The outlook for the economy and financial markets is ominous. The bear market in equities will worsen. The credit crunch will persist, even though the Fed will almost certainly maintain its current easy Federal funds rate. The reasons. The housing price decline is at best only half over. There is no effective end in sight to mounting foreclosures and the pronounced downward pressure on home prices. Home prices are still far from a reasonable multiple of average personal income. That makes a recovery in the construction industry only a distant hope. Depressed prices on existing homes will further undercut demand for new construction. The continuing disasterous housing market means financial institution mortgage-related losses will continue to mount, maintaining their need for still more additional capital.
Oil prices will remain comparatively high and burdensome, even if they will eventually retreat as the US and global recession and a reduction in foreign subsidies cuts demand. But, near term, still higher oil prices certainly can not be ruled out. Indeed, the OPEC President forecast a rise to $170 a barrel this summer. Whether that forecast is fulfilled or not, expect a continuing plunge in automotive sales and production, especially in light trucks, suv's and recreational vehicles. That will further increase the cash drain of the auto manufacturers. But high oil prices are having a more far flung impact on vitually every sector of the US economy, including the consumer, government, business and the farmer. The oil price spike raises transportation costs for all. But it also raises the prices of the varied products that use oil and oil derivitives as a component, which extends far beyond plastics and fertilizer. That places a pronounced financial squeeze on the consumer, erodes or narrows the profit prospects for business and increases the budget deficits of school districts, cities and states. None of this new. It all happens in recessions, regardless of the specific cause for each recession. But, this week the equity market appeared to have a "light bulb" realization that this time it is oil and the economy's myriad other negatives. The consequent equity market drop has significantly adverse implications.
Equity prices are considered the most reliable of leading indicators. Thus, the 19.9%decline in the Dow Jones Index from its October 2007 peak (18% for the S&P 500), just a hairsbreadth shy of the 20% decline viewed as the "rule of thumb" definition of a bear market, portends deep trouble for the equity market and the economy. This weeks' equity price plunge was largely due to a continuing spike in oil prices {and the negative impact of oil prices on business profits and consumer discretionary spending), as well as renewed dollar weakness and increased concern over financial institution viability and auto company weakness.
Those who are looking for something positive to say about this dire stock market situation indicate that without financials and autos, the equity market is not down anywhere nearly as much. My answer to that is that there are always market leaders and followers. Excluding the weakest components from the equity market price averages proves nothing. What should be particularly troubling to investors is that Dow cyclical declines average some 30%. And by their very nature an average decline encompasses past cyclical declines that are both shallower and deeper. Given the sharp drop in consumer confidence to a 28-year low, the credit crunch, housing distress, financial institution problems, and oil prices, it does not seem prudent to assume a milder than average equity price decline.
Some mistakenly conclude that equity prices are now cheap. Not in my book. Based on last years earnings and current prices, the markets' average price-earnings ratios are still high. Estimates of future earnings are notoriously vulnerable to downward revision in recession. And if the stock market is retracing the pattern of price-earnings ratios of earlier eras, when they fell from above 20 to below 10, equity prices still have a very long way to drop.
Regardless of the cause, the drop in equity prices and the plunge in home prices are recessionary. Togther with the rise in oil and food prices and rising unemployment, these negatives are having a pronounced downward impact on consumer wealth and cash flow, as well as on consumer borrowing and repayment capacity. Those trends reinforce the economy's march toward a deeper recession. That cause and effect realty may help explain why equity and home prices are leading indicators. They do not just lead, they cause what they appear to lead. At this point you may be asking what about this past weeks' outsized improvement in personal income and spending? These increases were widely attributed to the temporary impact of the tax rebates. These funds will soon be a distant memory, overwhemed by higher oil and food prices and other consumer economic and financial burdens.
Next Thursday, due to Friday's holiday, look for a further sizable drop in nonfarm payrolls, perhaps by 50,000. But, as I indicated last month, the unemployment rate may slip to 5.4% from 5.5% after last month's surge. That would be only an interruption in the march toward a significantly higher unemployment rate. Other negative reports next week should include declines in the manufacturing supply mananagement index, previously called the purchasing managers report, and construction spending.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport New York 11731
Email Address: philibraverman@Gmail.com
Saturday, June 28, 2008
Sunday, June 22, 2008
Fed easy policy to stay on hold while other central banks firm
Even with actual and expected firming moves by foreign central banks, markets are increasingly dismissing the prospect that the Fed will soon begin a firming trend of its own intended to contain inflation and strengthen the dollar. A speed up of inflation globally most recently prompted the Central Bank of Mexico to firm, the European Central Bank to hint at a rate rise in its July 3 meeting and the Bank of India and others to suggest a firmer policy stance is coming. The reduction of energy subsidies in a number countries, including India and China, adds to price pressures but, like central bank firming, is an effective form of economic constraint that will slow global growth and energy demands. But, contrary to this trend, the Fed is now increasingly thought likely to maintain its current easy policy stance.
Despite a series of statements by Fed Chairman Bernanke and other Fed and Admistration spokesmen hinting that "receding" financial threats permit a new anti-inflationary pro-dollar Fed stance, the markets are coming to think otherwise. They recognize that the Fed's hands are essentially tied to an easy monetary policy. As I indicated in my blog last week, how could it be otherwise with the continuing credit crunch, housing debacle, necessary bank and investment bank capital restructuring, and developing recession. The Fed is either merely misleadingly feinting at a new policy direction to achieve the desired effect without actually moving in that direction or, far less likely, about to blunder badly.
While the Fed has certainly blundered numerous times, easing when it should have firmed and firming when it should have eased, to firm now would be a particularly egregious policy move for housing, the financial sector and the economy. Unless of course the Fed really wanted to accelerate the economy's glacial decent into recession, hoping to avoid taking responsibility for it, while taking credit for an anti-inflationary impact. Some may consider such a tactic not only adroit, but in the best traditions of devious central bankers. But, that is too deceptive and dangerous a political game to be played ahead of a Presidential election.
Also, the Fed has supposedly shifted to a more revealing, transparent type of policy setting behavior. To return to an opaque, indeed duplicitous, policy now, would be a throwback to an earlier Fed policy setting approach.
A little bit of financial history may be appropriate here. I recall when Arthur Burns (who had previously been my Economics Professor at Columbia University) was Fed Chairman and the Fed did not pre-announce its policy moves or even their direction. As the so called "Fed watcher" and Financial Economist at the time at the Chase Manhattan Bank, I detected in the data a policy change that the Fed was forced by economic circumstances to quickly reverse and I said as much. When questioned on my contention, Fed Chairman Burns publicly denied that a Fed policy reversal had taken place. He said neither the first move I had cited, nor the second had actually occured. It was all, he said, merely in the imagination of the Fed watcher, meaning me. Some three months later, when the Fed Quarterly report of Fed policy initiatives was published, both the first Fed policy shift to a new direction and its subsequent reversal were there revealed for all who cared to see it. That was certainly not the first Fed deception, nor was it the last.
The need for a continuing easy, supportive Fed policy is currently obvious. Indeed it is evident, even with mounting risks that inflation in energy and food will temporarily filter through to other prices and wages before economic weakness generally is able to effectively supress inflation pressures and expectations. The clear reason is the continuing fragility of the US financial system, compounded by mounting consumer financial and economic distress, rising unemployment, and the continuing slide-off in housing and autos. The adverse economic consequences of the negative wealth effect implicit in the downtrend in equity and home prices and the rise in energy and food prices, swamping the positives of fiscal and monetary policy, have yet to be felt or adequately apreciated. Eventually economic weakness and recession will supress inflation expectations and inflation reality. It would help lessen food inflation faster if human and animal food were not foolishly diverted to energy. Biomass can be an effective source of energy, but only if marginal land not suitable for food crops are employed to grow high energy content crops using relatively small quantities of water. Switchgrass and algae are excellent candidates, and they would solve the excess co2 problem.
Though moderating demands globally should lead to somewhat lower prices for energy and other commodities, concerns over the potential for an Isreali air strike on Iran's nuclear weapons facilites is likely to keep energy prices artifically high. That should accelerate the global economic slowdown implied by the sharp downtrend in many developing world equity markets. Those lower equity prices should not be viewed as an investment opportunity until the economic and financial developments they are forecasting are actually realized.
George Soros, in my view, is right on in his concern that the current break in various markets could be the bursting of a broad prolonged multi-market bubble with its potential of dire consequences. That risk, even if we are fortunate enough to dodge the bullet, should not be taken lightly. Investor caution remains appropriate.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport New York 11731
E-mail Adress: philipbraverman@Gmail.com
Despite a series of statements by Fed Chairman Bernanke and other Fed and Admistration spokesmen hinting that "receding" financial threats permit a new anti-inflationary pro-dollar Fed stance, the markets are coming to think otherwise. They recognize that the Fed's hands are essentially tied to an easy monetary policy. As I indicated in my blog last week, how could it be otherwise with the continuing credit crunch, housing debacle, necessary bank and investment bank capital restructuring, and developing recession. The Fed is either merely misleadingly feinting at a new policy direction to achieve the desired effect without actually moving in that direction or, far less likely, about to blunder badly.
While the Fed has certainly blundered numerous times, easing when it should have firmed and firming when it should have eased, to firm now would be a particularly egregious policy move for housing, the financial sector and the economy. Unless of course the Fed really wanted to accelerate the economy's glacial decent into recession, hoping to avoid taking responsibility for it, while taking credit for an anti-inflationary impact. Some may consider such a tactic not only adroit, but in the best traditions of devious central bankers. But, that is too deceptive and dangerous a political game to be played ahead of a Presidential election.
Also, the Fed has supposedly shifted to a more revealing, transparent type of policy setting behavior. To return to an opaque, indeed duplicitous, policy now, would be a throwback to an earlier Fed policy setting approach.
A little bit of financial history may be appropriate here. I recall when Arthur Burns (who had previously been my Economics Professor at Columbia University) was Fed Chairman and the Fed did not pre-announce its policy moves or even their direction. As the so called "Fed watcher" and Financial Economist at the time at the Chase Manhattan Bank, I detected in the data a policy change that the Fed was forced by economic circumstances to quickly reverse and I said as much. When questioned on my contention, Fed Chairman Burns publicly denied that a Fed policy reversal had taken place. He said neither the first move I had cited, nor the second had actually occured. It was all, he said, merely in the imagination of the Fed watcher, meaning me. Some three months later, when the Fed Quarterly report of Fed policy initiatives was published, both the first Fed policy shift to a new direction and its subsequent reversal were there revealed for all who cared to see it. That was certainly not the first Fed deception, nor was it the last.
The need for a continuing easy, supportive Fed policy is currently obvious. Indeed it is evident, even with mounting risks that inflation in energy and food will temporarily filter through to other prices and wages before economic weakness generally is able to effectively supress inflation pressures and expectations. The clear reason is the continuing fragility of the US financial system, compounded by mounting consumer financial and economic distress, rising unemployment, and the continuing slide-off in housing and autos. The adverse economic consequences of the negative wealth effect implicit in the downtrend in equity and home prices and the rise in energy and food prices, swamping the positives of fiscal and monetary policy, have yet to be felt or adequately apreciated. Eventually economic weakness and recession will supress inflation expectations and inflation reality. It would help lessen food inflation faster if human and animal food were not foolishly diverted to energy. Biomass can be an effective source of energy, but only if marginal land not suitable for food crops are employed to grow high energy content crops using relatively small quantities of water. Switchgrass and algae are excellent candidates, and they would solve the excess co2 problem.
Though moderating demands globally should lead to somewhat lower prices for energy and other commodities, concerns over the potential for an Isreali air strike on Iran's nuclear weapons facilites is likely to keep energy prices artifically high. That should accelerate the global economic slowdown implied by the sharp downtrend in many developing world equity markets. Those lower equity prices should not be viewed as an investment opportunity until the economic and financial developments they are forecasting are actually realized.
George Soros, in my view, is right on in his concern that the current break in various markets could be the bursting of a broad prolonged multi-market bubble with its potential of dire consequences. That risk, even if we are fortunate enough to dodge the bullet, should not be taken lightly. Investor caution remains appropriate.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport New York 11731
E-mail Adress: philipbraverman@Gmail.com
Sunday, June 15, 2008
Fed hints at a firming to contain inflation and firm the dollar
The Treasury and currency markets apparently accepted this weeks Fed statements at face value. But there is reason to doubt that the Fed meant exactly what it seemed to be saying. Before assessing the Fed statements it is necessary to repeat their general import.
The Fed this past week hinted that a Federal funds rate increase later this year may be necessary to head off rising inflation pressures. Fed Chairman Bernanke indicated the Fed would "strongly resist" inflation expectations. The comments seemed to squash any lingering remote hopes that the Fed would ease further after its easing pause ended.
Recognizing that the rapid surge in the price of oil and other commodities stems partly from the dollar downtrend, there was also a stepup in efforts by Fed spokesman and Treasury Secretary Paulson to talk up the dollar. In response to these comments, this week the dollar rose versus the Euro and Treasury yields increased sharply, especially in the short end of maturity yield curve. The Treasury two-year yield rose more this past week than any week since 1982, when inflation was running rampant.
Europen Central Bank's Triichet implied that an early firming to deal with inflation might be necessary. It is unclear if the Fed comments were deliberately coordinted with those of the ECB or were a verbal effort at self-defense in the face of an impending anti-inflationary ECB tightening.
The Fed only appeared to add credibility to its increased emphasis and focus on inflation by indicating that its concern over economic and financial weakness is receding. But that view is not justified. The run of financial losses and need for beleagered financial firms to raise new capital is far from over, This week Lehman Brothers indicated that the firm lost $3 billion in the latest quarter, its first loss since it became a public company in 1994. Furthermore, Lehman announced the loss will require it to raise $6 billion in additional capital. And they are far from being the only financial institution that needs to raise additional capital in order just to to be able to recognize losses, let alone to increase lending. Indeed, regulators are encouraging banks to cut their dividends as a means of rebuilding capial. Financial institutions, especialy investment banks, have to continue the deleveraging process. In addition, the Fed statements on inflarion led to a sharp increase mortgage rates that will only prolong and worsen the housing market debacle. The volume of foreclosures continues to mount, imposing a further heavy downward pressure on home prices and mortgage market losses.
And most significant, the employment picture has sharply worsened. The unemployment rate,already 5.5%, is likely to reach 6.0% by the turn of the year. The Fed is highly unlikely to firm in the midst of rising unemploment. Thus, the conclusion that must be drawn is that the Fed was essentially practising open mouth policy. If there is to be firming, which seems unlikely, it will be limited to a single one quarter point move just to reinforce the Fed anti-inflation intent. And even that will most probably only come after the November elections.
The realty is that despite fiscal stimulus and Fed easing, the US economy is confronted by the prospect of a prolonged recession and credit crunch. In time, that recession will engulf the global economy. That recession will supress inflation pressures and inflation expectations. And that process will produce a complete preversal of the rise in Treasury yields, producing new yield lows and further Fed easing.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport New York 11731
Philipbraverman@Gmail.com
The Fed this past week hinted that a Federal funds rate increase later this year may be necessary to head off rising inflation pressures. Fed Chairman Bernanke indicated the Fed would "strongly resist" inflation expectations. The comments seemed to squash any lingering remote hopes that the Fed would ease further after its easing pause ended.
Recognizing that the rapid surge in the price of oil and other commodities stems partly from the dollar downtrend, there was also a stepup in efforts by Fed spokesman and Treasury Secretary Paulson to talk up the dollar. In response to these comments, this week the dollar rose versus the Euro and Treasury yields increased sharply, especially in the short end of maturity yield curve. The Treasury two-year yield rose more this past week than any week since 1982, when inflation was running rampant.
Europen Central Bank's Triichet implied that an early firming to deal with inflation might be necessary. It is unclear if the Fed comments were deliberately coordinted with those of the ECB or were a verbal effort at self-defense in the face of an impending anti-inflationary ECB tightening.
The Fed only appeared to add credibility to its increased emphasis and focus on inflation by indicating that its concern over economic and financial weakness is receding. But that view is not justified. The run of financial losses and need for beleagered financial firms to raise new capital is far from over, This week Lehman Brothers indicated that the firm lost $3 billion in the latest quarter, its first loss since it became a public company in 1994. Furthermore, Lehman announced the loss will require it to raise $6 billion in additional capital. And they are far from being the only financial institution that needs to raise additional capital in order just to to be able to recognize losses, let alone to increase lending. Indeed, regulators are encouraging banks to cut their dividends as a means of rebuilding capial. Financial institutions, especialy investment banks, have to continue the deleveraging process. In addition, the Fed statements on inflarion led to a sharp increase mortgage rates that will only prolong and worsen the housing market debacle. The volume of foreclosures continues to mount, imposing a further heavy downward pressure on home prices and mortgage market losses.
And most significant, the employment picture has sharply worsened. The unemployment rate,already 5.5%, is likely to reach 6.0% by the turn of the year. The Fed is highly unlikely to firm in the midst of rising unemploment. Thus, the conclusion that must be drawn is that the Fed was essentially practising open mouth policy. If there is to be firming, which seems unlikely, it will be limited to a single one quarter point move just to reinforce the Fed anti-inflation intent. And even that will most probably only come after the November elections.
The realty is that despite fiscal stimulus and Fed easing, the US economy is confronted by the prospect of a prolonged recession and credit crunch. In time, that recession will engulf the global economy. That recession will supress inflation pressures and inflation expectations. And that process will produce a complete preversal of the rise in Treasury yields, producing new yield lows and further Fed easing.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport New York 11731
Philipbraverman@Gmail.com
Saturday, June 7, 2008
Unemployment spike and oil price surge point to deepening recession
The May unemployment rate spiked 0.5% to 5.5%,from 5.0% in April, in the largest one-month rise in over two decades. This rise taken from the so called household survey is a response to an horrendous 861,000 May jump in the number of unemployed, well in excess of an outsized 577,000 May rise in the labor force. This unemployment rise reflects students and other new entrants to the labor force, including returning workers, as well as the newly unemployed. In addition to the 8.5 million now unemployed, there are some 5.2 million workers who could not find the full time employment they were seeking and were forced by economic circumstances to instead take part-time employment.
The worsening unemployment situation in the household survey undoubtedly more accurately mirrors the intensifying recession than the milder deterioration in the establishment payroll survey. For example, in the payroll survey nonfarm employment declined by 49,000 in May. But nonfarm payrolls are partly estimated by assuming that new and small companies that are not actually surveyed are hiring. As a result of such estimates, the payroll survey tends to lag the household survey in recognizing economic turning points. The payroll survey appears to be doing exactly that currently, underestimating the severity of the falloff in employment.
There is a risk that the sharp spike in the unemployment rate to 5.5% in May may have been partially boosted by improper seasonal adjustement. If that turns out to true there could be a partial 0.1 percentage point reversal in the next month or two. However, the trend path of the unemployment rate is decidedly up, and should hit 6.0% by year-end or early next year.
The index of aggregate hours worked was 107.1 in May and 107.2 April, down from 107.6in March, suggesting weaker GDP growth in the second quarter than in the first quarter and perhaps negative growth.
As if it were not enough that there is a continuing housing depression, credit crunch and mounting financial institution losses which threaten to top %400 billion, oil and other key commodity prices are spurting upward. The record setting rise in oil prices last week poses a serious threat to consumer discretionary spending. It is no wonder that the combination of the spike in the unemployment rate and oil prices contibuted to a sell-off in equities, renewed expectations of further Fed easing, a new decline in the dollar and a modest dip in Treasury yields. With a credible near term forecast of oil prices at $150 and not too far off at $200, speculators are piling on the trade, rapidly pushing prices toward those objectives.
Even at lower oil prices, the consumer will be forced to cut nonenergy and food related spending. That in turn will cut the profitably of discretionary consumer product and services companies. Truckers and airlines are already suffering profoundly. The worsening consumer led recession will eventually supress demand sufficiently to contain inflation.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport New York 11731
philipbraverman@Gmail.com
The worsening unemployment situation in the household survey undoubtedly more accurately mirrors the intensifying recession than the milder deterioration in the establishment payroll survey. For example, in the payroll survey nonfarm employment declined by 49,000 in May. But nonfarm payrolls are partly estimated by assuming that new and small companies that are not actually surveyed are hiring. As a result of such estimates, the payroll survey tends to lag the household survey in recognizing economic turning points. The payroll survey appears to be doing exactly that currently, underestimating the severity of the falloff in employment.
There is a risk that the sharp spike in the unemployment rate to 5.5% in May may have been partially boosted by improper seasonal adjustement. If that turns out to true there could be a partial 0.1 percentage point reversal in the next month or two. However, the trend path of the unemployment rate is decidedly up, and should hit 6.0% by year-end or early next year.
The index of aggregate hours worked was 107.1 in May and 107.2 April, down from 107.6in March, suggesting weaker GDP growth in the second quarter than in the first quarter and perhaps negative growth.
As if it were not enough that there is a continuing housing depression, credit crunch and mounting financial institution losses which threaten to top %400 billion, oil and other key commodity prices are spurting upward. The record setting rise in oil prices last week poses a serious threat to consumer discretionary spending. It is no wonder that the combination of the spike in the unemployment rate and oil prices contibuted to a sell-off in equities, renewed expectations of further Fed easing, a new decline in the dollar and a modest dip in Treasury yields. With a credible near term forecast of oil prices at $150 and not too far off at $200, speculators are piling on the trade, rapidly pushing prices toward those objectives.
Even at lower oil prices, the consumer will be forced to cut nonenergy and food related spending. That in turn will cut the profitably of discretionary consumer product and services companies. Truckers and airlines are already suffering profoundly. The worsening consumer led recession will eventually supress demand sufficiently to contain inflation.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport New York 11731
philipbraverman@Gmail.com
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