Fed’s Lockhart: economic outlook

He is currently leaning towards cuts, but watching carefully for signs of improvements in market functioning and output, and aware of the risks of his inflation forecast being wrong.

Fed’s Lockhart: Economic Outlook

From Atlanta Fed President Dennis P. Lockhart: The Economy in 2008

Looking to 2008, I believe the pivotal question—the central uncertainty—is the extent of current and future spillover from housing and financial markets to the general economy. The dynamics I’m watching—stated simplistically—are the following. First, there’s the effect of dropping house prices on the consumer and in turn on retail sales and other personal expenditures. And second, I’m watching the effect of financial market distress on credit availability and, in turn, on business investment, general business activity, and employment.

Yes, we are all watching that carefully. So far so good, but consumer spending is always subject to change.
I’m watching credit availability, but seems the supply side of credit is never the issue. The price changes some, but quantity is always there at ‘market’ prices that provide desired returns on equity.

Business investment seems to hold up nicely as well, probably due to most investment being for cost cutting rather than expanding output. This makes investment a type of profit center.

Employment is still increasing, more in some fields than others.

And, of course, overall, from the mainstream’s view, demand is more than enough to be driving reasonably high inflation prints.

My base case outlook sees a weak first half of 2008—but one of modest growth—with gradual improvement beginning in the year’s second half and continuing into 2009. This outcome assumes the housing situation doesn’t deteriorate more than expected

Meaning it’s expected to deteriorate some. I’m inclined to think it’s bottomed.

and financial markets stabilize.

They are assuming this and it already seems to have happened. FF/LIBOR is ‘under control.’

A sober assessment of risks must take account of the possibility of protracted financial market instability together with weakening housing prices, volatile and high energy prices, continued dollar depreciation, and elevated inflation measures following from the recent upticks we have seen.

That statement includes both deflationary and inflationary influences – not sure what to make of it.

But he will vote for 50 bp cut in January.

Maybe if the meeting were today, but much can change between now and then.

I’m troubled by the elevated level of inflation. Currently I expect that inflation will moderate in 2008 as projected declines in energy costs have their effect. But the recent upward rebound of oil prices—and the reality that they are set in an unpredictable geopolitical context—may mean my outlook is too optimistic. Nonetheless, I’m basing my working forecast on the view that inflation pressures will abate.

Doesn’t say what the Fed might do, if anything, if inflation doesn’t abate.

To a large extent, my outlook for this year’s economic performance hinges on how financial markets deal with their problems.

He believes the performance of the real economy is a function of the health of financial markets.

I’m not sure that is turning out to be the case.

The coming weeks could be telling. (What does he know). Modern financial markets are an intricate global network of informed trust. Stabilization will proceed from clearing up the information deficit and restoring well-informed trust in counterparties and confidence in the system overall.

To restore market confidence, leading financial firms, I believe, must recognize and disclose losses based on unimpeachable valuation calculations,

Maybe they already have. The penalties for not being ‘honest’ are severe, and it’s hard to see how any public company would try to cover anything like that up.

restore capital and liquidity ratios, and urgently execute the strenuous task of updating risk assessments of scores of counterparties. The good news is that markets can return to orderly functioning and financial institutions can be rehabilitated quickly. With healthy disclosure, facing up to losses, recapitalization, and the resulting clarity, I believe there is hope for this outcome.

May already be happening.

So far only about $50 billion of announced bank losses. Q4 reports will add some to that, when the majority of the remaining losses will be disclosed.

In Aug 1998 $100 billion was lost all at once with no recovery prospects, back when that was a lot of money.

So far this crisis has been mild by historical standards.