The data released since the August edition of the Harmonic Notes e-newsletter suggests that, like a patient recovering from an illness who suffers an alarming relapse, the global economy seems to have regained its path towards gradual recovery — at least for the moment. Unlike last month, when the data was across-the-board sour, some data series have recently stabilized or risen.
- CONSUMER
- Home sales were abysmal after the expiration of the homebuyers’ tax credit, consumer credit continued to decline (although this is a necessary evil and a therefore a mixed blessing) and of course unemployment remains sickeningly high.
+ Retail sales, however, came in stronger than expected, as did other measures of consumer spending. Also, the Consumer Price Index rebounded to show marginally positive month-over-month growth (not that we’re rooting for inflation, but it’s better than outright deflation.) Finally, although private payrolls were uninspiring (the US economy needs about +120K new jobs each month to keep up with population growth, so +67K isn’t up to snuff) the figure improved from July and was better than expected, and the Average Hourly Earnings rose a solid +0.3%.
- BUSINESS
- Business productivity turned negative as costs rose during 2Q10, and the ISM Service Index fell again (although it remains marginally in expansionary territory).
+ Industrial Production and Capacity Utilization were reported better than expected, though CapU remains at a very low level. Business inventories also grew. Importantly, the ISM Manufacturing Index unexpectedly rose well into expansionary territory.
- INTERNATIONAL TRADE
+ Exports rose and imports fell as the July trade gap narrowed significantly, reversing June’s drop.
- GENERAL
- Second quarter GDP growth was revised further down, to 1.6%.
+ The Chicago Fed National Economic Activity Index rebounded to neutral. One of our favorite leading indicators, the ECRI Weekly Leading Indicator, has trended sideways for the last 2 months; after a precipitous decline it hasn’t deteriorated further, so we’ll consider that a positive.
FISCAL POLICY
Tax policy is an issue that has the potential to push the economy one way or the other. We’re not hard-core anti-tax advocates, but it seems obvious that an economy experiencing such a fragile recovery will have a difficult time bearing the weight of higher taxes. We’re pleased, therefore, to see some dialogue about extending the lower capital gains and dividend tax rates passed during the previous administration. Doing so isn’t a panacea to the US economic problems but a 1-2 year extension might keep a little more cash in consumers’ and businesses’ pockets that they could use toward helping the economy recover.
We’re in wait-and-see mode on the recently proposed additional stimulus measures, like road and rail infrastructure spending, extension of research tax credits and a 100% write-off of business investments. Our constant refrain may sound like a broken record, but job creation is the key to driving the economy forward: To the extent these measures create jobs we’re in favor. However, it should be noted that the proposed infrastructure bill is only $50 billion, a drop in the bucket compared to the size of the US economy, and any legislation faces (1) an extremely contentious election season until early November, when political points are worth more than solutions, and (2) a lame duck Congress from November through early January.
NO DOUBLE-DIPPING
The more positive tone of the recently released data buttresses our assertion that a double-dip recession seems unlikely. Very importantly, the consumer has for the moment risen to the occasion by heading back to retail stores after an early summer pause, and the small (12% of GDP) but crucial manufacturing sector continues to expand. Though significant headwinds remain – surveys of truckers, retailers and homebuilders have recently weakened, and a recent CFO survey showed a sharp decline in optimism, so second half economic growth won’t be stellar – our view on the currently available data is that growth won’t be negative.
Risk remains clearly skewed to the downside, however. It may be that, like an aircraft taking off, a certain amount of velocity is required for an economy to “get lift” without stalling. That supposed level is about 2% according to ISI Group, so we need to see more growth than the revised 1.6% 2Q10 figure.
Quarter-over-quarter GDP growth, 3Q05 – 2Q10
BLESSED ARE THE WEAK…
Recent further weakening in the US Dollar helps, since it makes US exports more attractive abroad. As the alarms predicting an imminent collapse of Eurozone have faded, the Euro has strengthened against the US$. The German economy has been an unexpected bright spot. The Yen has also strengthened against the US$, recently hitting a 15-year high.
CASH IS KING
It’s well known that corporations are holding a substantial amount of cash on their balance sheets. Interpretation of this fact is in the eye of the beholder: For those with a negative outlook, the roughly $2 trillion in liquid assets held by nonfinancial firms is seen as companies creating their own “insurance policy”, rational behavior in a highly uncertain (or deflationary) economic environment. According to ISI Group companies also about $1 trillion in unrepatriated foreign earnings of US firms. For those with a more sanguine outlook, those balances are potential fuel for a market rally.
“FEELING” BETTER (SORT OF)
Obvious to even the unseasoned observer (although not to the economists that have been blinded to reality by theory) is that sentiment plays an enormous role in the workings of economies and markets. While consumers and businesses apparently “feel” a little better than they did when we wrote last month’s newsletter, they remain very uncertain about the long-term prognosis.
Nov 11th
Economic Insight: Harmonic Notes e-newsletter, November 2010
Author: Kenn Lamson
Comments: 0
The data released since the last edition of the Harmonic Notes e-newsletter in mid-September suggests continued slow growth but feels a bit wobbly, like that recovering surgical patient we analogized in the last note. The data is anything but one-sidedly positive to be sure, and many worry that pressures like the ongoing foreclosure crisis could sideswipe the nascent economic recovery.
DATA OVERVIEW
- The major negative factor facing consumers is, of course, stubbornly (intractably?) high unemployment levels. Also, home sales have recently been mixed, with sales of new homes flat but sales of existing homes rebounding. On an absolute level, however, sales across the board remain at historically low levels.
+ Retail sales again came in stronger than expected, as did other measures of consumer spending. Also, the Consumer Price Index stayed flat at about 1.0% year-over-year and barely positive month-over-month as the economy shows evidence of disinflation but not the dreaded deflation. Observers got a nice surprise with the release of the October jobs data, which showed a much stronger-than-expected jump of +151K (+159K private payrolls). While Average Hourly Earnings rose only modestly, Average Weekly Hours rose +0.1 hour.
- Industrial Production and Capacity Utilization were reported worse than expected and CapU remains flat at a very low level.
+ The ISM Manufacturing and Service Indices both jumped unexpectedly and both remain solidly in expansionary territory. Business productivity rebounded in 3Q10 as costs were flat. With such a high unemployment rate it’s clear there’s no wage-based inflation pressure.
- Exports rose less than imports the August trade gap resumed its widening trend.
- The initial report on third quarter GDP growth showed a slight quarter-over-quarter improvement, from 1.6% in 2Q10 to 2.0%. This rate is substandard and at risk for “failure to launch.” Further, much of the growth in the third quarter appeared to come from inventory restocking, not more sustainable sources. Also, our favorite coincident macroeconomic indicator, the Chicago Fed National Economic Activity Index, fell back into negative territory after rebounding a month earlier.
+ Our favorite leading indicator, the ECRI Weekly Leading Indicator, has continued its gradual improvement; after a precipitous decline for about nine months beginning late 2009, it’s risen slightly since mid-year.
GDP growth (white, right scale); Chicago Fed National Activity Index (yellow, left scale); Economic Cycle Research Institute Weekly Leading Indicator (blue, right scale)
HOPEFUL GLIMPSES
It appears as though the economic teeter-totter has risen ever so slightly from being fully pegged down on the negative side, where it remained for an uncomfortably long time. Both anecdotal and quantitative evidence offer glimpses of hope:
ISM Manufacturing Index, 5 years ending October 2010
BROWN SHOOTS
While the worst storms may be behind, that’s obviously not the same as having clear sailing ahead. There remain plenty of things about which to worry:
QUANTITATIVE EASING (round II)
The more positive tone of the recently released data buttresses the assertion in our last newsletter that a double-dip recession isn’t in the cards, a situation that’s more certain now that the Fed is on the scene with the cleverly acronym-ed QE2. Shorthand for the Fed’s purchase of bonds in order to drive down interest rates, the recently announced $900 billion quantitative easing program is the 800 pound gorilla in the markets and a giant question mark for the economy. Its potential effect has been vigorously; it’s an unfortunate truth that even those at the Fed who’ve launched the program in an attempt to stimulate the moribund economy don’t really know what will happen.
Of particular note is the -7.3% drop in the US Dollar since Fed Chairman suggested in late August that QE2 might be forthcoming. While the Dollar’s decline is a boon to US exporters our trading partners appreciate none-too-much that our central bank appears to be manipulating our currency to their detriment, and holders of our debt don’t care much for having their investments eroded to increasing inflation.
Our concerns about the program are pretty straightforward: This medicine probably won’t achieve the desired boost to economic growth but may create some undesired side effects, like asset bubbles (remember stocks in 2000 and 2007, and real estate in 2005-2007?) and ultimately inflation. A major problem with QE – with monetary policy generally –is that it’s dependent on the financial system to execute. The analogy I recently used to an undergrad class with which I was speaking was that of a spigot with a hose attached (the spigot is an analog for the Fed, obviously): If there’s a knot in the hose it doesn’t matter how wide open you turn the tap. This is why the current (or recently ended, depending on your perspective) recession is quite different than any since in the US the ‘30s.
SOLUTIONS
The problem of subpar economic growth won’t be solved until credit creation begins again, and that requires both lenders and borrowers to participate. While their comfort may be gradually growing, at the moment lenders remain skittish while borrowers either:
To quote the recently released quarterly Fed Senior Loan Officer Survey – “banks eased standards and terms over the previous three months on some categories of loans to households and businesses” but “substantial fractions of banks reported… that standards for many categories of loans would not return to their longer-run averages for the foreseeable future”.
Solid Line = large companies; dotted line = small companies
Fiscal solutions would seem in order – tax cuts targeted at small business hiring, temporary guarantees or mandates to encourage banks to lend to creditworthy borrowers once “well-capitalized” levels have been reached, etc. – but those seem extraordinarily unlikely. We are concerned that, quite bluntly, almost nobody in DC “gets it”. Further, it’s spectacularly naïve to expect that simply because there’s been a change in the party controlling the House that politicians will begin putting the country before their own self-interests. We’ve all heard the old saw “gridlock is good”; that’s true only when the economy is working properly. Consider how counterproductive it would be for doctors to be arguing over treatment while our archetypal surgical patient is slipping into a coma.
At the macro level the solution to the problem’s obvious: We must have credit creation and job creation. Lower rates probably won’t do it– in fact, may well hurt in the long run. As always, the devil’s in the details.