In a recent commentary article on Charles Schwab, Liz Ann Sonders recently pointed to signs of an impending recession. We’re experiencing an oil price shock, inverted yield curves, and a real estate slump. Three things that, while inconclusive, are not particularly desirable.
First, the oil price phenomenon:
“Since the late 1990s, oil prices have gone up from $10 to $76 per barrel! With OPEC effectively flat-out producing, the U.S. producing a record low percentage of its own consumption, pipeline problems in Alaska and our imports coming from increasingly unstable regions, a major drop in prices is unlikely. Add the effect of rising interest rates and rising medical expenses, and consumers are now spending 55% of their disposable personal income on “essential” non-discretionary consumption, an all-time record. The massive infusion of liquidity by the Federal Reserve, via 46-year record low interest rates earlier this decade, had been the tailwind offsetting the headwind of rising oil prices.”
So maybe the liquidity we saw in recent years will evaporate. Interest rates are rising, and if home equity stops flowing, consumer spending won’t be able to keep buoying up the economy. Consumers are important too. They account for close to two-thirds of our GDP.
Combine tightening consumer budgets with recent indicators of inverted yield curves. Inverted yield curves occur when longer-term interest rates are lower than shorter-term rates. Historically, these have preceded recessions. Especially a special one where the Fed inverts the curve by raising the fed funds rate above the 10-year Treasury yield. The Fed did this in June. Since the ’70s this happened 6 times and in every case the economy shortly therafter (or already) was in a recession.
“One of the well-watched models for recession predictability [the inverted yields thing I mentioned - JAW] now shows the odds of a recession at greater than 25% based on the degree of inversion (as of Aug. 11) between the 10-year Treasury bond and the 3-month Treasury bill, presently at -0.10 percentage points.”
Regarding housing, mortgage application volume was down nearly 30% year-over-year as of July 28th. Housing starts? They were down 11% from a year ago. Existing and new home sales? Yes, down too: 9% and 11%, respectively. One could hastily conclude people aren’t opening mortgages with the increasing rates. Or maybe Americans are too greedy and want too much for their homes, so buyers are more scarce. Perhaps. The inventory of unsold homes was up close to 40%.
The impending doom Ms. Sonders predicts, may or may not materialize. Regardless, I want your articles or predictions of the current economy. Please leave a comment below, just click the “comments” link.
Big news this week was the Fed’s decision to not change short-term interest rates, held at 5.25%. More housing slowdown was reported: August housing starts dropped 6% to a three-year low. Equally stunning was a 0.4% drop in the August core PPI. These numbers had a mixed influence on the stock market, but both were bullish for the bond market.
For the week, the S&P 500 fell 0.4% to 1,315. The 10-year US Treasury note fell 21 basis points to 4.59%
August’s numbers for finished goods’ PPI rose a modest 0.1% (excluding food and energy, PPI fell 0.4%)
August’s index of leading economic indicators fell 0.2% in August (for the 5th time in the last 7 months)
August’s new residential construction fell a larger than expected 6.0% (starts are down almost 20% year over year)
Many economists stop short of predicting a wholesale housing bust. The Fed’s policymakers said they believed the “gradual cooling of the housing market” would help slow the economy and allow inflation pressures to moderate.
The Fed’s cease-fire on rate hikes came after various reports showed the housing boom is definitely over. Sales of new homes and existing homes have been falling. Though median prices are still rising, gains have been the smallest in years.
A record level of unsold homes is expected to exert even greater pressure on prices in coming months.
The concern is that the sizable inventory glut could worsen as millions of Americans with adjustable rate mortgages, taken out when interest rates were at four-decade lows, suddenly find they can’t meet new higher monthly payments.
Last week was short due to the Monday US Holiday. Some inflation concerns did surface.
Q1 and Q2 unit labor costs were revised upwards (much higher than expected)
Q2 productivity growth was steady
The Fed’s Beige Book showed continued economic expansion from mid-July through late August
August’s ISM Non-Manufacturing Index rose to 57.0, indicating continued services expansion
July’s consumer credit increased
For the week the S&P 500 fell 0.9% to 1,299 and the 10-year U.S. Treasury yield rose 4 basis points to 4.77%
Labor costs were on the rise for Q1 and Q2, 2006:
The Labor Department reported that unit labor costs were revised upward significantly for both first and second quarters. First-quarter growth in costs soared to an annualized 9.0% from the previously reported 2.5%, while growth in the second quarter measured an annualized 4.9%, up from 4.2%. Both revisions came as a result of changes in hourly compensation and were higher than expected.
However, business owners can relax slightly, as:
The new first-quarter figure may be a result of the inclusion of employee year-end bonuses and the exercise of stock options and may not be indicative of an inflationary trend in wages.
Sales of new homes fell in June for the first time in four months, and the government also lowered figures for May, providing further evidence the high-flying housing market is losing altitude.
The Commerce Department reported Thursday that new home sales fell 3 percent last month to a seasonally adjusted annual sales pace of 1.131 million units. It was the first decline since an 11.5 percent drop in February.
The government also cut its estimate of sales activity in May to a pace of 1.166 million units, substantially below its initial estimate of 1.234 million units.
The economy may be able to manage a “soft landing” after all. Despite another gloomy week for housing data, other signs of the economy (labor market and manufacturing) are healthy. A soft landing is the “avoidance of both inflation and high interest rates as well as a recession as an economy slows its growth rate.”
For the week the S&P 500 rose 1.2% to 1,311 and the yield of the 10-year U.S. Treasury note fell 5 basis points to 4.73%
Augusts’ nonfarm payroll data showed employment increase by 128,000 in August.
The index of consumer confidence dropped to it’s lowest level since Hurricane Katrina.
Q2 GDP was revised to 2.9% annualized growth (up from the original 2.5% figure)
In July the personal savings rate slipped further: to -0.9% of disposable income (June was -0.7%)
The Institute for Supply Management (ISM) reported that manufacturers enjoyed a 39th consecutive month of economic expansion.
From Vanguard and Briefing.com, I’ve put together the following (references below):
Based on this week’s reports, the U.S. labor market and solid manufacturing activity continued to hold up consumer spending in the face of deterioration in the housing market and weaker consumer confidence. For the week, the S&P 500 Index rose 1.2%, to 1,311, and the yield of the 10-year U.S. Treasury note fell 5 basis points to 4.73%. The risk of inflation picking up in the months ahead is still present. Should that occur, the Fed may raise rates again. Higher inflation is never good for the financial markets.
Employment growth showed some healthy numbers. Friday’s nonfarm payroll figure showed employment increased by 128,000 in August. That represents a 1.1% annual rate of increase that, if coupled with 2% productivity growth, is consistent with continued real GDP growth near 3%. The payroll trend is also consistent with a soft landing for the economy. The payroll increase was higher than the average monthly gain for the prior four months, which stood at 117,000. The unemployment rate for August was little changed at 4.7%, reflecting 7.1 million people who actively sought work in the past month but not 1.6 million who wanted work but were not actively looking. Average hourly earnings in August rose $0.02, or 0.1%, less than the increases in the prior two months.
Tuesday showed the release of the index of consumer confidence. It posted a sharp drop in August. A July reading of 107.0 fell to 99.6 in August, its lowest point since the period following Hurricane Katrina. The reading reflected consumers’ increasing pessimism over both current and future business conditions. The number of consumers who saw jobs as being plentiful dropped 14.6%. The number who saw jobs as being scarce increased 7.6%. The proportion of consumers who expected that their incomes would increase in the months ahead—an important indicator for consumer spending—declined to 17.7% from 18.3%.
The preliminary revision to real gross domestic product (GDP) for the second quarter was close to consensus estimates. The economy grew at an annualized rate of 2.9% in the second quarter, higher than the 2.5% originally reported but a sharp drop from the 5.6% annual growth rate of the prior quarter. The boost partly reflected strong growth in state and local government spending and greater investment in inventories. Vehicle sales, which added to first-quarter growth, detracted from second-quarter GDP.
Another major event was Tuesday’s release of the August 8 FOMC minutes. The minutes clearly stated an inflation concern and strongly suggested that, at that time, many Fed members believed a further rate hike was likely. On Tuesday, however, the market rose on the idea other statements in the minutes regarding concerns of going too far with rate hikes was more significant.
Consumers’ debt levels rose, which may have influenced the fall in consumer confidence. The personal savings rate slipped further in July, as the increase in personal spending continued to outstrip the increase in income. Personal savings as a percentage of disposable personal income fell to a negative 0.9% in July from June’s negative 0.7%. The slip resulted from a 0.5% increase in personal income—which got a large boost from income on rental property—versus a 0.8% rise in spending, twice the prior month’s spending increase. The personal consumption expenditures price index, closely watched by the Federal Reserve Board, increased 0.3% in July.
Orders for factory-made goods fell a less-than-expected 0.6% in July. Orders for durable goods fell 2.5%, while orders for nondurable items increased 1.6%. Transportation and electrical equipment led the decline in durable-goods orders, while orders for petroleum and chemical products supported the increase in the nondurable column.
Manufacturing activity was positive although construction spending was down (as the recent trend has been). The Institute for Supply Management (ISM) reported that manufacturers enjoyed a 39th consecutive month of economic expansion. The ISM Index stood at 54.5 in August, little changed from the prior month. Construction spending fell 1.2% in July from June. The steepest fall was in private residential construction, down 2.0% from June. Private nonresidential construction increased 0.3%, and public construction fell 0.7%, partly due to a slowdown in highway construction.
Next week, the Federal Reserve releases its Beige Book on Wednesday, providing an overview of economic conditions in the 12 Federal Reserve districts. The book will figure in the Federal Open Market Committee’s rate-setting deliberations on September 20. Other reports include the ISM Non-Manufacturing Index and second-quarter productivity and costs (both on Wednesday) and the Fed’s consumer credit report (on Friday).
