Thursday, August 28, 2008

When MORE seems like LESS

GDP surprises then amazes...
GDP was up strongly by 3.3% but most of that was trade- stronger exports and dropping imports. Without trade GDP was up by a skinny 0.2% (saar). So amazingly stocks rose sharply. It's no wonder that stocks improved on these sorts of fundamentals. And some key bank stocks that had been troubled were up by 5% on the day. Fannie and Freddie saw their shares up by 17% and 9% respectively. Why? Beats me. Strong GDP for a fluky reason?

Optimism is beginning to spread. But maybe it's only bull optimism in a still-bear market - or barren market.

It's Dell and it's not swell
At the close of Biz on Thursday Dell reported earnings numbers that were somewhat mixed; better revenues but it missed on its earnings-per-share. The real dirt was in Dell's comments as it saw a cutback in tech spending spreading in Europe and in parts of Asia. Even the bullet proof economies are taking it on the chin or at least beginning to cut back.

Still bullish?

There is a school of thought out there that sees the economy strengthening. I don't get it.

An uphill road for the consumer
The tax rebates are done and consumers have been pulling back even before the job losses got to be very large in this cycle. The rebates themselves did not spur all that much spending as it turns out. Sure oil is off-peak and at-the-pump gas prices are some 11% off their recent highs, but gas is still expensive. Consumer confidence reports are still bottom feeders even if they up off their most recent lows. A downdraft in gas prices will do that for you... but not much more. There is little to cheer prospects for improved consumption.

Dell as bellwether?
If the Dell report is a harbinger it is saying what I have believed all along, that the slowdown is global and that it will include even the formerly fast-growing developing nations. If the overseas economies slow and oil prices remain high where does the stimulus come from to boost consumers again? House prices are still falling, and while housing may be trying to get some traction we are looking a prices that remain weak, continue to drop, and at banks that have continued to tighten up lending standards.

What'cha gonna do when the well runs dry?
Where are consumers going to get any extra to spend? Incomes are limited by continued temperance on wages. Businesses are not expanding payrolls. Lower house prices do not encourage equity tapping - some consumers have no equity to tap in any event.

Hope...a four-letter word
The good news is that inventories seem to be in good stead. Durable goods orders, backlogs and shipments have been firming. MFG reports seem to have stopped eroding. They are not strong but they are not unraveling.

There is a case to be made for some stability and a drawn out recovery, but nothing fast. I still don't believe it or buy into it, but there is enough there to get some...traction on the TV circuit.

I fear this is a best case that still is poor and still is too good to be true.

Best case scenario is not for the best case
There is far more reason to look for more slippage. While stocks are falling in line with their historic performance in recession they are bracing for an upside that might be delayed further - history be damned! What I am concerned about is that this consumer-led recession is different. I have said in the past, the worst forecasts I have seen have come from forecasters under estimating the consumer. The American consumer is resilient. But this time the consumer is really in a bind. The debt economy has caught up to American consumers, businesses and banks. Consumers simply do not have the options they have had in the past. Banks are seeing to that. Consumers are no longer in the driver's seat. You can't score if the coach won't let you off the bench and into the game. Consumer resilience may not even be a factor this time.


Sunday, August 10, 2008

The dark side of weak oil prices

Dropping oil prices change everything.

But like every other economic event it will happen in time.

Central banks can begin to feel more comfortable but they may still have some difficult numbers to face. The worst of headline inflation should be over. But the overshoot will not go away overnight - just overtime.

Lower oil prices are both good news and bad. The good news is obvious: less inflation pressure and fewer funds taken from consumers so their discretionary income rises. We saw US discretionary stocks rise sharply this past week on just those hopes... But the bad news of dropping oil prices remains. It is that weak prices just might reflect an overall drop in demand. We are getting some very weak economic figures from Europe and Japan to join with what have been weak numbers from the US.

Some US numbers are getting much weaker too. Jobless claims and announced corporate layoffs each are up sharply. Those who say claims are up because new job market entrants are not being absorbed can't so easily dismiss the rise in planned corporate layoffs. Nor can they blame that on teenagers becoming unemployed...

The dark side of low oil price is that the world economy is weakening faster than we thought. And with energy prices that climbed so rapidly that would not be hard to believe. Along with continuing financial problems and and key sectors like autos that need restructuring and a housing sector that is still deteriorating the US has its challenges ahead of it. Lower oil prices will help. But at the same time they might indicate how deep the abyss is that the US is trying to avoid.

Wednesday, August 6, 2008

They may rule...but what's a dove?

Unity in separatism - The Fed is classically looked up as an organization that is mostly close-knit but where members regularly clash over the outlook and policy, but in the nicest of ways. The Fed is well-known for its collegial atmosphere. Members have and maintain separate views and even encourage such differences in opinion to get the analysis of the economy right.

Hawks and Doves: While many different camps or splinter groups can be identified is trying to assemble the FOMC members into ideological groups, the most stark division is the partition of the FOMC between Hawks and Doves.

  • Hawks are the ardent anti-inflationists who usually see inflation risks where others do not. They are more likely to be voting for rate hikes or to slow down rate cuts.
  • Doves typically are more pro-growth and are more concerned that policy might be holding the economy back from its best growth potential. Doves are more likely to be voting for rate cuts or against the rate hikes, that they view as unneeded.

Hawks VS Doves: not a full partitioning -- Even though at any particular meeting we can usually put members into a rate cutting or rate hiking camp that does not mean that all members of a group seek that same policy for for the same reason. Indeed after different times you may see the same member in different groups since policy is often a judgment issue not simply about dogma.

Naming some names... Three names appear in guise of hawks although only one dissented at this past Fed meeting.
  • In this cycle we can identify Dallas Fed president Richard Fisher as a super, but conditional, hawk. I name him as such because he can be depended on repeatedly to vote against a policy to stand pat with rates preferring a hike. He was against the last Fed rate cut and continues to protest that cut with his dissent. But if the Fed were to retract that cut and hike rates would Fisher continue to want rates higher still? We don't know.
  • Charles Plosser is a former member of the SOMC (Shadow Open Market Committee) and a very well know anti-inflationist. Ahead of the August 2008 meeting he had been saying that rates would have to go up 'sooner rather than later'. Still he did not dissent in August.
  • Neither did Minneapolis Fed President Gary Stern dissent. He had sounded somewhat hawkish ahead of the meeting. He voted with the majority to stand pat and on little change in the policy language.

So who were the doves that carried the day? What did they believe?

The doves are not classical doves and the hawks are different too -- The classical dove definition does not seem to apply here. Few on the Fed- IF ANY AT ALL - seek rate cuts. What we have instead are hawks with real inflation fear as oil prices shot up near $150/bbl and as the CPI headline neared 5% tempering their traditionally expected actions. In this environment doves are more concerned with financial stability than with growth or inflation. Hawks have come to realize that the trade offs are not just inflation or growth but also financial stability- that has changed the game and the debate at the Fed.

  • This makes the current Fed Hawk/Dove dilemma richer and more vexing to understand.
  • In this environment Hawks are not simply trying to stop inflation at the cost of some near term growth. But they have to balance the risk of inflation against the possibility that too aggressive an anti-inflation posture might be even more dangerous to the economy.

Financial instability is the risk of this period not simply recession. It portends a loss that could be much more damaging. Hawks know that inflation left unchecked will cause great problems and will lead to even more rate hiking later on and, eventually a worse recession. Anti-inflation hawks aim to head off such consequence. Doves typically don't disagree with them about consequences, but about the degree of the risk in the current circumstance. For the first time the hawks have to balance the risks of inflation with the risk of financial backsliding. So the argument of the doves is more subtle and more powerful than it used to be. Financial backsliding is a much more vexing worry.

The Fed knows that recessions come and go. This is what makes the hawks willing to risk recessions. Recession is worth the price if it stops inflation and avoids a bigger recession later on. But when the risk is not just a 'garden variety' recession but something potentially more lasting and devastating it changes the decision process.

That is how headline inflation got to be so high. It was the realization that to counteract it would have taken a rate hiking policy at a time the Fed in fact chose to cut rates. There were in fact no dissenters at that time to that course of action. Still, core inflation has emerged from this episode relatively well behaved. The Fed's credibility is still in tact. The Hawks and Doves are still engaged in conflict, but is a new one. The costs are not as clearly specified and that makes both sides more careful.

Tuesday, August 5, 2008

Doves RULE hawks DROOL!

Who'd a thunk it?

Man bites dog? 98lb weakling beats up weightlifting champ. Nerd gets prom queen. Just think of the other oxymoron headlines this one ranks with.

No one has named any athletic team 'the Doves.' There are the Atlanta Hawks. Doves are not fighters. They are peacemakers. And i don't mean that as a reference to the old western six shooter also called a 'peacemaker' or 'widowmaker'. No this is like Gandhi (no team named after him either).

But after this FOMC meeting everyone knows that DOVES HAVE TEETH, well figuratively speaking, please - no emails from orinithologists.

Of course the doves are more powerful with a tail wind, especially if it's a hurricane-force wind. And dropping oil prices had that sort of force on the markets. While there was speculation about how many dissents we might have had at this meeting (like how many angels can stand on the head of a pin, anyway?) we had only one.

And at what cost did the Chairman 'buy their acquiescence' with the majority? Did he make the language really hawkish? Did he compromise a lot? No. He compromised very little. The statement is on balance DOVISH. I guess all those pre-meeting stories of all that hawk angst were off-base.

Look at our story 'When doves cry' below. What we saw in train one day before the meeting was a growing tail- wind supporting the doves after the hawks had come to power and were being undermined. That in fact is the story of the August 5th Fed meeting.

Still Plosser has been on a bit of a an anti-inflation war path (Fed will have to hike rates sooner rather than later). And Stern has been inflation-wary himself. But the breakdown in oil prices took the burning need out the hawk's stance. Plosser is more of an ideologue than Stern but even Plosser stepped back from the slippery slope of dissent. So we were left with Fisher as a fixed dissent (since he feels that the last cut was unwise, he apparently will protest it as long as he is a voter or until something fundamental changes). As such that dissent is without much policy impact.

It is both interesting and reassuring to see that something as simple as lower oil prices could re-unite the committee. The fact that the statement tells us that Bernanke did not have to cut deals with verbiage to gain consent is a telling sign that the Fed sees energy prices as the problem. AND left to go on long enough some were coming to fear that the Fed's steady hand was not enough. But high energy prices were certain to be their own undoing through their impact on demand. What has happened here was in fact inevitable. Thankfully it happened before the Fed was forced to hike rates to fight the threat that undermined itself: high oil prices. Now we wait to see if oil prices will continue to move lower and how much time we have bought for ourselves. With any luck it could be a lot.

Monday, August 4, 2008

When Doves Cry

Events bury doves: The Fed Hawks have the upper hand. The balance has been shifting. The reason is clear. After the aggressive rate cuts early in the year market rates began to rise instead of fall. At that it became clear that further rate cuts would not be helpful and in fact had become harmful. It was as though the doves had scored a basket for the wrong team.

Hawks circle: The main reason for the hawks to have gotten the upper hand was that the doves had no strategy once rate cutting stopped working.

Facts favor hawks: As oil prices continued to spiral higher in 2008; headline inflation soared too. Core inflation stayed more or less tranquil but it came to show a bit more pressure than the Fed has wanted, as it ahas informally desired core PCE inflation at 'no more than' 2%. In this circumstance the hawks gained more strength. As of June the Core PCE is rising 2.3% Yr/Yr. The Core CPI is up by 2.4% Yr/Yr. As the CPI generally rises by 0.4% per yr faster than the PCE, its range tops out at 2.4%. So the CPI is at the border of acceptability in terms of its inflation pace but the PCE core is excessive as its top is at 2% and its pace at 2.3%.

A complication: These are not draconian departures from price stability as the Chairman has defined it by his ranges (which are not formal targets or accepted by the FOMC as as a committee). But with headline CPI inflation at 4.9% in June and total PCE deflator up by 4%, the Fed is concerned about its credibility. Fed credibility is what anchors inflation expectations, and that is what keeps inflation under control. Credibility may not be only abut inflation's core. Various arguments have been conjured up to blame the falling dollar on Fed policy and rising oil prices in turn on dollar weakness. So the headline inflation rate is in play as well as the core...

Doves cry but hawks are tethered:
With these developments in train the Hawks have pressed their upper hand with talk of coming rate hikes and with enough credibility to move some futures markets. Still the Fed has extended its special credit facilities into next year, an implicit acknowledgment that financial conditions remain out of kilter. And while economic conditions may not have deteriorated sharply there is evidence of some further deterioration: in car sales, in confidence, in the unemployment rate, and so on. There probably is enough of this evidence now to stay the hawks hands... or talons, as the case maybe.

That is what has the Fed in a stalemate.

The worm turns again: Economic weakness is not fading away and this too keeps the hawks at bay. It actually looks as if weakness is getting more intense. And oil prices have broken out of their dead run toward $150/bbl and are looking weaker: still high but in a downtrend. That weakness lowers the risk of continued acceleration in headline inflation and further brings the hawks to heel. While the hawks still seem to hold sway at the moment they do not hold enough firepower to get a policy change. Moreover, the events that govern policy, economic growth and inflation dynamics, seem to be shifting again, this time to favor the doves.

The passive hawk position is still activist: If the economy continues to weaken the threat to inflation will not seem so severe. Some hawks will nonetheless want to hike rates on the grounds that rates are simply too low for price stability. That is the passive hawk posture. But to execute this plan the economy will have to be stronger not in its current weakening mode.

Doves to draw to inside straight? Headline inflation will continue to be a negative for price stability for some time to come. It will take some out-sized weakness in the economy to truly keep the hawks at bay by driving down headline inflation, oil prices, and other commodity prices - all at once. But I think that is exactly where we are headed - to real recession-like weak growth, to steep job losses and to clearly worsened conditions. That will put the hawks on hold and bring the doves back into favor.

The race to November: While hawks retain the upper hand for now, they are losing their grip and have the elections closing in as an immediate rate-hiking impediment. Still, they have a long lasting desire to move rates up just because they are too low. Doves, on the other hand, have no plan. Fed financing facilities have kept the economy aloft. The economy will have to get very weak and market conditions will have to change a lot to put a rate cut as a serious option on the table. It's not clear if anyone on the Fed now fits into this category of dove - one that wants a rate cut now. At the moment it seems almost impossible that the Fed could do it. But if the economy weakens sharply, the doves could regain control and could even spread more dove-like wings, especially ahead of the elections. Stranger things have happened. And strange things do happen when they depend on the economy's performance. It should be clear that policy does not depend on dogma but instead on the fate of the economy.

Job market is no recession counterpoint

The June jobs report allayed some fears of recession.

It shouldn't have.

If this is a recession that began in December of 2007 as many suggest, then as of its eight month it displays the third smallest job losses of any recession since 1960. The average recession drops the level of jobs from their threshold recession level by 1.5%. Currently jobs are lower by only 0.3%. In the eighth month of recession. In the eight month of the 1960 and in the 1973 contractions jobs fell by less. They were still recessions. The 1960 recession tuned out to be a recession of relatively light job losses (jobs fell by only 1.2% at their worst) but at 1.6% the losses in the 1973-75 downturn were a bit worse than average.

Still recession severity cannot be told by the depth of job loss alone. Recessions are about the economy at large the depth, breadth and length of the economic slowing of all sorts, not just the job market. The three metrics of breadth. depth and length are the key applied across all sectors.

But job losses alone do not even tell us the full scope of labor market weakness. Since the economy had different job growth momentum coming into each of these previous recessions the true impact is not just job losses. It is the shift in job growth that tells a better story of disruption.

Since 1960, in recessions monthly job growth slowed by an average of 263,000 compared to the 4-9 month average gain prior to the recession's start. After the first four months of recession the down shift in job growth intensified to being 331,000 slower than its pre-recession period.

Each recession period has seen a minimum shift in job growth of at least -400K in the recession compared to pre-recession monthly growth. The average maximum monthly job slowing in recessions creates one-half of one million jobs less in the worst month compared to the pre-recession average.

The 2008 experience is like the 1973-75 experience in that the slowdown in job growth is not severe. Although jobs are declining steadily, the slowing from the pre-recession environment shows a shift in growth of only -156,000 on average. In 1973 jobs did not slow from their pre-recession pace appreciably until the 13th month of recession. But then weakness came on with great severity. The average slowdown in the first eight months of recession in 1973-75 was even less than what it is now. But the 1969 recession appears as more severe on this metric. So the 2008 recession does not stand alone it does stand as most similar to the last oil price/embargo induced recession of 1973-1975.

In 2008 there has been little evidence of acceleration in job losses and that is what is perplexing even though that result is not unprecedented in recessions.

In 2008, however there is also evidence that economic weakness is still spreading. The Challenger Announced Corporate Layoff data show that the layoff trend is on the rise. Vehicle sales have been slowing as well to an anemic 12.55mu sales pace in July. Arguably the economy was slowing on the housing situation and financial troubles coming into 2008 then spiking oil prices pushed it over the limit. I look at the economy as successfully having fought off recession from housing and the financial sector problems but as now succumbing to the impact of strong oil prices. The rebates hardly have helped. By and large they have been saved by the consumer. These multiple attacks on the economy account for its slow or herky-jerky recession start.

But we still think it is a recession and we think it is going to develop metrics more like past harsh recessions.

Jobless claims are spiking, announced corporate layoffs are high and rising, the unemployment rate is up sharply. Consumer spending on durables is sharply lower and consumer confidence is off. The signs are clear and uniform in their message. Why ignore them just because of job patterns (that have not even undergone their final revisions) don't look exactly as they have in most past recessions? They are after all close enough and other supporting signals should be clear enough.

Still don't think it looks like a recession?

Just wait.