Tag Archives: Employment

Fed’s Lockhart: economic outlook

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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.

♥

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Dec 11 balance of risks update

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Labor markets remain stronger than expected, right up through this morning’s Manpower survey for next quarter. Inflation risks remain elevated, with estimates of 1.5% PPI and 0.6% CPI the consensus for Thursday and Friday, and CPI core moving higher as well. While several funding spreads have widened vs. fed funds, absolute rates for reasonable quality mtgs. and corp. bonds are down- what the Fed calls an ‘easing of financial conditions’ for this component. And removing the stigma from using the discount window will ease year end issues.

A 0.25% fed funds cut and 0.50% discount rate cut are priced in for today’s meeting, and more cuts are priced in for future meetings. At the same time the balance of risk as highlighted below, with those cuts priced in, seems tilted towards inflation.

Conclusion:

Those closest to the Fed expect a 0.25% cut in the fed funds rate and a 0.50% cut in the discount rate. They see the Fed’s motivation as fear of the balance of risks swinging sharply back towards ‘market functioning risk’ if the Fed doesn’t deliver the cuts already priced in. It’s a case of ‘let’s put to bed the market functioning issues first, and then move on to other issues.’

Data Highlights:

  • ECONOMY – SHOW ME THE WEAKNESS!
  • EMPLOYMENT – better than expectations right up through today:
    • ADP employment strong.
    • Payrolls up 94,000- above expectations.
    • Unemployment rate 4.7% – down slightly.
    • Weekly claims very slightly higher.
  • HOUSING – exceeds expectations:
    • Mortgage applicationsstrong and trending up.
    • New home sales 728k vs. 750k expected, and 716k previous month.
    • Existing home sales 4.97million vs. 5million.
    • Permits 1.178m vs. 1.200million expected, previous month revised to 1.261million from 1.226million.
    • Pending home sales up 0.6% vs. down 1% expected. Previous month revised to up 1.4% from up 0.2%.
    • Housing starts 1.229 vs. 1.117 expected.
    • NAHB housing index 19 vs. 17 expected.
  • AND THE REST is still showing no sign of weakness:
    • CEO survey positive.
    • Q3 GDP revised up to 4.9%.
    • Personal income and spending up .2%, (.1% less than private forecasts), real spending flat.
    • Total vehicles sales over 16 million and unchanged.
    • Factory orders up 0.5% and 0.3%, above expectations.
    • October construction spending down 0.8%, vs. up 0.2% for September, year over year down 0.6%, somewhat below expectations.
    • Durable goods – 0.7% vs. up 0.3% expected but previous month revised from 0.3% to up 1.1&.
    • Capacity Utilization 81.7 vs. 82 expected.
    • Industrial production was down 0.5% vs. up 0.1% expected.
    • Retail sales ex autos up 0.2% in line with expectations, core up 0.1%.
    • Sep trade balance -56.5 vs. -58.5 expected.
    • Consumer confidence down- too many people watching CNBC.
  • INFLATION RISKS HIGHER:
    • CPI consensus (Dec 14): 4.1% YoY from 3.5%, core 2.3% YoY from 2.2%.
    • December Michigan inflation expectations up- one year 3.5% from 3.4%, five year 3.1% from 2.9%.
    • October PCE deflator up 2.9% YoY, vs. 1.8% pre Oct 31 meeting .
    • October Core PCE up 0.2%, up 1.9% YoY, vs. 1.8% pre Oct 31 meeting.
    • OFHEO home price index down 0.4%, first decline since 1994, but still up YoY.
    • Import prices up 1.8% vs. 1.2% expected, YoY up 9.6% vs. 9% expected.
    • Prices received up in all the reported surveys (ISM, Purchasing Managers, region feds, etc.).
    • Prices paid all up except Phil Fed survey prices paid down slightly.
    • Although the net percentage of firms raising selling prices slipped to 14% in November from 15% in October, the percentage of firms planning to raise prices rose to 26% from 22%. The NFIB noted, “There was no significant progress on the inflation front.”
    • 10 year TIPS floater at 1.85% shows expectations of Fed only keeping a real rate of less than 2% for the next ten years.
    • 5×5 TIPS CPI break even rate is down to 2.42% vs. 2.49% October 31.
    • Crude oil is at $89, down from $94 at the last meeting, and vs. about $55 last year.
    • Saudi oil production up, indicating higher demand at the higher prices.
  • MARKET FUNCTIONING/FINANCIAL CONDITIONS – little movement but markets muddling through the ‘Great Repricing of Risk’:
    • Bank loans up, commercial paper down.
    • Assorted losses and recapitalizations but no business interruptions.
    • S&P index down about 1% since October 31, but remains up about 8% for 2007, and substantially up from the inter meeting lows.
    • 3 month FF/LIBOR spread is 73 bp, wider since October 31.
    • Mortgage rates down, jumbo mortgage spreads are wider but off the widest levels.
    • Mortgage delinquencies up, probably within Fed forecasts.

♥

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Bear Stearns U.S. Economics: Small business optimism down

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The NFIB small business optimism index fell to 94.4 in November from 96.2 in October. Although the net percentage of firms planning to expand was little changed at 13% in November versus 14% in October, the net percentage of firms expecting the economy to improve fell sharply to -10.0 from -2.0.

Watching too much CNBC.

In November, 7% of firms reported that credit was harder to get, up from 6% in October. The NFIB noted “Credit conditions continue to look normal … There is no credit crunch on Main Street, all the angst appears to be confined to Wall Street and its observers” (November’s percentage of firms reporting that credit was hard to get compares to an average of 5% for the 21-year history of the monthly survey).

Agreed, and this goes unreported in the financial press.

The percentage of small firms planning to increase employment was unchanged at 11% in November, although 19% of firms reported jobs as being “hard to fill,” down from 22% in October.

Employment holding up confirming other data.

Although the net percentage of firms raising selling prices slipped to 14% in November from 15% in October, the percentage of firms planning to raise prices rose to 26% from 22%. The NFIB noted “There was no significant progress on the inflation front.”

Right – supports risks tilting toward inflation.

♥

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