Wednesday, April 11, 2007
It looks to me as if the economy is picking up slightly right now. I doubt it has legs, but there are some good shorter-term indicators as well as negative ones.
Commercial paper outstanding has been going up for several weeks. Yes, it could be that companies are broke and floating paper to pay their bills, but I suspect it stems from an increase in business activity. The theory is that commercial RE credit should now begin to see the same type of pricing spreads based on risk as has occurred for consumer mortages. We will see. I am not convinced. I think supply and demand is just as active in credit markets as it is in any other economic activity.
Employment is so-so. It's not as good as the monthly release would normally make me think, because continuing claims are still running above this year's starting point:
The high was 2,624,000 on 2/17 and the four week running average is continuing to drop. Continuing claims over the first quarter seem to me to be a very good economic indicator. They are issued each week with the initial claims reports. (For March 31st, initial claims blipped up, but it was not significant - yet.) You can pull the entire series from this page, if you're interested. If you look at bad vs good years, you see a pattern in which the SA continuing claims rise from January to March significantly in the run-up to an official recession. What we are looking at now is intermediate. The numbers have only risen marginally instead of by a couple of hundred thousand, as they did in 2001 and 2003.
ISM Services came in as a dud. It showed marginal growth, but the details looked dim indeed. Particularly notable was a drop in the hospitality (restaurants, hotels, etc) sector. That is not a promising economic sign. Information also reported diminishing expectations.
Consumer credit was somewhat restrained in February. It will be a while until we have March! The February number did not look that exceptional, although it tends to give the lie to the idea that restraints on the wilder excesses in mortgage lending will be compensated for as consumers charge up their credit cards. My belief is that people were charging up their credit cards because they believed that they could pay it off by refinancing and rolling the CC debt into their new mortgage. Certainly the GSE stats showed this happening - last year most people were refinancing into a higher interest rate and a higher principal balance, and all through the year total homeowner equity percentage kept dropping.
Both ISM services and manufacturing showed very high increases in costs. The domestic reports were quite similar to JP Morgan's global reports overall. Inflation of such inputs tends to propagate through the wholesale/retail chain and end up in the consumers' laps. It does not seem that this type of inflation will stop any time soon.
I think inflation is the real factor putting the crimp into consumer spending. We have an interesting pattern of inflating needs prices (food, fuel, utilities), while pricing on a lot of bigger ticket items that fall into the discretionary purchase category have been dropping, including the ultimate discretionary purchase for most consumers - a home. I don't see this changing at all in the next few months. Advance retail and food sales for March is due out April 16th, and that will be interesting. When corrected for price increases, that report has been showing YoY declines for several months in several categories. In pure discretionary (hobby & books) there was an absolute YoY drop, but some of that could have been as a result to online shopping. I will be extremely curious to see what the 722 item (restaurants) shows for March.
Inflation can mask a recession to some extent, but stagflation is as unpleasant for the consumer as an outright recession. Nonetheless, I think I was wrong and that we are not in a recession right now. Instead we are in a period in which base-level inflation is soaring beyond wages, and that spending is constrained as a result. I don't see how this can end without a recession, because building and building employment has just begun its real decline, employment is soft-ish (but softening from a very good level), and there's not a darned thing that can happen for companies in this environment but to pull back and lay off workers.
The banking environment will be poor overall this year, and bank stocks are going to be weak as a class for some time to come.
What we are not seeing is a rise in long-term rates for credit to sound borrowers. If anything, we seem to be seeing a marginal drop in rates for these borrowers because everyone's scrabbling for them. So in that sense, we are not experiencing inflation at all. Needless to say, this is going to ameliorate the less-than-stellar economic situation.
So can the Fed cut to stimulate this economy? I say it cannot. A rise in long-term rates would precipate a further decline in the housing market and exacerbate the problem of the resetting adjustable rate mortgages. The Fed is doubtless afraid to look soft on inflation for fear of causing a rise in long rates. By doing so, they would run a risk of producing a really bad economy. A drop in fuel costs would greatly assist to quash the type of inflation that we are seeing, but the Fed can do nothing about that.
The situation is aggravated domestically by the stupid ethanol binge. There is more acreage under corn now than any time since 1944, and that means corn and other grain costs will rise more than one would expect from just the fuel and other input cost increases. Growing corn on marginal or less-worked lands is more expensive. A stupid energy policy has produced a very unfavorable situation for lower-income people.
Unless these conditions change, the Fed is more likely to raise rates than to increase them, but my belief is that they will sit on their hands and solemnly genuflect to the ability of the markets to compensate and adjust.
Stuff like rolling the principal and unpaid interest over into a new loan are just commonplace, in my experience, in the last few years. It's because of competition. Rates were also way too low for the risk, and that was because of competition. I think the collateralization is not there, either.
When I look at balance sheets, I rarely see a company that seems flush on cash. I do think they need to borrow to ramp up business, and that's why I think the uptick in outstanding is significant for the economy.
No one is writing about the commercial credit problem very much, but I think that's the huge vulnerability. I could tell stories.... I don't see how we can avoid a recession at this point, and I don't think the balance sheets will hold - a lot of this stuff is going to go bad.
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