Saturday, February 27, 2010

The Mixed Tone of the Economic Data

The various economic reports in the last few weeks have been mostly on the disappointing side, raising some uneasiness over the prospects for the economic recovery. While it was well understood that the inventory-driven pace of GDP growth in the fourth quarter was not sustainable in the early part of 2010, the latest data, taken on face value, suggest that the economy's momentum may fizzling in a disconcerting fashion.

The housing sector indicators have been particularly disheartening. Sharp declines of 11.2% and 7.2% in both new home and existing home sales respectively, with spikes in the inventory of unsold homes in both reports, highlight the still precarious state of the housing market, contrary to some tentative evidence of stabilization that had emerged previously.

The significance of a 3.0% gain in durable goods orders last month was undercut by the fact that it was entirely driven by a 15.6% surge in the famously noisy transportation category, excluding which orders were down 0.6%.

But perhaps the single most unnerving message from the various economic indicators since the beginning of the year comes from the stalling of the previously solid downtrend in initial jobless claims.
After a nearly relentless decline since the spring of 2009, the series has drifted modestly higher since early January. Although noise in the weekly claims data around the turn of the year is hardly surprising, a resumption of the earlier downtrend in the coming weeks becomes an almost pressing issue to provide reassurance that the improvement in underlying labor market conditions (as reflected in the monthly payroll data) has not been disrupted meaningfully.

Despite the above, the data have not been uniformly weak recently.

The manufacturing statistics remain overall healthy, despite today's moderate drop in the February ISM to a still healthy 56.5 from 58.4. (Important to remember that this is a diffusion index, meaning that, as long as it remains above 50.0, the sector is still growing, albeit at a somewhat slower pace than in January). Besides, industrial production rose by a robust 0.9% in January, with the key manufacturing component up a solid 1%.

Also, retail sales for January posted a reasonable (although unimpressive gain) of 0.5%, with the key ex-autos category rising by 0.6%, indicating that personal consumption is still holding up.

What is then one to make of the inconsistent tone of the various reports recently?

The decidedly mixed, and often soft, tone of the data should not be viewed as downright worrisome bur rather as a reflection of the reality that this is only a 3.25-3.5% GDP growth type of economic recovery, as opposed to a more typical 5.0% to 6.0% kind of recovery in past cycles. With so much damage inflicted across the economy by the most recent economic downturn, the moderate pace of economic growth that is unfolding is not strong enough to make the data look, and feel, consistently healthy. Setbacks and pauses should be viewed as almost the norm in that setting and it will probably take several more quarters before the economic recovery engages all of its cylinders on its way to a full-fledged economic expansion.

Anthony karydakis

Tuesday, February 23, 2010

Consumer Confidence Plunges in February

The shockingly sharp decline in the Conference Board's consumer confidence index by more than 10 points to 46.0 in February is a stark reminder of the bumpy road that the economic recovery is facing.

Source: Action Economics

Although the drop in the index can be viewed as a payback for solid, back-to-back gains in December and January, the reality is that the magnitude of the drop is attention-catching. This is so, not only because it has left the series at its lowest level in 10 months but also because of the unnerving drop in the "current conditions" component to 19.4, which is the lowest in nearly 28 years. To add to the downbeat message of the February report, the "expectations" component nearly cratered this month, falling to 63.8 from 77.3 in January.

Anxiety over the job market's prospects remains at the core of consumers' seemingly bleak assessment of both current conditions and the 6-month outlook for the economy. On the face of it, such renewed concerns over job prospects in February run contrary to other evidence in the last few months suggesting that the pace of erosion in labor market conditions is slowing. A plausible, although still wanting, explanation here might be that the cumulative anxiety and frustration over the lack of any readily visible improvement in job growth and the lingering high unemployment rate are taking a toll on household psychology.

Still, the consumer confidence/sentiment measures are "soft" indicators and contain more than their fair share of noise. It is also true that, ultimately, psychology alone will not be the defining factor of what households will do in terms of spending, as this will be shaped by whether labor markets and associated income growth continue to improve. However, the report today is a vivid example of how the decidedly sub-par (by historical standards) pace of this economic recovery to date has failed to project a convincing message to all that an economic recovery is actually taking place at all.

Anthony Karydakis

Friday, February 19, 2010

CPI Inflation, Nearly Perfect

The CPI report for January, showing a gain of 0.2% in the overall index and a 0.1% decline in the core measure, helps bring to focus some key elements of the broader inflation picture in the current environment.

In terms of the January report itself, the discrepancy between the overall CPI and core was almost entirely due to a sharp rise in energy prices (+2.8%) and, particularly, gasoline (+4.4%). The unusual drop in the core last month (its first decline since 1982) was largely the result of an uncharacteristic pullback in the shelter component (-0.5%) which accounts for 33% of the overall CPI; in turn, the decline in the shelter component was driven by a sizable drop of 2.1% in hotel prices ("lodging away from home").

Moving beyond the specifics of the January report, the overall CPI is now up 2.6% from a year ago, while the core index has risen 1.6%- versus a 1.8% year-on-year gain to December 2009. (In reality, both measures would have been even lower on a year-on-year basis, if it were not for a 30% surge in tobacco prices that have added approximately 0.3 percentage during that period).

Source: Bureau of Labor Statistics

Despite pronounced -and exaggerated- anxiety in the wake of the financial crisis and deepening recession in the second half of 2008, that the economy might be facing the specter of deflation, the behavior of the CPI in recent months has safely put such fears to rest. Despite a severe weakening in labor market conditions and ensuing wage trends, as well as a sharp reversal of oil and other commodity prices in late 2008 and early 2009, core inflation has remained comfortably within a 1.5 to 2% range. While some further modest downward drift in the months ahead even as the economic recovery gains traction is still possible (inflation is appropriately considered as a lagging indicator), it is likely to bottom out in the 1 1/4% to 1 1/2% range later in the year.

This leaves the inflation picture at an almost ideal spot. The severity of the recession has predictably enough pushed the core CPI lower by one percentage point (from about 2.5-2.6% in the summer of 2008 to 1.6% today) but any further disnflationary forces are steadily diminishing in the context of an economic recovery taking hold. The substantial, but reasonable, moderation of inflation provides the Fed with some breathing room in its upcoming campaign to normalize the structure of short term rates over the next 12 to 18 months. At some point, over that time frame, inflation will probably show an upturn and, given its inherent inertia, this may not be fully successfully contained by the Fed at first. But with the cushion that the recent retreat of core inflation provides, a moderate bounce back of inflation next year is not likely to trigger any widespread anxiety over the risk of a disturbing comeback.

Anthony Karydakis

Tuesday, February 16, 2010

As the Eurozone Saga Continues...

With mounting resistance by the German public to the prospect of a Greece bailout, that solution appears a tad less likely now than as recently as the end of last week. Positions by the powers-that-be within the EU are stiffening, with tougher demands now imposed on Greece to bolster the credibility of its already announced measures by taking additional action.

The euro remains under pressure and that is unlikely to be alleviated unless specific reassurances, tantamount to a bailout, are announced in the coming days. With Germany and France (the countries that are de facto on the hook for any action to rescue Greece) have pointedly refrained from attaching any specifics to their initial, generic, promises that Greece "will not be left alone". As the gap between words and specifics persists, relatively unconventional ideas as to how to handle the crisis with Greece's debt are being proposed and receiving some attention.

One such suggestion is the one proposed by Martin Feldstein in an article in the Financial Times, which would imply allowing Greece to bring back the drachma as its currency for certain types of transaction, while maintaining the euro for others (link below).

Another suggestion that was, at first, viewed as nearly unthinkable, but no longer so, is to simply expel Greece from the eurozone and that could serve as the wake-up call for the other fiscally challenged countries (Portugal, Spain, Ireland, and, to a somewhat lesser degree, Italy) to put their house in order quickly. The EU, without openly saying so, appears quietly intrigued by the idea that cutting out of the Eurozone its weakest member may be one of the plausible outcomes and may not necessaily mean the disintegration of the euro system.

For the time being, global financial markets continue to punish the most fiscally irresponsible countries by driving their sovereign borrowing costs through the roof and the cost of credit default swaps on their debt near record-highs. After a period of lull for most of January, the Dubai debt affair is coming to the forefront again, with credit default swaps on Dubai World's debt rising sharply in recent days.

Against that backdrop, and despite the re-insertion of a distinct risk component into certain instruments, global financial markets are keeping, on balance, their cool. After suffering a setback stemming from Greece's troubles in the second half of January, stock markets both in the U.S. and Eurozone are making a partial comeback, speaking volumes of the long distance that the world of global finance has covered in the last 18 months or so.

The Eurozone's fiscal woes are often being cast as the inevitable hangover from the combined effect of a global economic downturn and financial crisis that exposed the weakest links among European countries. Moreover, the affair surrounding Greece's troubles may hold more unpleasant developments, as a possible default on that country's debt will have serious reverberations across banks in Europe that are holding mountains of such debt.

All of this may be so, but eliminating all pockets of potential blow-ups in the financial system around the world is not a realistic expectation to have, as the damage that the financial crisis has left behind will take a considerably longer period to heal. A far more sensible yardstick of where the global financial system stands today is whether it has regained its ability to absorb such disturbances, within an acceptable framework of noise-or, even turmoil- that is always inherent in financial markets even in the most normal of times. Based on that standard, the answer to that question is, so far, encouraging.

Anthony Karydakis

Thursday, February 11, 2010

Re-writing the Playbook on Monetary Policy

Mr. Bernnake's Congressional testimony on the specifics of the Fed's planned "exit strategy" yesterday was quite thorough but held no surprises, as nearly all of the measures he outlined had already been mentioned, in a somewhat piecemeal fashion, as being under consideration in the last few months.

Those measures include, raising the interest rate that the Fed currently pays banks on both their required and excess reserves, offering banks term deposits, and conducting Reverse Repurchase Agreements to drain liquidity directly.

This last point included actually a twist, as the Fed Chairman confirmed that the Fed will be looking to conduct "triparty" Reverse RPs, meaning that, for the first time, the Fed will use counterparties in such open-market operations other than primary dealers. Traditionally, the argument has been that the Fed conducts such sensitive operations only with especially vetted securities firms that have received its "seal of approval". However, this rule will need to be broken now, as this "innovation" is mandated by the staggering amount of reserves -in the vicinity of $1 trillion- that the Fed will need to absorb in due course, while the primary dealer community is thought to be able to handle transactions totaling only $100 billion or so. As such additional counterparties, the Fed is considering the money market mutual fund industry, which has a much greater ability to handle transactions of the required magnitude (link below).

Mr. Bernanke reiterated the obvious- that is, that the federal funds rate is likely to remain at "exceptionally low" levels for an "extended period" and it is indeed unrealistic to expect the Fed to move into a tightening mode over the next six to eight months. However, no one can accuse the Fed of not making meticulous preparations to return the financial system to more normal liquidity conditions when the appropriate time comes. And, just as injecting that massive liquidity at the start required an extraordinary amount of creativity and history-making measures, draining all of that liquidity on the back end will require a comparable degree of innovative tools and tactics, as the Fed continues to re-write the monetary policy-making playbook in this country.

Anthony Karydakis

Monday, February 8, 2010

A Matter of Degree

The acute trouble Greece's economy is in and its implications for the Eurozone have already received extensive coverage in the last few weeks- some of which in reasonably articulate and comprehensive articles (like the ones below).

The current predicament that the entire Eurozone entity and the euro as a currency are facing extends beyond Greece, as Portugal, Ireland and Spain are also confronting severe budgetary shortfalls and have shown widely varying degrees of willingness to tackle them effectively.

All in all, Ireland's measures announced late last year have received some cautious praise by the EU but, others, like Spain, are showing overt resistance to the idea of improsing draconian measures to bring their fiscal mess under control. Greece has now been cast in the spotlight due not only to the magnitude of the surprise that the country sprang on the EU last November by announcing "revised" data showing a deficit nearly triple of the previous "estimate" but also due to the country's sad history of avoiding to tackle some of the endemic problems that plague its economy.

How the whole crisis plays out in the next couple of months may have some implications for the dynamic of the U.S. economic recovery as well.

While the most likely outcome remains that, Greece (and, if need be, Portugal as well) will ultimately be rescued in some fashion, either by the EU or the IMF, a prolonged anxiety over the outcome and brinkmanship involved in the process can have wider repercussions for financial markets and the U.S. economy.

If the uncertainty over the fiscal crisis in those four Eurozone countries, which account for approximately 1/5 of the Eurozone GDP, is not convincingly contained soon, a further weakening of the euro can become an additional moderate headwind for the U.S. recovery, as the implied strengthening of the dollar will adversely impact the export-oriented manufacturing sector. This is a sector that has made a surprising comeback in recent months, with the ISM (the most comprehensive barometer of activity in that sector) currently standing at its highest level since 2004. But with more than 20% of U.S. exports going to EU countries, a further drop of the euro (used by only 16 of the 27 EU countries, but also tracked by a number of other currencies that aspire to join it) is bound to have more than just a negligible negative effect on the sector.

The other channel via which an extended period of doubts over the ability of any of the four Eurozone countries currently in the headlines to service their external debt without interruption is the equity markets. Equities have already suffered a setback in most European countries since the beginning of the year, in response to the dismal fiscal situation of some member countries, which has re-introduced a distinct element of risk aversion into the picture. The U.S. equity market has suffered in sympathy, as, one thing that has been learned all too well in the midst of the financial crisis in the last 18 months, is that markets are indeed global. As a result, any additional erosion in U.S. and global equities can impair the ability of households in this country to step up their spending in an environment of high unemployment and a recently elevated savings rate.

Greece is a small country with a pretty inconsequential GDP size within the Eurozone and, in different times, the gross mismanagement of its economy would not have attracted much attention outside its borders. But these are not exactly normal times, as such ripples come at a time when the global financial system is in its early phase of healing from a deeply traumatic experience and nerves can become frail more easily than in the past. Still, as the Dubai episode late last year demonstrated, financial markets have recovered enough to handle isolated glitches, but their ability to do so has its limits. Everything is a matter of degree and that is why the risk of possible contagion across other Eurozone countries bears close monitoring in the coming weeks.

Anthony Karydakis

Friday, February 5, 2010

January Employment Data: A Mixed Picture, But No Real News

Last month's employment report is consistent with the broader picture of slowly improving labor market conditions, but not much beyond that.

Still, a cautionary note should be issued, as today's numbers are somewhat hard to interpret.

A key factor complicating any attempt to form a straightforward impression of the report is the benchmark revisions to the establishment survey (which produces the nonfarm payroll series) that have now shown a more disturbing trend in payrolls since April 2008. Based on the revised data, the economy had shed about 930,000 more jobs in the twelve-month period leading up to March 2009 than previously estimated. In terms of the most recent months, the revised data show that 553,000 more jobs were lost in the period from April to December 2009 than previously estimated.

All in all, according to the BLS, a total of 8.4 million jobs have now been lost since the beginning of the recession in December 2007.

In January, payrolls fell 20,000, following a sharp downward revision to December's decline from -85,000 to -150,000. Construction employment continued to erode (-75,000), while retail trade, manufacturing, and health care, all showed gains (42,000, 11,000, and 17,000 respectively). In an unmistakable sign that businesses remain cautious about stepping up appreciably their pace of adding permanently to their labor force, temporary jobs turned out another solid increase for the month (52,000), after gains of 59,000 and 95,000 in the two prior months.

Nonfarm Payrolls (monthly data; in thousands)

Source: Bureau of Labor Statistics

It is hardly surprising that, given the fiscal woes of most states around the country, 41,000 of state and local government jobs were cut last month, although this was mostly offset by an outsized increase of 33,000 in federal government jobs (in part related to hiring for the 2010 census).

The headline-grabbing 0.3% drop in the unemployment rate to 9.7% last month should be approached cautiously, as it is the result of an essentially stagnant size of the labor force in January and a curious (but perfectly within the margin of routine noise for the series) 541,000 surge in employment, as measured by the household survey. The latter represents essentially a reversal of a 589,000 decline in employment- in the household data- in December. It is much too soon to view January's drop in the unemployment rate as the beginning of a trend and, in fact, it is quite likely that the rate will move higher again in February as a payback for the counter-intuitively sharp decline last month.

A small uptick in the workweek to 33.3 hours does little to create a sense of an emerging trend, as the series gas been bouncing around that level for several months now.

In what is perhaps the single most encouraging- and meaningful- detail in the overall data, the number of persons working part-time for economic reasons (also called "involuntary part-time workers", because either their hours had been cut by their employers or they were unable to find a full-time job) dropped sharply in January to 8.3 million from 9.2 million in December. This can indeed be a sign that more full-time jobs are starting to become available.

The message from the January data is that labor markets continue to show credible evidence that they are turning the corner, but the turnaround process is proceeding at a much-to-be desired pace. Still, the odds remain squarely in favor of a moderate payroll growth trend emerging again in the coming months, with gains perhaps averaging 50,000, or more, in the spring. Such numbers are almost certain to benefit from the pick-up in hiring by the government for the 2010 census, which suggests that the emphasis in the coming months should shift toward private payrolls and not the overall number.

Anthony Karydakis

Thursday, February 4, 2010

Productivity Surges

Nonfarm productivity surged 6.2% in the fourth quarter of last year, following a downward revised- but still impressive- gain of 7.2% in the prior quarter. (In fact, the Q3 gain was the biggest quarterly increase in the series since Q3 of 2003). In the second quarter of 2009, the series had also surged 6.9%. As a result, on a year-on-year basis, productivity is now up a stellar 5.1%.

However, the spectacular gains in productivity in the last few quarters are hardly unexpected.

From the analytical standpoint, productivity consists of a cyclical and structural component. It is typical for the series to show outsized increases in the early phase of an economic expansion, as businesses tend to use their existing, underutilized, labor force more intensively for a while before they are convinced that an economic recovery is taking hold and start hiring more workers. Once that process runs its inevitable course and hiring picks up, productivity gains are bound to moderate precipitously again.

So, it is hardly surprising that, with economic activity bottoming out around mid-2009, productivity gains have spiked. The obvious message here is that they should not be celebrated as representing any improvement in long-term productivity trends in the U.S. economy but simply as a reflection of the economic juncture. It would take several years of a perceptible uptrend in the series to reach the conclusion that something more fundamental is happening. In fact, as the chart below shows, the current productivity surge is nothing exceptional by the standards of the behavior of the series in the early phase of the two previous economic recoveries during 1992-93 and 2002-03.

Nonfarm Business Productivity

Source: Bureau of Labor Statistics

Unit labor costs, which are essentially the mirror-image of productivity have been trending lower in recent quarters.; they fell 4.4% in Q4, following a 1.5% drop in Q3, and are now down 2.8% from a year ago. Once again, it confirms the weak state of labor markets and absence of wage pressures- not exactly surprising against the backdrop of labor slack and a 10% unemployment rate.

The spike in productivity in recent quarters helps explain how GDP growth has been taking off (averaging nearly 4% in the second half of 2009), while the erosion of jobs continues (albeit at a much slower pace). This is indeed plausible for some time but cannot remain the case moving forward, as ultimately a pick up in employment would be needed to support income growth and consumption. So, the mirage of economic growth co-existing with the absence of job creation is essentially on short leash.

Anthony Karydakis