Tuesday, August 23, 2011

Malicious ECB rate hikes

Lieblings quote of the day by Dean Baker:
"The ECB is run by a perverse cult that worships 2.0 percent inflation and is prepared to sacrifice almost all other economic goals to meet this target."
The article goes on to argue that the ECB should increase its inflation target to 3-4% in order to facilitate positive wage growth in the debt deflationary economies like Spain. I've argued a similar point in the past.

However, I'd like to add that this "pervese cult" called the European Central Bank (ECB) raised its policy rate on April 13 - a point in time that correlates perfectly with a shift in trend across euro-area bond markets. Specifically, April 13 marks the upswing in risk premia on Italian, Spanish, and Belgian bonds relative to German bunds. Hmmm...policy mistake?

Now that's just malicious.

Rebecca Wilder

US economy in August: moving sideways

This piece was first written at Angry Bear blog.

by Rebecca Wilder

With the (roughly) 11% decline in US equities year-to-date, talk of a US recession has resurfaced. Through mid August, the high frequency economic indicators point to further weakness, rather than a double dip.

In my view, whether or not the US is IN a recession - defined as the coincident variables followed by the NBER (.xls) are turning downward - is really a moot point for a good chunk of the working-aged population. It probably 'feels' like the economy never exited recession to many.

As an aside, it would be difficult for the US economy to actually ENTER a contractionary phase right now, since the cyclical forces that normally drag the US into recession - inventories, auto sales, and housing - are at severely depressed levels. Confidence (or lack thereof) can reduce domestic spending and investment - it's in this respect that the losses in equity equity markets are important. It takes time for shocks to work their way into the economic data. Nevertheless, high frequency indicators do not point to recession...for now.

Claims are elevated but ticked up last week. If claims do not fall back in coming weeks, the unemployment rate will rise again. This could indicate the outset of a contracting economy.

Weekly diesel production shows an increase in transportation activity (please see this post for an explanation of the data).

The demand for diesel (in real barrels per day) recovered, rising at a rate of roughly 15% annually for each of the weeks of July 29 and August 05. Annual growth declined to -3% in the week of August 12; but this series (even in annual growth rates) is highly volatile, and the 4 week moving average of annual growth decelerated only mildly, from 7% to 6%.

Finally, daily Treasury tax receipts are slowing but growth remains positive.

The chart illustrates the annual growth rate of the 30-day rolling sum of daily withholding receipts for income and employment tax payments. This series proxies the health of the labor market. Spanning the last three months, the annual growth rate decelerated to 4% (May 18 through August 18 this year compared to the same period last year) from 4.6% in the three months previous. There's no indication of a contraction in tax receipt activity, but a further trend downward in the pace of tax receipt gains would turn some heads.

Nothing to indicate a contraction in the high-frequency data; but the deceleration is worrisome, given that consumers must 'earn' their consumption rather than 'borrow' for consumption. I don't feel particularly positive about the state of the US economy. Neither does Mark Thoma.

Thursday, August 18, 2011

G7 expansion? Not even close. Canada's in a league of its own

Disclaimer: I'm in Germany, and the keyboard takes some getting used to. Therefore, some of my posts in the coming week will be short and sweet (so that I don't include characters lik รถ, which is sure to turn some heads). Furthermore, blogger spellcheck doesn't work in English here.

The Q2 real GDP data across the G7 are now in, except for Canada who is always the last to release their statistics. We now know that the G7 expansion has been nothing short of pathetic. Why? Because among the G7, ONLY Canada - the G7 consists of the US, UK, Germany, France, Canada, Italy, and Japan - has fully regained its GDP lost during the recession (it had by Q3 2010 no less). Canada's in an expansion league of its own.

Hence, the G7 ex Canada remain in "recovery" mode through Q2 2011 and roughly 3.5 years since the previous cyclical peak (see table in reference of post).

(Note: I differentiate "recovery", or regaining output lost, from "expansion", or growing beyond the previous cyclical peak, in this post.)

The chart above illustrates real GDP (just "GDP" from here on out) across the G7 around the peak of each country's GDP during the last cyle, point 0. Only Canada has fully recovered its real GDP lost, having expanded to a level that is near 2% over its previous peak through Q1 2011.

A full business cycle can be measured as the bottom of a recession to the bottom of the next recession, or the trough to trough measure. In the US, the latest cycle lasted 91 months from the trough of the 2001 recession to the trough of the 2007-2009 recession. And here we are, 14 quarters since the peak in Q4 2007, of which GDP is 0,42% below. For comparison, GDP fully retraced the peaks previous to the 1981-82 and 1990-91 recessions in 7 and 6 quarters, respectively (by my quick count).

Even Germany, the wunderkind of euro area growth had not regained its GDP lost as of Q2 2011. And don't even get me started on Japan.

The ECB is tightening; US Congressional leaders are recklessly endangering the economy; and some euro area governments are pushing through even further fiscal spending cuts to calm market angst. This stinks of policy mistakes - and here in the US, we're patting ourselves on the back because the economic data do not scream recession yet?


Rebecca Wilder

Reference: Business cycle peak dates for chart above

Monday, August 15, 2011

Global slowdown underway - it's more than the Japanese supply chain disruptions

The global economic rebound is slowing markedly. With a tightening bias in emerging markets and a US recovery that continues to disappoint, external demand for any country that 'needs it' - those countries mired in fiscal austerity without monetary autonomy, i.e. euro area countries - is decelerating precipitously.

Exhibit 1: import demand for manufactured goods from 22.5% of the world (see chart at the end of this post) is slowing quickly, even contracting.

The chart illustrates the growth of import demand for manufactured goods from the US (12.8% of world import demand in 2011) and China (9.7% of world import demand in 2011) on a 3-month over 3-month annualized and seasonally adjusted basis. Spanning April through June 2011 compared to January through March 2011, US imports for manufactured goods slowed to a 4.9% annualized clip, while Chinese manufacturing imports contracted at a 22.9% annualized pace. US import demand growth peaked at 36.9% in March 2011 (again, on the same 3M/3M SAAR basis), while Chinese import demand growth peaked a bit earlier at 108.2% in January 2011.

One may argue that the sharp slowdown (US) and deceleration (China) of manufacturing imports is a product of supply chain disruptions stemming from the Japanese earthquake and ensuing tsunami. Let's take a look.

Exhibit 2: Japanese distortions started to ease in April and May, leading global imports by roughly 1 month.

The chart above illustrates the dynamics of the Japanese industrial sector before and after the earthquake. Industrial production started to recover in April 2011 and hit a month/month peak of +6.2% growth in May. The sector has all but recovered, and should have been reflected in the US and Chinese import data as positive momentum by June- it hasn't. In June, the seasonally adjusted import demand decelerated to a 0.6% pace in the US, while that in China contracted 4.3%.

In contrast, we saw the easing of supply chain disruptions in the US domestic industrial production stats. In the US (not shown, but you can get the IP data here), production of motor vehicles and parts fell 6.6% in April, which has improved sequentially through June (-2% M/M). This should be reflected in import demand (first chart), but the opposite's occurred. In fact, import demand has worsened, while the supply chain disruptions improved. Better put: there's weakness in global demand that is unrelated to Japanese supply chain disruptions.

Global growth is slowing - according to import demand of manufactured goods by the US and China, it's slowing rather quickly. Where will this be felt? In Europe, of course. Germany derives near 50% of GDP from export demand, and imports roughly 45% of its goods and services from within the euro area (data here). The PIIGS countries - Portugal, Ireland, Italy, Greece, and Spain - necessitate strong external demand from the core countries (Germany and France) and from outside the euro area in order to successfully deleverage amid sharp fiscal retrenchment. Unless the German consumer really starts spending, the global industrial sector is unlikely to drive demand sufficiently enough in Europe.

Rebecca Wilder

Reference: dynamics of US and Chinese shares of world import demand

Monday, August 8, 2011

A three day snapshot of U.S. equity markets

This will affect consumer sentiment. Watch them scramble now.

Rebecca Wilder

Wednesday, August 3, 2011

Endogenous business cycle spending + tax receipts at record lows = deficit hysteria for the wrong reasons

This article is crossposted with Angry Bear blog.

by Rebecca Wilder

Readers here will know more about the US federal government income statement than I. However, given the near ubiquitous deficit hysteria, I wanted to illustrate the truth about the budget deficit. The truth is, that deficit hysteria has been set in motion by big government spending on items like unemployment compensation, food stamps, and other types of 'support payments to persons for whom no current service is rendered' AND low tax receipts. Yes, long-term reform is needed; but my general conclusion is that the deficit hysteria is sorely misplaced.

First things first, the fiscal deficit - receipts minus net outlays as a % of GDP - is big. In June 2011, the 12-month rolling sum of net receipts (the budget deficit) was roughly 8.5% of a rolling average of GDP. This is down from its 10.6% peak in February 2010, but the level of deficit spending clearly makes some nervous.

Why should they be nervous about the 'level' of the deficit? I don't know, since recent 'excess' deficits are cyclically endogenous. The chart below illustrates the spending and tax receipt components of the US Treasury's net borrowing (see Table 9 of the Monthly Treasury Statement). Weak tax receipts and big spending are driving the federal deficits (spending, as we will see below, has surged on items directly related to the business cycle).

In June, the 12-month rolling sum of tax receipts - mostly corporate and individual income taxes and social insurance and retirement receipts - was 15.6%, which is up from its 14.5% cyclical low in January 2010. On the spending side, net outlays in June 2010 were a large 24.2% of GDP and down just slightly from the 25.3% peak in February 2010.

Deficit hysteria should be more appropriately placed as "lack of jobs and tax receipts hysteria". At this point, the budget could just as easily worsen as it could improve, given the fragile state of the US economy (see Tim Duy's recent post at Economist's View).

Why the wrong hysteria?

Reason 1. Taxes. Some would love to increase taxes - but the fact of the matter is, that tax receipts remain well below their long-term average of 18% of GDP. Tax receipts will not improve without new jobs since individual income taxes account for near 50% of total receipts.

Reason 2. The spending has been on cyclical items.

The best time to 'worry' about government spending is NOT when the economy is barely moving.

The chart below illustrates the big ticket items of the monthly outlays - roughly 87% of total outlays. The broad spending components are listed in Table 9 of the Monthly Treasury Statement. The long-term average shares of total spending are indicated in the legend.

The items health, medicare, and income security (inc security) are all above their respective long-term averages. But spending on income security outlays is the only spending component to have broken its trend, i.e., surge. According to the GAO's budget glossary (link here, .pdf), this item includes the following cyclical spending:
Support payments (including associated administrative expenses) to persons for whom no current service is rendered. Includes retirement, disability, unemployment, welfare, and similar programs, except for Social Security and income security for veterans, which are in other functions. Also includes the Food Stamp, Special Milk, and Child Nutrition programs (whether the benefits are in cash or in kind); both federal and trust fund unemployment compensation and workers’ compensation; public assistance cash payments; benefits to the elderly and to coal miners; and low- and moderate-income housing benefits.

It's spending on unemployment and food stamps that's driving spending at the margin.

The same deal exists with the 'smaller ticket items'. Of these <5% of total spending items, energy, environment, and veterans have arguably broken trend. I would surmise that some of the 'veterans' spending is tied to the business cycle, given the timing of the surge.

OK - so deficit hysteria is about, but it's misplaced. One could argue for more, not less, spending to get the jobs growth, hence tax receipts, up.

Rebecca Wilder

Tuesday, August 2, 2011

The euro area bond crisis in charts

Edward Harrison draws our attention to the euro area bond crisis: Spain, Italy, Belgium yields now under attack. I'd like to add to this thread by offering some illustrations of the polarizing of bond markets that's coincident with the euro area bond crisis. (Notice I do not say currency crisis because it's really the bond markets that are seething - the euro area, hence the currency, is thought to be relatively secure for now.)

(click to enlarge)

Spain, Italy, and Belgium are breaking away from the 'core', Germany, Austria, Netherlands, Finland, and France. But if you look really hard, France is showing a fair bit of stress too; it's underperforming the other core countries.

This is ironic. By attempting to stem broader contagion by ring-fencing Greece, Ireland, and Italy, euro area policy makers focused market attention on those countries too big to quickly ring-fence, i.e., Italy and Spain.

(click to enlarge)

Let me cite Warren Buffet's interview with CNBC again when he said the following about euro area policy: “When you have 17 countries that all have the same currency, and the yields on their bonds are dramatically different, the situation is not solved.”

I'll say it again (some of this pricing is a couple of weeks old):
If the US States are any comparison, let’s see what a ‘divergence’ in pricing and risk should mean for a single-currency union. A AAA 10-yr Maryland municipal bond trades at 2.68%, while the worst (in pricing) of the States, Illinois, which is rated at A1/A+, trades at 3.98%. That’s a 130 bps risk premium for a 4 notch rating differential. Forget the ‘worst’ in Europe, Greece, because it’s about to go into default. Or even the next or next or next worst in European bond pricing (in order, these would be Ireland, Portugal, Spain, and Italy). But Belgium, an Aa1/AA+ country is trading at 145 bps over the AAA Germany and just one notch lower in rating, Aa2/AA+.

Something’s wrong here; bond markets are still in crisis mode.

Rebecca Wilder

Monday, August 1, 2011

Global PMIs and Fed Policy: they're linked

Today a host of global purchasing managers indices (PMIs) reiterated that the global economy is slowing....quickly.

Within 24 hours, China, the US, and the euro area all reported July PMIs falling toward the feared 50 (below which the manufacturing industry is contracting) - 50.7, 50.9, and 50.4, respectively. The UK PMI fell below 50 to 49.1 in July.

I would posit (and I believe that others have, too, like Edward Hugh) that this is directly related to Fed policy, specifically that of quantitative easing (QE).

The chart above illustrates the stated PMIs alongside the dates of a shift in the Federal Reserve's QE policy. The shorter bars indicate those dates when the Fed ended QE and announced that it would reinvest maturing proceeds. On the other hand, the full bars illustrate the outset of QE.

Falling PMIs correlate with the end of QE. New QE correlates with a rebound in global PMIs. Given this correlation and the latest GDP release, I expect that talk of QE anew to surface.

Rebecca Wilder