Friday, September 30, 2011
Today's data releases weren't particularly newsworthy—more of a mixed bag. Personal income in August was a bit weaker than expected, while personal spending was about as weak as expected; the personal consumption deflator was a tiny bit higher than expected; the Chicago and Milwaukee ISM indices for September were stronger than expected; and the Univ. of Michigan confidence number was higher than expected. Since the income and spending data is old news, and we know the economy has been weak for the past several months, the ISM data from this month might actually be some genuine good news, but we need to wait for the overall ISM number on Monday to be sure. And as I noted yesterday, the very up-to-date claims number shows no economic deterioration at all.
The chart above uses the August data for inflation, and yesterday's data for interest rates, so it is a fairly accurate picture of the current state of monetary policy. The real Fed funds rate is a good proxy for how "easy" or "tight" the Fed is: the higher the rate the tighter. Currently the Fed's policy rate is as easy as it been since the inflationary 1970s, when the Fed consistently failed to raise its target rate fast enough to get ahead of rising inflation. The slope of the Treasury curve from 1 to 10 years is also a good indicator of how easy or tight the Fed is; a steeper slope in the yield curve suggests easy money, while a flat or negative (inverted) slope suggests very tight money. So a relatively high red line and a relatively low blue line are strong confirmations that monetary policy today is easy.
As the chart illustrates, recessions have always been preceded by a significant tightening of monetary policy: a flat to negatively-sloped yield curve, and a relatively high real Fed funds rate. The early years of a recovery are typically just the opposite, which is what we have today. For all its efforts to artificially depress the long-term bond yields, the yield curve still has a relatively steep, positive slope. And of course real borrowing costs are clearly negative. Using the headline PCE deflator gives you a real Fed funds rate of -2.5%, which would be close to a record low on this chart.
So monetary policy is still quite "easy" and thus the likelihood of a recession is very low. Yet I see more and more analysts predicting that we are on the cusp of another recession, most notably the folks at ECRI. I could always be wrong, but another recession at this juncture would fly in the face of a lot of historical evidence to the contrary.
Posted by Scott Grannis at 9:47 AM