Weekly jobless claims back at low end of range

Weekly initial jobless claims reversed last week’s rise, falling 16,000 to 453,000.  The 4-week moving average came in at 458,000, down from 464,250, while continuing claims fell 83,000 to 4,457,000.


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The current high level is not overly impressive and continues to highlight the uncertainty in the business community. However, claims are near the low end of the nine month range, strongly suggesting the economy is not poised to enter a new recession.

Consumer confidence sags but retail sales chug along

Much has been made about the uncertainty that is clouding the economic outlook, including the recent dip in consumer confidence.

Whether one looks at the Conference Board’s survey, which reveals that confidence has returned to the low end of the range its been stuck in for 18 months, or the University of Michigan’s Index, which shows that sentiment has rolled over, many are losing faith in the recovery.

Surprisingly, however, so-called “core sales” are chugging along at a decent pace. Core sales exclude the volatile automotive category as well as sales at gasoline stations, which are whipsawed by the ups and downs in the price of gas.


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As the chart reveals, the downturn in core sales was not nearly as dire when the near collapse in auto sales and the impact of falling gasoline prices were removed.

Conversely, rising gasoline prices also exaggerated the rebound earlier in the year.

Still, given the troubling numbers coming from consumer confidence surveys, core sales have been holding up. 

Combined with timely data on weekly jobless claims, which have been holding in a narrow range since the start of the year, obituaries being written on the recovery are a bit premature.

Minneapolis Fed Chief Kocherlakota weighs in on QE

Debate rages at the Fed

The Minneapolis Fed Chief Narayana Kocherlakota became the latest to weigh in on new purchases of government bonds by the Fed, highlighting the differences that exist within the central bank. See text.

Popularly known in academic and financial circles as quantitative easing (QE) – buying government securities over and above what’s needed to keep rates at or near zero, and thus, create excess reserves (cash over and above what banks need to keep on hand for unforeseen emergencies) - Kocherlakota gave his views on the much-debated subject and suggested new measures of quantitative easing may have only a “muted effect.”

The newly appointed Fed president began his speech with an overview of how the Federal Reserve is structured and quickly moved into the nuts and bolts of  monetary policy.

He discussed the sluggish recovery and the uncomfortably low rate of inflation but said that the “Minneapolis forecasting model predicts that it (inflation) will rise back into the more desirable 1.5-2 percent range in 2011.”

An often stated reason for a new round of QE can be summed up in the fears expressed by St. Louis Fed President James Bullard, who said that new purchases of bonds are needed to prevent deflation from setting in, thus preventing a Japan-like outcome.

Ben Bernanke has also weighed in on the debate but has only discussed the tools the Fed still has available at its disposal.

However, just broaching the subject has brought on speculation that it is only a matter of time before new purchases begin, as the Fed normally telegraphs changes in policy in advance.

The Minneapolis Fed chief went on to say that the “FOMC is also maintaining a portfolio of roughly $2.3 trillion. Over 2 trillion of those dollars are invested in Treasury securities or government-backed securities issued by Fannie Mae, Freddie Mac, and other government-sponsored enterprises.”

He noted that this has created “nearly $1 trillion of excess reserves.” See chart below.


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In normal times, inflation would ensue, but these are not normal times. He acknowledged that the excess reserves “create a potential for high inflation at some point in the future if the FOMC does not react sufficiently fast when it starts to see inflationary pressures.

“But I do not see this risk as being heightened in any meaningful way by banks holding even more excess reserves than what they are holding today,” Kocherlakota added.

He went on to say that based on academic research the Fed’s massive purchases that began at the height of the recession has “reduced the term premium on 10-year Treasury bonds relative to 2-year Treasury bonds by about 40-80 basis points (on an annualized basis).

“(The term premium is a measure of the difference in yields that is not explained by the expected path of short-term interest rates.) This fall in term premia led to a slightly smaller fall in the term premia of corporate bonds.”

He concludes that further QE would have a more limited impact this time around.

Summary
Kocherlakota is probably right. There is nearly $1 trillion sitting at the Fed earning 0.25% that could be lent to consumers and businesses.  Adding even more reserves into the system would do little to encourage lending, as the effect on rates would probably be small.

Note that falling yields may have already priced in a new round of QE.

Unfortunately, consumers are more interested in saving than spending, fiscal policy is being held hostage to the federal deficit, which leaves only monetary policy to do the heavy lifting.

And since we are at or near a liquidity trap – a theoretical term used by Keynes to describe a period when monetary policy becomes ineffective because it can no longer influence interest rates, the economy may have to heal on its own.

Case-Shiller Index posts gains

The S&P Case-Shiller Home Price Index  released yesterday showed that home price rose 0.8% in July in the ten-city index and 0.6% in the 20-city index, providing a pleasant surprise given all the lousy data we’ve been seeing on the housing market.

Year-0ver-year, prices rose 4.1% for the index of 10 metro areas, while the 20-city index gained 3.2%. But as the chart from S&P Case-Shiller reveals, gains have moderated.


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However, for now at least, prices have stabilized, according to the survey.


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“Home prices crept forward in July. Ten of the 20 cities saw year-over-year gains and only one – Las Vegas – made a new bottom, as the impact of the first time home buyer program continued to fade away,” says David M. Blitzer, Chairman of the Index Committee at Standard & Poor’s. “The year-over-year growth rates for 16 of the cities and both Composites weakened in July compared to June.

“While we could still see some residual support from the homebuyers’ tax credit, which covers purchases closing through September 30th, anyone looking for home price to return to the lofty 2005-2006 might be
disappointed. Judging from the recent behavior of the housing market, stable prices seem more likely.”

With sales apparently stabilizing at low levels, and economic uncertainty and still-high foreclosures casting a shadow over the housing market and the economy, price stability might be a bit optimistic at this point but it would be welcome.

Consumer confidence – stuck in a rut

The Conference Board’s survey on consumer confidence fell a greater than forecast 4.7 points to 48.5 points in September, the third decline in four months and the lowest reading since February’s 46.4.

As chart chart below highlights, consumer confidence has been in a narrow range for over a year, with no signs of breaking out to the upside.

Worse, the Present Situation Index, which as its name implies, measures current attitudes on the economy, continues to scrape the bottom. It fell from 24.9 to 23.1.


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Future expectations, which has rebounded off the recession low, fell to 65.4 from 72.0.

Taken together, consumers have little good to say about current conditions, while expressing very guarded optimism about the future.

Just the facts – taken from the Conference Board’s survey
Digging into the release, those saying business conditions are “bad” increased to 46.1 percent from 42.3 percent, while those claiming business conditions are “good” declined to 8.1 percent from 8.4 percent.

Those claiming jobs are “hard to get” rose to 46.1 percent from 45.5 percent, while those stating jobs are “plentiful” decreased to 3.8 percent from 4.0 percent.

Consumers are also more pessimistic about future employment prospects.

Those expecting more jobs in the months ahead remained essentially unchanged at 14.5 percent in September, compared to 14.7 percent in August. However, those anticipating fewer jobs increased to 22.7 percent from 19.6 percent. The proportion of consumers expecting an increase in their incomes declined slightly to 10.2 percent from 10.6 percent.

This means…
The glum mood detected in the survey and also reflected in the University of Michigan’s survey has not caused consumer spending or retail sales to falter.

What it is likely doing is putting a cap on growth and suggesting further gains in economic output will be slow in coming.

Consumer and business lending is stagnant

Yesterday, I argued that one of the most concrete signs that uncertainty is hanging over the economy and holding back growth is the nearly $1 trillion in bank excess reserves  sitting at the Federal Reserve earning next to nothing.

Today we’ll look at what’s happened to consumer credit over the last thirty years, take a quick look at commercial and industrial loans and focus on the much-talked about gamble by the Fed to keep inflation from falling below zero and boosting growth.

The nearly uninterrupted upward trend in consumer credit over the last couple of generations came to a screeching halt during the last recession. Despite an economy that began to grow last summer, consumers have shied away from taking on more debt. See chart 1.


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Chart 2 looks at consumer credit from a different angle, focusing in on the annualized monthly change in consumer credit. 


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Businesses and industrial firms reacted far more negatively to what’s been going on in the economy, as chart 3 illustrates. Only in the last couple of months has lending stabilized. 


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Consequently, the trillions the Fed has pumped into the system kept the credit markets afloat, but the funds did not work their way into the economy in the form of new lending. It ended up as excess reserves (see chart) that are being held at the Fed.

This brings us to the possibility that the Fed will implement a new plan in order to prevent a possible bout with deflation and support growth.

In the just-released Fed statement, Committee members said:

“Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.”

Members added that they will

“continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.”

Thus far the Fed has purchased $1.25 trillion of agency mortgage-backed securities, about $175 billion of agency debt and $300 billion in Treasury securities. 

It also announced in August that it will no longer allow its balance sheet to shrink, and instead, will take the proceeds from maturing debt and purchase longer-term Treasurys.

The massive purchases may have capped longer-term yields, but it has failed to spark a robust recovery.
Another round of quantitative easing may bring down longer-term yields a bit more – the Fed’s sway over long-term interest rates is not concrete like it is over the fed funds rate – but one has to wonder how low mortgage rates have to go in order to encourage fence sitters to enter the housing market and prop up prices and sales.

Again, we are back to the premise that monetary policy has lost its effectiveness, i.e., is the Fed just pushing on a string (see Excess reserves and heightened uncertainty).

The cloud of uncertainty that’s limiting visibility needs to be blown out to sea, and only then will the stage be set for a healthy recovery.

Excess reserves and heightened uncertainty

Much has been made about the uncertainty that hangs over the economy.  Consumer sentiment has languished, the upturn that began over a year ago has come to a halt and the recovery that began 15 months, according to the NBER, has produced few jobs.

However, the excess reserves sitting at the nation’s banks is among the most concrete signs that financial institutions, consumers and small businesses are feeling extremely queasy when it comes to looking at how the current recovery may play out.

Normally, excess reserves – those over and above what the Fed requires be held in the event of some unexpected need such as customer withdrawals – are minimal.


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Prior to the credit crisis that hit its zenith in September and October of 2008, excess reserves held steady at between $1 to 2 billion, a paltry amount given the size of the economy.

Banks normally have very little reason to hold extra cash because of the low rate of return and the incentive to earn income by lending out the funds.

This held true until September 2008, when excess reserves jumped from $1.8 billion in August to nearly $60 billion, and then continued its run before peaking in March 2010 at just under $1.2 trillion – no paltry amount!

A liquidity trap?
Former Fed Chairman Alan Greenspan correctly pointed out in a recent comment printed by Bloomberg News, “There is a heavy weight of uncertainty on the system such that we are not getting the impact of a trillion dollars already on the books into the marketplace.”

Consumers, worried about their own financial predicament are in no mood to take risks, even with rock bottom interest rates. And banks, still trying to repair battered balance sheets, aren’t in any mood to lend.
Consequently, what we have looks like a “liquidity trap”  - where flooding the system with money no longer has any impact on interest rates.

An economist would argue that the demand for money is completely elastic, i.e., the demand curve for money is horizontal. Or a layman might say that conventional monetary policy is no longer effective because adding more money works about as well as pushing on a string.

Let’s not forget, however, that the Fed is now harping on deflation and longer-term Treasury yields have come down.  That has knocked mortgage rates to record low levels, so it does appear that the Fed still has ammo in its arsenal.

Credit markets seize up
We got to this point after the crisis that was precipitated by the failure of Lehman Brothers and the near collapse of the financial system.  Among other things, the Fed opened up the spigots and flooded the system with money to keep credit markets from disintegrating – see chart below.


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Horrendous inflation did not ensue because the velocity of money – or how often it turns over in the economy – plummeted.

If consumers began demanding and banks began lending, the excess reserves on hand would send economic activity into the stratosphere and eventually cause a huge run-up in inflation.

To prevent such a scenario from causing a new burst of unwanted inflation, the Fed has already telegraphed it would begin withdrawing reserves and hiking rates in order to prevent the economy from overheating.

All of this is theoretical, of course, and a roaring economy, coupled with rising inflation, is unlikely at this point.

As already mentioned (as well as the major thrust of this article), the excess reserves sloshing around the system underscore the uncertainty that pervades the economy.

New home sales face myriad of headwinds

New homes sales continue to paint a glum picture for home builders, according to the most recent government data. New home sales held steady in August at a seasonally adjusted annual rate of 288,000, below most forecasts. Sales did remain slightly above the rate of 282,000 in May, the lowest reading since records began in 1963.

Meanwhile, the number of new homes for sale fell from 8.7 months in July to 8.6 months in August.  The absolute number of homes for sales eased from 209,000 to 206,000, the smallest number of new houses on the market in 42 years, according to data supplied by the Commerce Department.

In a moment, I’ll take a look at how the supply of houses is more a function of sales rather than the absolute number languishing on the market.

For now, however, the theme remains little changed.  New home builders are facing a number of stiff headwinds, including competition from late-model foreclosures, lackluster consumer confidence, high unemployment and worries about the direction of housing prices.

First a quick explanation of the chart below. The left side measures new home sales (blue line) and the absolute supply of homes for sale (red line).  The right side of the chart measures the supply of homes in months based on current sales (green line).


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As noted by the chart above, housing sales peaked at just under 1.4 million units in July 2005.  Sales then began a downward descent (blue line) over the next five years that is yet to fully abate.

Since early 2009, the downward trend seems to have run its course, though the bottom we’ve seen over the past 18 months has been soft at best.

A moving target

In the meantime, the absolute number of houses for sales (red line) peaked at 566,000 annualized units in June 2006, steadily falling to the current level of just 206,0000.

But the 36% decline in actual homes on the market has been more than offset by an 80% collapse in sales from the peak.

Based on the current rate of sales, builders are stuck with a supply of 8.6 months, well above the average of 6.2 months going back to 1963 when data were first collected but down from the all-time high of 12.1 set in January 2009.

In addition to poor house sales, developers must also contend with the high number of foreclosures of late-model homes that were financed with a number exotic loans that buyers neither fully understood nor really qualified for, if realistic underwriting standards had been applied.

The absolute supply of houses is very near an historical low, and based on population growth over the past generation, inventory would be considered extremely thin. That is at least one favorable tailwind for the market in what has otherwise been a gloomy outlook.


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And any burst in sales activity could even produce a shortage of homes available on the market.  Odds of this occurring are very remote at the present time.

But given current trends, builders are struggling (see …builder confidence in the basement), and the high number of foreclosures hanging over the market acts like a shadow inventory that continues to work against the market.

The jobless recovery

Early in the week, the National Bureau of Economic Research (NBER) declared that the recession that began in December 2007 ended in June 2009, making the recession the longest since World War II.

In the article, The recession is officially over, I take a look at the devastating impact the worst contraction since the Depression has had on the labor market, comparing job losses over the past couple of years with those in the steep recessions of 1973-75 and 1981-82.

Although the economy is no longer in a recession, according to government data, enthusiasm among most of us remains subdued amid still-high unemployment and the fog of uncertainty that continues to hang over the economy.

In order to graphically demonstrate what’s happened since the end of the recession, I’ve put together a chart that looks at how nonfarm payrolls  have performed following the end of each recession since 1975, save the short recession of 1980.


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The 16 month declines in economic activity during 1973-75 and 1981-82 were difficult times for the U.S. economy.  But as is typical of nasty recessions, the economy bounced back nicely, creating conditions that were very favorable for hiring.

In contrast, the milder recessions of 1990-91 and 2001 were followed by mild recoveries, producing what have been called “jobless recoveries.”  Unfortunately, that’s what we are seeing today.

Looking at the data since June 2009, employment didn’t bottom for another six months (month 7) and remains over 300,000 jobs below the level reached when the recession was officially declared to have ended.

This has been an atypical recovery following an atypical recession – one brought on by a financial crisis and not from an overly tight monetary policy.

Consumers and businesses continue to hold back, which has given us a sluggish expansion. Consequently, companies remain reluctant  to add to payrolls, putting this recovery just ahead of the feeble gains experienced after the 2001 recession ended.

The graph below provides a closer look at how the job market performed during the 1991, 2001 and 2009 recoveries.


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Mortgage rates steady, hold below 4.40%

Home prices are stable or falling in most areas and mortgage rates have held below 5% on the 30-year fixed loan for 20 consecutive weeks.  Consequently, it would appear that a once-in-a lifetime opportunity to get a great deal on a new house, while also locking in a 30-year rate that is below 4.40%, are at hand.

So far, potential buyers aren't biting. Instead, they are waiting for an improvement in the economy and signs housing prices won’t keep falling before taking the plunge.

Freddie Mac, in its weekly survey, said the 30-year fixed-rate mortgage  averaged 4.37% with an average 0.7 point for the week ending September 23, 2010, unchanged from last week. Meanwhile, the 15-year fixed rate mortgage held at a record low of 3.82%.


(click chart to enlarge)

Plenty is working in favor of borrowers who would like to either refinance their current loan or would like to trade up or purchase their first house.

Mortgage rates are closely tied to the yield on the 10-year Treasury bond. Because the slowdown in the economy has further diminished inflation expectations, investors have been snapping up U.S. Treasurys.

But that's not the only reason mortgage rates have come down.  The Fed announced on August 10 that it would keep its balance sheet from shrinking by taking the runoff from mortgage-backed securities that are either maturing or being paid back via refinancings and reinvest the proceeds in Treasury bonds.

The added purchases have also worked to bring down yields, while the latest Fed statement suggested a more aggressive approach designed to bring down longer term rates and encourage more business and consumer spending (think housing) is also working in favor of low rates.

How long mortgage rates will hold at current levels is anyone’s guess, but the current environment has greatly increased the affordability of homes.

A look at the Leading Index

The Conference Board’s Leading Economic Index increased 0.3% in August, and as the graph from the Conference Board shows, the recovery remains intact but the pace is expected to be sluggish.



Interestingly, the Coincident Index, which measures economic data that reveals how the economy is currently performing (as opposed to the LEI which is future oriented), began its rise when the recession ended in June 2009.

Gains in the CI have been gradual, reflecting the slow recovery. Over the past three months, the CI has increased an anemic 0.1%, as growth slowed over the summer.

Another perspective is available at my page on Examiner.

Weekly jobless claims back up

The downturn in weekly jobless claims finally came to an end in the latest week, with the claims rising 12,000 to 465,000.  The 4-week moving average, however, slipped by 3,250 to 466,500.

According to Bloomberg News, problems surrounding seasonal adjustments tied to the Labor Day holiday have been responsible for some of the decline over the past couple of weeks.

The backup in claims is a bit disappointing, since the weekly figure is still stuck in the elevated range it has been in since the start of the year.  However, it is down from the yearly high of just one month ago, which is a good indication that the economy is slowly improving.

Fed sees deflation as public enemy number one

Falling prices, however, are still remote

Tuesday’s Fed statement had all the markings of a central bank that seems ready to pull the trigger on a more aggressive round of quantitative easing, i.e., purchases of longer-term Treasurys in order to fight a perceived threat – deflation.

And its remarks weren’t lost on bond traders, who snapped up government bonds in anticipation of new buying.

Comments such as, “Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.”

And it is “… prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.”

Still, the Fed did leave itself an out as it said it still expects inflation to rise “to levels the Committee considers consistent with its mandate.” At a minimum, the comment suggests that policymakers believe the odds inflation will fall below zero are still remote.

Don’t know much about history

First a short history lesson is in order. Looking back at the last six years, the Consumer Price Index moved in a mostly upward trend until July 2008, when it peaked at 5.5%, its highest level since January 2001, according to BLS data.



Higher food prices lent support to the headline number, but big gains in crude oil were the primary culprit.  Who can forget gasoline selling at $4 per gallon during the summer of 2008?

Core inflation, which minuses out food and energy, was more muted, as higher energy prices did not noticeably bleed into the general price level.

Enter the collapse of oil prices and the onset of the Great Recession:  headline inflation plunged to levels not seen since the early days of the Truman administration.

The disinflationary trend (a falling rate of inflation) in core inflation, however, has been more gradual, as annual price increases fell back below 2%, generally considered the top end of the Fed’s comfort zone, in December 2008.

From there, core inflation has gradually been heading south amid the rise in unemployment, falling/sluggish demand in the economy and weak wage growth.



The second chart highlights the subtle slide in core inflation pressures and the eventual descent below 1%, which is generally considered the bottom of the range of what the Fed is comfortable with.

Note, however, that core inflation has been holding steady at 0.9% over the past five month, interrupting the downward trend that actually began in late 2006 (see top chart).  And commodity prices have exhibited modest strength in recent weeks, suggesting the global recovery is continuing uninterrupted.

It would be highly unlikely that deflation could take hold in the U.S. without a significant drop in commodity prices.

Still, it’s still too early to call a bottom, but the slowly expanding economy seems likely to put a floor under prices and prevent a slide to zero, in my view.

Turning Japanese?

Japan saw its twin bubbles, stocks and real estate, burst in 1990, which was followed by feeble attempts by the Bank of Japan to revive the economy.  Instead, huge government outlays were tried without much success.

Many, including myself, believe that the BoJ was too slow to act, and the Japanese economy eventually slid into a deflationary swamp.

Taking its cues from Japan, Ben Bernanke took a much harsher tone on the rate front. And when he  ran out of bullets in his conventional arsenal, the Fed authorized purchases of government securities.

The big concern is that falling prices will further encourage consumers to put off purchases and weaken the recovery or send the economy into another recession.

And falling wages, which would likely ensue, would exacerbate tensions in the financial markets.  Debt, however, does not shrink on its own, increasing the odds of more defaults.

So it’s easy to see why deflation is not the preferred outcome. Put more bluntly, it’s to be avoided.

Let’s create lots of money

The Fed chief, who earned the nickname Helicopter Ben for his remark in a 2002 speech that “a money-financed tax cut is essentially equivalent to Milton Friedman's famous ‘helicopter drop’ of money,” appears ready to leave the landing pad with a pile of cash.

Some question whether such a strategy will truly boost growth amid lackluster consumer and business  confidence and a skittish public that has shied away from borrowing, even at rock-bottom rates. There are risks to such a strategy, and it could mark the beginning phase of a new bubble, but the Fed appears determined to avoid a Japan-like outcome.

House prices dip to six-year low

Housing prices fell a seasonally adjusted 0.5% from June to July, according to the Federal Housing Finance Agency’s monthly House Price Index, which comes on top of a downwardly revised 1.2% dip in June.

The index is 3.3% lower versus one year ago and is now 13.8% below its April 2007 peak. At the current level, prices are near a six-year low.

Source: FHFA website

The chart below, also from the FHFA website, details the drop in prices after the peak reached in April 2007.

Price declines have moderated since November 2008, but the general trends remains to the downside.

We did see some support leading up to the expiration of the first time homebuyers tax credit in November 2009, and some additional support leading up to the second extension in April 2010, which also included repeat buyers who met certain criteria.

But buyers have been scarce in recent months, putting renewed pressure on housing prices.

The index is calculated using purchase prices of houses backing mortgages
that have been sold to or guaranteed by Fannie Mae or Freddie Mac, according to the FHFA.

Traffic helps to drive housing starts

Talk from some analysts suggests that falling housing starts may actually be good news because it helps to clear up inventory that’s already on the shelf.

That may be true in many other industries, when over production can be dealt with by cutting back output and allowing consumers to mop up the excess. But housing is different.

If a consumer is looking at, say, a lawnmower.  He/she buys what’s available at the store and may be incented by a large markdown if there are too many sitting in inventory.

The customer doesn’t special order the product, picking from various colors and customizing features.  But housing, as already mentioned, is a different animal, and many want to choose from a variety of options that are available when their hearts are set on buying a “never-lived-in house.”

The chart below looks at single-family housing starts and compares starts to traffic from prospective buyers, a component of the Housing Market Index, who traipse through model homes.


(click to enlarge)

As the data suggest, traffic plays an important role in single-family starts.

When traffic headed lower between 2007 and 2008, starts declined.  But as lookers began to pick up, the increase in additional customers helped to bolster starts.  

Recent trends, however, have not been so sanguine, and single-family starts are just off a 15-month low.

Fed meeting holds few surprises

The Federal Reserve met to day and decided to keep policy unchanged, but warned that it could taken action down the road if conditions deteriorate. More details on the statement at Examiner.

What I want to do in this space is look at some of the subtle shifts in the language of today’s statement versus the one released August 10 and provide an interpretation.

Starting at the top, the Fed maintained that spending on business equipment and software is still rising but added that increases are coming “less rapidly than earlier in the year." However, though it noted that bank lending continues to contract, the decline has been “at a reduced rate in recent months.”  Not much in the way of good news, but a turnaround in lending is a prerequisite for a more robust recovery.

The second paragraph gets to the crux of the statement and reveals that the FOMC is growing more concerned about prices.

In the prior statement, the Committee said:

“Measures of underlying inflation have trended lower in recent quarters and, with substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.”

The latest version details growing worries:

“Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate.”

The extensive language almost seems contradictory. On the one hand, the Fed clearly states for the first time what we all know – inflation is too low, and Fed officials are growing increasingly concerned.  On the other hand, that last clause suggests that everything will work itself out, and the economy will not experience deflation.

At a minimum, the Fed seems to be saying that falling prices are still just a remote possibility.

Moving on the FOMC did seem to inch closer to new measures, making just subtle changes in its verbiage.

“The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.”

versus:

“The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if need to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.”

Note the more overt "return inflation, over time, to levels consistent with its mandate" compared with the more generic "promote...price stability."  

Final thoughts

The Fed still believes deflation is a remote possibility, but direct references about falling inflation indicate that monetary officials also believe the odds have risen, and policymakers aren’t taking any chances.

Hence, they remain ready and willing to employ all necessary tools at their disposal to prevent what happened in Japan from washing up on the shores of the U.S. economy.

Housing starts jump on surge in multi-family

Otherwise, data not signaling upbeat trend

At first glance, a surge in new home construction last month is welcome news for an industry that has been battered over the past three to four years, but as one digs just below the surface, homebuilders have little reason to celebrate.

Housing starts jumped an impressive 10.5% in August to a seasonally adjusted annual rate of 598,000 units.  That’s good news for those who hammer the nails and sell materials to the construction industry.

But much of the increase came from a 32% jump in multi-family starts, which is a very volatile and small part of new-home construction.  Single-family starts were up a more modest 4.3% to a rate of 438,000 units.



Building permits, which provide a better look at how the industry may perform in the near term, increased 1.8% to an annualized 569,000, while the more important single-family, fell for the fifth-consecutive month to the lowest reading since April 2009 (see chart above).

Builder confidence has languished over the past four months, which is being reflected in a concrete way by the drop in permits for single-family homes.

More worrisome, the upward trend that began in January 2009 has reversed itself.  The tax credit may have something to do with recent weakness, though permits were not impacted in the way that is currently happening when the credit expired at the end of last year.

More likely, uncertainty over the direction of the economy and the high level of foreclosures that builders must compete with are keeping traffic down at the model homes.

The silver lining: the pace of decline has been slowing.  In addition, new housing makes up less than 10% of the market.   Existing home sales offer a better look at what’s happening in residential real estate.

The recession is officially over

But it’s not just the economy, stupid, it’s jobs

The National Bureau of Economic Research (NBER) said today that based on a number of factors the recession that began in December 2007 officially ended in June 2009.

This means that the recession lasted 18 months, which makes it the longest of any recession since World War II. Previously the longest postwar recessions were those of 1973-75 and 1981-82, both of which lasted 16 months.

In pinpointing the month the economy hit bottom the NBER said it places particular emphasis on measures that refer to the total economy rather than to particular sectors.

These include a measure of monthly GDP that has been developed by the private forecasting firm Macroeconomic Advisers, measures of monthly gross domestic income, real personal income excluding transfers, employment and aggregate hours of work in the total economy.

       
The NBER pointed out what most of us already new, this recession has been longest since WWII. But at least one thing that makes this contraction unique has been the damage it has done to the labor market.

Looking at the chart above, it took two years for employment to hit a bottom, with the the net loss totaling a whopping 6% from the peak employment level.

This compares very unfavorably to the roughly 3% decline experienced in the nasty recessions of 1973-75 and 1981-82.

Losses in employment were fast and furious in the ‘74 recession but were followed by a fairly brisk recovery.  It’s is worthwhile to point out that though the recession began in November 1973, companies were slow to cutback, adding workers until July 1974.

The contraction in the early 1980s saw employment bottom as the economy hit bottom.  And it didn’t take long for the robust recovery to begin generating substantial gains in employment. Remember President Ronald Reagan’s 1984 campaign slogan “It’s morning in America?”  Job growth was impressive in 1983 and 1984.

This time around the economy continued to experience a net loss in employment even after the recession ended.  And given the heavy amount of uncertainty still facing businesses and the shallow recovery, job gains have been frustratingly slow.

Consequently, though the statisticians have declared that the recession is over – and the data does bear this out, many of us don’t “feel” as if the recession has ended because of the lack of employment growth and ongoing problems in the housing market.

Housing Market Index reveals builder confidence is in the basement

Builder confidence held at an 18-month low in September, signaling little chance a pick up is coming any time soon for home builders and the new home market.

The NAHB Wells Fargo Housing Market Index held steady at 13, far below a reading of 50 which would indicate that builders are neither confidence nor pessimistic about their industry.


(click chart to enlarge)

"In general, builders haven't seen any reason for improved optimism in market conditions over the past month," noted NAHB Chairman Bob Jones, a home builder from Bloomfield Hills, Mich. "If anything, consumer uncertainty has increased, and builders feel their hands are tied until potential home buyers feel more secure about the job market and economy."

"The stall in the nation's housing market continues," agreed NAHB Chief Economist David Crowe. "Builders report that the two leading obstacles to new-home sales right now are consumer reluctance in the face of the poor job market and the large number of foreclosed properties for sale.

“However, we do expect that moderate improvement in the job market will help boost consumer confidence and improve conditions for new-home sales in this year's final quarter."

The index hit an all-time low of 8 back in January 2009 and entered into an upward trend that lasted over a year, peaking at 22 in April when potential buyers were enticed off the sidelines by the government’s tax credit.

Mounting evidence now suggests the credit appears to have done little more than whipsaw the market by forcing sales sharply higher in the spring while leaving far fewer active participants in the months that followed.
The latest data suggest that housing starts, and by proxy, new housing sales (less than 10% of the market) are stabilizing at a low level.

Confidence and sales highly correlated

The chart below, which goes back to 1985, shows how builder confidence (in blue) has tracked new single-family starts (in red).


(click chart to enlarge)

Given the close correlation, it is easy to see that builders have a good feel for what's happening in their market, and there isn't much to be optimistic about in the near term.

Downward trend in consumer sentiment

Plenty of worries abound and the headwinds buffeting the economy are taking a toll on consumer sentiment, as evidenced by the latest survey from Thomson Reuters and the University of Michigan.



One interesting and troubling stat in the survey.  The one-year inflation expectations measure fell to 2.2% from 2.7% August, the lowest reading since last September. Nearly a third of consumers surveyed expect deflation or a zero inflation rate during the year ahead, Reuters said.

The survey's five-to-10-year inflation outlook index was unchanged from August at 2.8%.

Modest inflation expectations, along with the shallow recovery, have played a major role in preventing the rate of inflation from falling to zero.  If short-term inflation expectations head lower, pressure will rise on retailers to hold the line on any price increase.

Details at Examiner.

Greenspan on Bush tax cuts: let them expire

Former Fed Chief Alan Greenspan said yesterday that Congress and the president should let the Bush tax cuts expire at the end of the year, surprising many who see Greenspan as a champion of free markets and limited government.

Noting that this is the first time in his memory that he has favored raising taxes (though he did favor tax hikes in the early 1980s to save social security), his seemingly reluctant admission stems from his fear that the country does not have much time to implement a credible deficit reduction plan and send a signal to the financial markets and global purchasers of Treasurys that the U.S. is serious about tackling its fiscal imbalances (see Greenspan warns on deficit spending, calls for immediate action).

A broad tax increase at this juncture in the business cycles would be extremely risky and could easily tip the economy back into a recession since a reduction in disposable income may be remedied by reduced spending.

One has to wonder if Greenspan, whose tenure at Fed has been tarnished by the implosion in housing, has come to the conclusion that deep spending cuts, including reductions in popular entitlement programs, will not be forthcoming no matter who controls Congress in 2011.

Despite inefficiencies in the public sector, Washington has done little to rein in spending over the past 50 years.  And when it has occurred, brief bursts of fiscal sanity were followed by a renewed spate in outlays. 

Hence, as he put it, the choice to raise or not raise taxes is not a choice "between good and bad; it’s between terrible and worse."

Recent dip in jobless claims encouraging

But data issues may be behind drop

Weekly jobless claims are an excellent barometer of business confidence and offer plenty of information about what is going on in the economy.

That’s why the recent drop is a concrete sign that the economy is not poised to enter a new recession, but any excitement should be balanced against indications that  issues with the data may be responsible for the recent decline.

In the latest week, weekly initial jobless claims fell 3,000 to 450,000, the lowest reading in two months. The 4-week moving average declined 13,500 to a 464,750.



On the surface this is definitely good news, though keep in mind, weekly claims are now at the bottom of the range they have been in since the start of the year.  From that standpoint, there has been little progress.

Digging a bit deeper, the 54,000 decline in the weekly figure over the past four weeks may have more to do with data collection issues than an improving economy.

According to Bloomberg News, "Delays surrounding Labor Day, both administrative delays on the government side and delays for those filing claims, may be holding down the total.”

We’ll likely know in the next few weeks whether the drop is for real or has been more of an illusion brought on by quirks in the filing process.

If claims settle in around 450,000 over the next few weeks, odds of a double-dip recession will recede.  Still, we won’t be seeing real progress until claims fall below 400,000.

Not a good month for factory output

Industrial production slows

As the inventory rebuilding cycle wanes, industrial production last month grew just 0.2%, while output in July was downwardly revised from a preliminary estimate of 1.0% to 0.6%.

Simply put, the slowdown in manufacturing that had surfaced in numerous surveys is being detected by the Federal Reserve’s index of industrial output.

Much of the weakness came in a steep drop in auto output, which is a category that tends to be extremely volatile.

However, there were pockets of strength, including gains in high-tech equipment, semiconductors, construction supplies, consumer goods and business equipment (roughly 40% of output).

In the meantime, capacity utilization edged up from 74.6% in July to 74.7% in August, indicating that plenty of slack still remains in the economy. Readings near or above 80% would put the economy closer to capacity, which can unleash worries about inflation at the Fed.

The data are not pointing to an imminent slump, but it does highlight that the economy hit a soft patch.

Empire Manufacturing – slowing

The first look at September output comes in the form of the Empire Manufacturing Index, which is a look at conditions in New York.

 

The index fell by 3 points to 4.1, the lowest reading in over a year.  A level of zero indicates neither growth nor contraction, therefore, the dip suggests a deceleration in growth.

However, new orders and shipments improved, suggesting stabilization at lower levels in the near term.

Upward trend in retail sales

The chart below shows that the gradual uptrend in retail sales remains intact.  Though consumer spending is not surging ahead and fueling a strong economic recovery, retailers can claim a modest degree of success when it comes to enticing shoppers into their stores with sales.  Details are available at Examiner.

Retail sales increased 0.4% in August. Ex-autos, sales grew by 0.6%, and removing autos and a 1.9% rise in gasoline stations sales (compliments of higher prices at the pump), s0-called “core sales” increased a respectable 0.5%.

Rising wholesale inventories a sign of slowing demand

Somewhat of a mixed bag of news from the Commerce Department  today. Wholesale inventories jumped 1.3% in July.  On the one hand rising inventories will translate into higher GDP in the short term; however, increased inventories at a time when the economy has slowed could cap growth later in the year if businesses ease up on production.

Sales did rebound following a 0.5% decline in June, rising 0.6% in July.  The inventories-to-sales ratio, which looks at how many months it would take for businesses to liquidate their stockpiles at the current sales pace, inched up from 1.15 to 1.16.



Some comfort comes from the fact that very sharp and painful cutbacks in production in 2009 have eliminated excess and unwanted inventories  following the near collapse in demand in late 2008.

Although the economy has hit a bump during the summer, goods on hand are very near historical lows.  If economic activity is just in a temporary pause, and that is probably the most likely scenario in my view, July’s jump in inventories should not be viewed as a worrisome event.

If inventory growth continues to outpace sales, we are more likely to see a more pronounced slowdown in manufacturing.

Trade deficit narrows, wiping out June’s rise

The trade deficit narrowed significantly in July, falling from $49.8 billion in June to $42.8 billion in July.

Exports of goods and services increased to $153.3 billion in July from $150.6 billion in June, while imports fell to $196.1 billion in July from $200.3 billion the prior month.

The good news is that the improvement came from higher exports of capital goods ($2.3 billion), other goods ($0.5 billion) and industrial supplies and materials ($0.5 billion).

Imports declined, reflecting a drop in consumer goods ($1.9 billion), automotive vehicles, parts, and engines ($0.7 billion) capital goods ($0.6
billion).

Taking a look at the last couple of months it appears that the data were affected by unexpected swings (difficulties in seasonal adjustments?) in both imports and exports, which tended to cancel each other out in July.

Looking at the chart above, the trend toward an expanding trade deficit remains intact, as rising exports – aided by an expanding global economy – are more than offset by modest gains in consumer demand and higher oil prices.

For the first seven months of the year, oil imports have totaled $148.7 billion, up by $52.5 billion versus the same period one year ago, according to data provided by the Commerce Department. 

Blame the rise in oil prices for much of the deterioration in the country’s trade gap over the past twelve months.

Weekly jobless claims record largest monthly drop in over a year

After hitting a 2010 peak just four weeks ago, weekly jobless claims have been on a nearly uninterrupted downward trend, dropping by 53,000 in just a month’s time.

In the latest week, weekly initial jobless claims fell 27,000 to 451,000, putting the closely-eyed figure on the labor market back near the bottom of the range it  has been in since the year began. The 4-week moving average declined by an impressive 9,250 to 477,750.

According to Bloomberg News that the Labor Department told Market News International that nine states had to be estimated due to delays tied to the holiday shortened week, but the government stressed that data since received confirm the improvement.

Holiday weekends sometimes cause difficulty when it comes to producing a reliable report, as seasonal adjustments to not always capture the nuances of that particular holiday or event.

So it may take another couple of weeks to confirm that conditions are actually improving in the labor market.

If the trend continues – and there’s a giant question mark hanging over that statement as the chart above reflects the many false starts we’ve seen since the beginning of the year –  and claims settle in between 400,000 and 450,000 it would be a sign that the lull in summer activity has come to an end.

Readings below 400,000 would be a more concrete sign that economic activity is accelerating.

Fed’s Beige Book: growth slows but pace still modest

Each month the Fed releases what is called the Beige Book, which is a summary of economic activity in each of  the Fed’s twelve districts.

It is no surprise that anecdotal information collected over the period showed “widespread signs of a deceleration compared with preceding periods.” But the most common characterization of overall conditions – the economy is still growing at a modest pace.

Highlights include -

“Consumer spending appeared to increase on balance despite continued consumer caution that limited nonessential purchases.”

“Manufacturing activity pointed to further expansion, although the pace of growth eased according to several Districts.”

“Demand for commercial real estate remained quite weak but showed signs of stabilization in some areas.”

“Home sales slowed further following an initial drop after the expiration of the homebuyer tax credit at the end of June, prompting a slowdown in construction activity as well.”

In summary, a new slump is not imminent but don’t expect a noticeable pick up in economic activity any time soon.

MBA’s Purchase Index suggests some stabilization in housing

Not out of the woods yet

The U.S. Mortgage Bankers Association reported this morning that it’s weekly look at mortgage applications for new and existing homes, or it Purchase Index, increased by 6.3% from one week earlier on a seasonally adjusted basis.

“Purchase applications increased last week, reaching the highest level since the end of May.  However, purchase activity remains well below levels seen prior to the expiration of the homebuyer tax credit, and is almost 40 percent below the level recorded one year ago,” said Michael Fratantoni, MBA’s Vice President of Research and Economics.

In the wake of the expiration of the home buyers tax credit, mortgage applications quickly plunged to levels not seen since 1997, doing an excellent job of foreshadowing the collapse in housing sales this summer (see Purchase Index points to near-term housing weakness).

The most likely reason: rational buyers moved up purchase decisions to capture the extra cash the U.S. Treasury was providing. 

However, several factors, including waning consumer confidence, tight lending standards, high unemployment and foreclosures, and concerns that housing prices could still decline are also keeping potential buyers on the sidelines.

Mortgage rates are at historic lows and affordability is high, according to surveys, lending modest support to the market. But stiff headwinds are preventing a solid foundation from being formed under the market.

Until housing begins to recover, it seems unlikely that a robust economic recovery will develop.

ISM surveys highlight disparity between manufacturing and services

Hard hit in the recession, goods producer lead  the way

When the credit markets froze in September 2008, what had been a mild recession quickly turned ugly, and demand throughout the economy plummeted, sending stocks sharply lower and the unemployment rate skyward.

The ISM Manufacturing and Non-Manufacturing Indexes (offered up by the Institute for Supply Management) are monthly surveys of  the economic landscape that closely monitor conditions among goods producers and non-goods producers (or service industries), respectively.

As the chart above reflects, manufacturing activity contracted sharply in the second half of 2008.  The service sector of our economy, which makes up the lion’s share of activity, was not immune from the recession either, as consumers hunkered down and focused on debt repayment and savings.

Manufacturers were so quick to respond to rising inventories and quickly slashed production, resulting in a severe contraction in the sector.  By getting inventories under control, this part of the economy has accelerated much quicker than the service sector and has been crucial in aiding overall GDP.

However, as mentioned above, the service sector accounts for most of the wealth produced in the U.S.  Though it was not his as hard by the recession (relatively speaking), it has also been slower to recover.  And the more feeble recovery in services continues to cast a long shadow on  the recovery.

Good news on the labor front being tempered by weak service sector gauge

A key gauge of service sector activity showed that growth in much of the economy nearly came to a halt in August, detracting from a better-than-forecast rise in private-sector employment.

The ISM Non-Manufacturing Index slowed from 54.3 in July to 51.5 last month, well below the consensus forecast offered by Bloomberg News of 53.0 and below the bottom end of the range that ran from 52.0 to 54.3.  A reading of 50 suggests that the service sector, which makes up a majority of economic activity, is neither expanding nor contracting.

Weakness was broad-based, as nearly every category gave up ground. And at 51.5, the index stands at its lowest reading since January, when it began a string of 50+ readings that indicated the economy was beginning to move forward.

But data have been mixed lately.  Housing has been under pressure and jobless claims are still too high.  But consumers have been a little less stingy with purchases and manufacturing growth has accelerated.

The increase in jobs last month is taking a little bit of pressure off the Fed, but today’s reading on service industries is likely to get noticed by central bankers.

Nonfarm payrolls dip

Growth in private sector exceeds forecasts

Good news on the hiring front: Nonfarm payrolls fell less than expected, and private sector employment, which has gotten most of the attention lately due to distortions caused by the hiring and laying off of temporary 2010 Census workers, increased by a better-than-expected 67,000.

The unemployment rate ticked up from 9.5% in July to 9.6% in August, as the number of new hires was outpaced by growth in the labor force.

Overall, job growth remains anemic, but very modest hiring suggests that businesses do not believe the economy is about to stall.

Details are available at Examiner.

A quick look at natural gas

Despite a summer in most parts of the country and an accompanying increased use of air conditioners, the price of natural gas been heading downward in recent weeks, falling below $4 per million British thermal units.

And today’s report of another modest rise in natural gas supplies did little to boost the sagging spirits of producers.  The Energy Information Administration announced that working gas in storage rose 54 billion cubic feet (bcf) in the latest week to 3,106 bcf, which is 208 bcf less than last year at this time and 169 bcf above the 5-year average of 2,937 bcf.

 

Not even a warm summer and increased usage was able to do much for natural gas producers, as many traders believe that an almost unlimited supply of the odorless and colorless gas is available thanks to new drilling methods that are tapping deposits contained in shale.

Unless a major hurricane comes barreling through the Gulf of Mexico and supplies are shut in, or we have an early and ferocious start to winter, prices are likely to remain at low levels compared to the past few years, providing consumers with a nice break  this winter.

Rebound in pending home sales suggests stability

May’s steep drop in pending home sales did a great job forecasting the steep decline in existing home sales, but today’s release of July index, which is designed to measure contracts for existing home sales that have been signed but not yet closed, suggests that housing may be stabilizing.

The Pending Home Sales Index released by the National Association of Realtors climbed by 5.2% to 79.4 based on contracts signed in July from a downwardly revised 75.5 in June, but remains 19.1% below July 2009 when it was 98.1.

NAR chief economist Lawrence Yun did not provide much comfort for those looking for a quick rebound, noting, “Home sales will remain soft in the months ahead…and the recovery looks to be a long process. Home buyers over the past year got a great deal, and buyers for the balance of this year have an edge over sellers.”

He went on to say that those who bought near the peak in bubble markets might not fully recover their lost equity for over a decade, but Yun does believe that “improved affordability conditions should help with a recovery.”

The housing market received a nice boost from the first time and repeat buyers tax credit; however, the market cratered (see Existing home sales plunge to 15-year low) following the credit’s expiration, signaling that many potential buyers moved up purchases to take advantage of the extra cash. Hence, it now appears that the credit served mostly to whipsaw demand and distort the market.

Yun is correct, however. Affordability is high right now due to record low mortgage rates and prices that are off their highs.  But many potential buyers remain on the sidelines amid concerns about the economy, still-high foreclosures and just a plain high level of uncertainty.

Until the job market picks back up and prices are on a firmer foundation, the negatives seem more likely to outweigh the positives.

Jobless claims down two weeks in a row

But still elevated

Weekly jobless claims have dipped for two straight weeks but remain stuck at levels that indicate the economy continues to struggle.

Details and a preview of tomorrow’s labor report is available at Examiner.com.

Challenger reports lowest level of planned layoffs in a decade

The job market has been sending plenty of mixed signals lately, as weekly jobless claims remain stuck at elevated levels, while ADP reported today the first decline in private sector employment since January.

But the global outplacement consultancy Challenger, Gray & Christmas said this morning that planned job cuts announced by employers fell by 17% to 34,768 in August, the lowest level in over a decade.

“To put this in perspective, job cuts never fell to these levels following the
2001 recession; not even when the economy was reaping the rewards of the housing boom. You have to go all the way back to the expansion of the late 1990s and early 2000 to find a similar pace of downsizing,” said Challenger.

“If there is a double-dip recession on the horizon, either companies do not see it or they have no slack in their existing workforces. The recovery may indeed be stalling, but any slowdown is unlikely to lead to a sudden resurgence in mass layoffs. Unfortunately, a slowing recovery could be met with further delays in much-needed hiring,” said Challenger.

Large companies are flush with cash following steep cuts in expenses and likely see less of a need to cut their workforces. But labor market conditions remain tepid, as evidence by the high level of weekly jobless claims, lukewarm consumer confidence and the lack of a significant number of new jobs being created by the economy.