Hard Times Trump Easy Money: Economic Data Uniformly Bad

In just over a week, between January 22 and January 30, The Federal Reserve (Fed) cut both of the interest rates under their sway by 1.25%. This is easy money on steroids. Last week hosted about the most feverish rate cutting ever seen. In an emergency meeting on January 22, and again at a scheduled meeting a week later, the Fed made huge cuts in the cost of short term credit to and between banks. By the second cut, the markets were jaded, had successfully pressed a flustered Fed into action and were no longer impressed. Wednesday’s 50 basis points, half of one percentage point, cuts were unable to keep any major US stock index above water. The Dow, S&P500 and NASDAQ all fell; even the ETF (exchange traded fund) of major financial firms (IYF) fell. Not too long into the future this will be understood as a turning point in the present financial turmoil. Hard times are beginning to trump easy money! There are many reasons why super cheap and super easy money failed to save the day. Everyone one of them is important.

About six hours before the Fed cut rates, the Bureau of Economic Analysis [BEA] released its advanced estimate of the economic growth for the fourth quarter of 2007.

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 0.6 percent in the fourth quarter of 2007,according to advance estimates released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 4.9 percent. (BEA Gross Domestic Product, January 30, 2008)

Needless to say, this is a hard times number. Everything in the report is advanced estimate and therefore, subject to large revision. Everything in the report is also hard times news. Fourth quarter advanced estimate GDP was reported 88% below third quarter GDP growth. That is a major tumble and was not forecast. The consensus estimates of fourth quarter GDP growth were in the area of 1%. We expected a poor number, nowhere near that poor. GDP is not the only jarring news. The BEA released Personal Income and Outlays December 2007. There was much bad news in this data as well. However, to see how bad it actually is you need to read the full report and make a few calculations. Therefore, it has largely gone unnoticed! The headline growth in December personal income is a strong .5%. Behind that number lurks the fact that income growth rates largely fell across essential categories.

Wages and salaries

Private wage and salary disbursements increased $21.4 billion in December, compared with an increase of $34.5 billion in November. Goods-producing industries' payrolls decreased $1.4 billion, in contrast to an increase of $6.8 billion; manufacturing payrolls decreased $2.0 billion, in contrast to an increase of $2.5 billion. Services-producing industries' payrolls increased $22.8 billion, compared with an increase of $27.7 billion. Government wage and salary disbursements increased$3.7 billion, compared with an increase of $4.0 billion. (BEA Personal Income and Outlays December 2007)

Greater bad news lurks in the data on spending and price level. The Fed’s preferred prices index- that excludes food and energy- rose by 2.2%. This is above the stated inflation comfort level and was enough to erase all gains in personal spending, PCE or Personal Consumption Expenditure.

Real PCE

PCE adjusted to remove price changes -- decreased less than 0.1 percent in December (emphasis added), in contrast to an increase of 0.4 percent in November. Purchases of durable goods decreased 0.3 percent, compared with a decrease of less than 0.1 percent. Purchases of nondurable goods decreased 0.2 percent, in contrast to an increase of 0.4 percent. Purchases of services increased 0.1 percent, compared with an increase of 0.5 percent.

The economic data is uniformly bad. Overall economic growth [GDP] is rapidly slowing, wage growth is slowing, adjusted for inflation there is no personal spending growth and price growth remains high. Slashing interest rates promises to increase price pressures and will take months- if successful- to provide broad economic support. Bad news was not limited to backward looking national economic figures.

The specialty firms that insure municipal bonds, monoline insurers, are in a ratings risk spiral. I wrote to you on this front on December 19, 2007. Having had many meetings, heard many proposals and bought much time, the ratings agencies may finally have to downgrade these firms. The four leading insurers wrote over a half a trillion dollars in insurance on mortgage backed securities that look risky enough to call into question their ability to pay off on possibly surging claims. Ambac Assurance Corp (ABK) and Security Capital Assurance (SCA) have already seen their insured assets downgraded by Fitch- a leading credit rating enterprise. Worries have already spread to other monolines and UBS, Merrill Lynch (MER) and Citibank (C).

The Fed pulled out all the stops. It was easy money to the rescue on January 22, 2008 and January 30, 2008. Markets were scared enough about the economy to cold shoulder the second gift. As attention refocuses on the all important jobs report due Friday, economic weakness is more in the driver’s seat than Fed accommodation. Thursday’s rally is the calm eye of the macroeconomic storm. The relief rally on a strong jobs number Friday, or the likely sell-off if there is a nasty surprise, will further establish the refocus of markets onto hard times and away from easy money.