Friday, September 30, 2011

Still no sign of a double-dip

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.


Ian said...

Could it be that the supposedly infallible ECRI actually got this call wrong? That would be a game changer. But now that every trader in the world hangs on ECRI's every word, it may be that they've lost their predictive ability.

It seems that ECRI's opinions are a lot more conventional than they used to be. In 2010, they were predicting expansion in the midst of recession calls, and in 2007 they were predicting recession when everyone was bullish. But now they're just giving us the standard doom and gloom that we're hearing from all parts. They're following sentiment now rather than leading it.

Maybe ECRI will become more and more like NBER--when they call a recession, most of the stock declines have already occurred.

Anyway, I trust you more than any black box system, so I'm going to bet against ECRI.

McKibbinUSA said...
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McKibbinUSA said...

I doubt America is on the verge of "another" recession -- growth trajectories are trending slightly upwards -- inflation is below the long-term historical average of 3% -- however, unemployment is unlikely to improve in the coming years -- anyone with only a high school education entering the workforce today is unlikely to earn wages that exceed the qualifying standard for food stamps in America -- workers with only a bachelors degree will also find the going tough in the coming years -- America needs to raise the bar on skills -- high schools and colleges need to be transformed from social institutions into places of high learning -- in the mean time, growth in the US economy will likely go up and down while trending upwards -- inflation will likely have its spurts and declines while averageing something close to 3% over the long-term -- however, unemployment is unlikely to improve significantly in the coming years with wages continuing to decline in unskilled occupations -- that's life in America, at least through 2025 or after...

PS: I would not rule out a repeal of Social Security and Medicare in the next few years, which will accelerate growth in the US while holding inflation in check -- as for unskilled workers, I expect to see millions of American families roaming the interstates in their minivans in the coming years...

Public Library said...

Problem is we are 1 sneeze away from another disaster and not really in a better place to deal with it. The Fed is more levered and discombobulated than ever. Not surprising though. Taxing the people to keep banks afloat is never a good recipe for investment and recovery.

Benjamin Cole said...

This same chart would conclude that Japanese monetary policy has been "easy."

So, for 20 years, the Bank of Japan has had an "easy" monetary policy, and thus prices roared up by negative 15 percent (GDP deflator stats). In nominal terms, Japan's GDP is lower today than in 1990.

There is a fundamental misconception (as Milton Friedman said) that low rates per se signal an 'easy" monetary policy.

Economists on the "market monetarism" school contend that the Fed is passively tight. This is an interesting and valuable observation, given the Japan situation.

Unknown said...

I understand the charts and the logic behind the "no new recession" calls, but isn't there a point at which the constant barrage of bad news causes a pull-back in corporate/private spending, which leads to a new recession? How do you monitor that? Won't the nattering nabobs of negativity win at some point?

MaggotAtBroad&Wall said...

Betting against ECRI is usually a bad bet. But they are so concerned about accuracy and not making a bad call, that the equity markets often figures it out before they do. The past couple of cycles the equity markets have already declined by 15% or so before they have gone public with their call. No different this time, if in fact we're entering a new recession.

Peronally, I don't see how we can be entering a recession with production in cyclical industries like autos running at 12-13 million units compared to 16-17 million in 2007 and housing starts still very near the lowest numbers in 50 years.

But I guess that's why I'm not Lakshman Achuthan.

Ian said...

So, in reference to MaggotatBroad&Wall's comment, I wonder how much stock market downside we have from here if ECRI's recession call is right. Presumably a lot of traders started selling when ECRI forecast a global slowdown in the spring and the WLI started turning down. So how much of the selling has already happened?

M Miller said...

All great thoughts on ECRI. I love ECRI, but I think the market front ran them this time with the decline.

On steep yield curve, Francois Trahan said slope of yield curve is not a good predictor of recession in zero rate world. In Japan, they had a steep yield curve for 20 years and a terrible economy - same thing now in U.S.

That's his call, but interesting contrary view.

If you put ECRI's recession call together with Buffett's once in a generation stock buyback, I think the conclusion is that ECRI is perhaps right, but so is Buffett. Stocks already discount recession and more and are too cheap to sell and cheap enough to buy.

I did notice Buffett said ECRI is wrong (no recession) but ECRI says GE, FDX (both clients) don't get it right on recessions.

Unknown said...


Is it possible that the yield curve we should be paying attention to is China, India's and Brazil. Aren't those curves inverted?

I know Brazil just lowered their rate, which I thought would make the EM's start to perform, but it only lasted one days. China needs to lower rates, but it may be too late. Asian markets are giving up the ghost.


M Miller said...

Great point on emerging market yield curves. But then lower rates should fix their issues, but not so in the U.S. So following that logic, there is hope for monetary policy in the emerging markets, but not in the U.S. But the emerging markets are where 80% of the future growth is, so I guess that means we have some hope of recovery in the critical emerging markets.

Kenneth said...

How are commodity prices faring and how do they factor into your outlook? You did not mention them as you frequently do despite weakness in some such as copper.