions in GLD, 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 his portfolio.
