Growing Body of Economic Data: No Severe Recession

donsutherland1 · 04-02-08, 12:44 PM

Prolonged economic booms often seduce investors and managers to increasingly discount risk. As that happens, expectations for an era of perpetual prosperity increasingly supplant market fundamentals and historic experience. The quality of their decisionmaking deteriorates. Such a posture is extremely hazardous. No market conditions are ever constant. Change is the norm. When risks previously written off as extinct seemingly awaken from their hibernation, fear sets in. Then, those caught by surprise—even some of the most knowledgeable in their field—adopt a perspective in which they become biased toward worst-case scenarios.

One saw such a panic during the 1997-98 Asian crisis. Then, George Soros, one of the world’s leading hedge fund managers said that the “financial markets have recently acted more like a wrecking ball, knocking over one country after another” and warned that the global market system was “coming apart at the seams.” Less than a year later, a robust recovery was overspreading the globe and the United States ultimately wound up avoiding a recession. More recently, in February 2008, New York University associate professor of economics and international business Nouriel Roubini said that the United States had slipped into recession “without much doubt” and warned that “a realistic assessment” of the state of the American economy and financial system “suggests that it will be very hard to avoid a severe economic recession.”

A month later, a run on Bear Stearns’ cash and dramatic Federal Reserve intervention through JPMorgan raised the specter of a financial meltdown and seemingly vindicated such dire assessments. At that time, the U.S. economy was slowly swirling around the event horizon of a recession and as far as the “Recessionistas” who had not already diagnosed a recession were concerned, it was only a matter of time before the U.S. economy tumbled into recession.

Not so fast. Perhaps, the early calls for a severe recession were merely an indication that fear driven by a rediscovery of risk was distorting perceptions. The coming months will likely reveal whether those predicting a severe recession had succumbed to the kind of fear-driven panic that drove Mr. Soros to proclaim that the global capitalist economy was disintegrating.

To be sure, a mild to perhaps moderate recession remains possible. However, more and more data suggest that a severe recession is not likely this time around. Indeed, if one looks at the emerging economic data that has been released in recent weeks, the data has revealed weakness but has also been showing greater strength than expected in consensus forecasts. The February reading of the Institution of Supply Management (ISM) Index was forecast to fall to 47.0 from January’s 48.3 figure. Instead, it came out at 48.6. February construction spending was projected to decline 1.0% but fell only 0.3%. The ADP employment data for March was forecast to show a loss of 50,000 private sector jobs. It registered an increase of 8,000 jobs. This week, Lehman Brothers reported that it raised $4 billion in new capital, bolstering its liquidity and further soothing concerns about potential liquidity challenges.

Looking farther ahead, the advance report of First Quarter GDP could be revealing. During the Fourth Quarter, real GDP increased by 0.6%. At present, opinion is skewed in favor a contraction in real GDP for the First Quarter. However, given the latest data concerning U.S. trade, personal consumption, existing home sales, and capital investments, I believe any First Quarter contraction—and a contraction is not a foregone conclusion—in real GDP will probably amount to less than an annualized 1% rate. A better economic performance is possible, especially if Gross Private Domestic Investment (GPDI) falls by less than it did during the Fourth Quarter. Some evidence hints at smaller decrease in GPDI. For now, if I had to speculate, the change in real GDP will probably come in at around 0.0% +/- 0.5% based on continued modest growth in real personal consumption expenditures, a slowing of the decline in GPDI, another reduction in net imports, and continuing growth in government expenditures. That idea seems consistent with Fed Chairman Ben Bernanke’s testimony today in which he stated, “It now appears likely that real gross domestic product (GDP) will not grow much, if at all, over the first half of 2008 and could even contract slightly. We expect economic activity to strengthen in the second half of the year.”

Such a scenario would not constitute a severe downturn. To put things into perspective, during the 10 post-World War II recessions, the U.S. experienced 11 quarters in which real GDP fell by an annualized rate of 4.0% or more. Furthermore, the 5 biggest post-World War II downturns saw real GDP contract by 2.2% or more.

In sum, while there remain numerous trajectories that the U.S. economy might take, recent economic data suggests that the risk of Professor Roubini’s severe recession scenario is diminishing. Instead, a milder outcome in which the economy undergoes a period of sluggish growth or modest contraction appears more likely. If so, that outcome would provide yet another example in which sentiments of doom coincided with the seeming return of risk and general economic conditions began to shift.

oldreliable67 · 04-02-08, 03:43 PM

Quote:

Originally Posted by donsutherland1

More recently, in February 2008, New York University associate professor of economics and international business Nouriel Roubini said that the United States had slipped into recession “without much doubt” and warned that “a realistic assessment” of the state of the American economy and financial system “suggests that it will be very hard to avoid a severe economic recession.”

While I tend much more to your point of view, I was in a meeting about two weeks ago at which Roubini made a presentation. He reiterated his call for quite a severe recession, essentially reiterating his "12 steps to meltdown." (An excellent discussion of which is in the Feb 20 FT by Martin Wolf.)

One of the differences between Roubini's forecast and others (Goldman's, for example) is that Roubini expects fully 50 percent of households in a negative equity situation will wind up in reposssession, while most others (of which I am aware, anyway) estimate only about 20 percent.

Roubini suggested that he expected losses that could approach $3,000 bn, or almost 20% of GDP.

Scary stuff.

ashurbanipal · 04-08-08, 11:07 AM

My read is that the current problems are being papered over enough that we will avoid anything very severe. There will be a slight bump up over the next couple of years, and then the big one will hit. Energy, Water, and Food will be the issues that bring everything down in the end.

oldreliable67 · 04-08-08, 01:50 PM

The change in the quarterly average of the Index of Aggregrate Weekly Hours from Table B-5 of the unemployment report is often a good rough estimate of the change in GDP for the quarter. This index averaged 107.7 in Q4 '07 and 107.4 in Q1 '08, for a 0.3% quarterly decline. For a rough estimate of Q1 GDP, one would probably want to add back a bit for the strength in exports, so on balance, I would expect Q1 GDP to be essentially unchanged to down about 0.3%.

Of course, the Feb and Mar '08 unemployment data are still subject to revision in next month's unemployment report. As we have seen with the Q4 data, the revisions can be significant.

oldreliable67 · 04-08-08, 03:16 PM

Not long after I posted the above, the FOMC released the minutes of the March 18 meeting, the meeting at which they lowered the funds target by 75 bps to 2 1/4%. The participants were particularly cognizant of the risks to their forecasts, and acknowledged that the current "adverse feedback loop" in the housing market was the key element contributing to that uncertainty. A couple of key paragraphs follow:

Quote:

The economy was expected to begin to
recover in the second half of the year, supported by
recent monetary policy easing and fiscal stimulus. Accommodative
monetary policy and a recovery in financial
markets along with an abatement of the downdraft
in housing activity were expected to help foster a further
pickup in economic growth in 2009. However,
considerable uncertainty surrounded this forecast, and
some participants expressed concern that falling house
prices and stresses in financial markets could lead to a
more severe and protracted downturn in activity than
currently anticipated.
[...]
Evidence that an adverse feedback loop was under way,
in which a restriction in credit availability prompts a
deterioration in the economic outlook that, in turn,
spurs additional tightening in credit conditions, was
discussed. Several participants noted that the problems
of declining asset values, credit losses, and strained financial
market conditions could be quite persistent,
restraining credit availability and thus economic activity for a time
and having the potential subsequently to delay and damp economic recovery."
[...]
Participants noted that the contraction in the housing
sector had deepened and that considerable uncertainty
surrounded the outlook for housing. Although some
stabilization in housing markets was likely needed to
help underpin an economic recovery in coming quarters,
there was little indication that that process had yet
begun. Elevated rates of foreclosures and large inventories
of unsold property were likely to depress home
prices for some time. Lower home prices would eventually
buoy home buying, but in the meantime the
prospect of continued price declines could lead potential
homebuyers to defer purchases for a time, further
damping housing activity and adding to downward
pressure on home values. Participants noted that the
trajectory of house prices was a major source of uncertainty
in their economic outlook.

[emphasis added]

Clearly, monetary policy alone will not correct conditions in the housing industry. Policy assistance is also required. Unfortunately for the current situation, fiscal/legislative policy is simply not designed to act with the promptness of monetary policy. Thus far, the Senate and the House have barely begun deliberations on their own versions of assistance, with their respective approaches being significantly different. Read about some of their deliberations, here. We should not expect a policy prescription for what ails the housing industry any time soon.

obvious Child · 04-09-08, 02:05 AM

I don't know about this.

Global writedowns are expected to be almost $1 trillion. US losses expected to be $600 billion. As of today, only about 1/3 of the US losses have been recorded.

That sounds like severe recession.

tecoyah · 04-09-08, 08:49 AM

Quote:

Greenspan, on CNBC: U.S. in recession

Tue Apr 8, 6:28 PM ET

WASHINGTON (Reuters) - Former Federal Reserve Chairman Alan Greenspan said on Tuesday the U.S. economy was in recession, and said it would be appropriate to tap public funds to resolve the mortgage-related crisis that has helped pull the economy under.

Greenspan, on CNBC: U.S. in recession - Yahoo! News

Not that I trust Greenspan as the supposed genius so many make him out to be...But, in this case I think he has a point or two.

donsutherland1 · 04-09-08, 11:45 AM

Quote:

Originally Posted by obvious Child

I don't know about this.

Global writedowns are expected to be almost $1 trillion. US losses expected to be $600 billion. As of today, only about 1/3 of the US losses have been recorded.

That sounds like severe recession.

There is little doubt that the U.S. has become the proverbial "sick man" in North America. However, the IMF's estimate of total write-offs of $945 billion worldwide (a significant portion to be borne by the U.S.) does not necessarily indicate a severe recession.

A number of points are in order:

1) Taking into consideration the financial market dislocations (write-offs, spillover into other economic sectors/global markets, etc.), the IMF's just-released world economic outlook forecasts a "mild recession" for the U.S. with anemic economic growth of 0.5% for 2008. In contrast, real GDP shrunk by 0.2% in 1991 during another mild recession.

2) The IMF forecasts that 2009 will also bring sluggish growth in the U.S. (+0.6% increase in real GDP).

3) It remains uncertain whether the U.S. will experience a credit squeeze or full-fledged credit crunch. The latter scenario would shave an estimated 1.4% off U.S. GDP growth. Both scenarios would have longer-lasting adverse effects. That is a major reason the IMF also expects sluggish growth next year. Separately, it should be noted that any stimulative impact from the forthcoming tax rebate should have unwound by next year, as well.

4) Prime U.S. mortgages have much larger equity cushions than subprime ones. According to the IMF, the equity cushion for subprime borrowers amounted to less than 5%. For prime borrowers, the average is in the range of 40%-50%. Hence, assuming that housing prices have experienced just over half their expected decline (an idea that is supported by historic price-rent ratios and housing prices relative to nominal GDP growth), the prime mortgage market should generally hold up.

5) The IMF also reported that "despite the weakening in mortgage markets, credit quality in the $2.5 trillion U.S. consumer debt market has remained fairly strong..." This relative strength is welcome.

6) One of the key caveats concerning the estimated write-offs concerns projected cash flows for the underlying assets. The IMF noted, "At present, pricing of mortgage-related derivative indices suggests higher losses than do calculations based on projected cash flows for the underlying loans." If so, current market valuations might be overstating expected losses. Such a situation would not be new. Markets often overshoot. One has to wonder whether the recent 7.2% run-up in the S&P 500, not to mention other stock market indices, hints at a repricing of risk that might be correcting earlier expectations. For now, it is too soon for me to speculate further on that.

7) The IMF states that in the historical context, the ongoing financial crisis "is of similar dollar magnitude to the Japanese banking crisis of the 1990s." Since 1993, world real GDP has doubled. As a result, the global impact of the crisis should be less than it was during the Japanese banking crisis. Hence, the U.S. could continue to experience some export-led growth during the year ahead and that growth could offset some of the losses in other sectors e.g., gross private domestic investment where most of the economic contraction has been occurring.

Nevertheless, some important wildcards remain. Moreover, there is some overlap among them. Four include:

1) Persistent high and perhaps rising energy/commodities prices. Such prices could preclude a continued decrease in the U.S. trade deficit. At present, the U.S. continues to lack a credible energy policy and the price for such policy neglect is enhanced vulnerability to energy price changes.

2) Persistent and/or rising inflation that causes inflation expectations to become unanchored, particularly should the Fed maintain an easy monetary policy. This could inhibit the Fed's room for stimulating the economy and could even compel it to raise interest rates at some point.

3) Persistent depreciation in the value of the U.S. dollar with a possibility that the decline becomes disorderly. This development could exacerbate inflationary pressures in the U.S. and have global implications.

4) The development of adverse feedback loops (a concern raised by the FOMC and IMF) that would put the U.S. economy on a trajectory for a much more significant and possibly protracted recession. Right now, Fed mechanisms such as the Term Auction Facility (TAF), Term Securities Lending Facility (TSLF), and Primary Dealer Lending Facility (PDLF) have mitigated this risk.

Finally, in the IMF's World Economic Outlook (Chapter 2), there is a fascinating discussion over whether fiscal stimuli work. In what should be a cautionary note given the breakdown in U.S. fiscal discipline that commenced in earnest in 2002, the discussion notes that high debt levels can stifle the benefits of fiscally stimulative policies. But that's another discussion for another time. The bottom line is that the IMF is also forecasting a "mild recession" at this time. The Q1 GDP report that will be released on April 30 should provide the first indication as to whether the IMF's idea (an assessment I share) is reasonably on track.

donsutherland1 · 04-10-08, 09:14 AM

This morning's trade data in which the U.S. trade deficit increased to $62.321 billion all but bakes a contraction into the proverbial economic pie. During the 4th Quarter, the +0.6% increase in real GDP was largely on account of an improvement in the trade deficit. With Q1's trade deficit winding up somewhat worse than Q4's deficit, it is highly likely that real GDP contracted.

The worsening of the trade gap will combine with anemic changes in real personal consumption expenditures and a continuing deterioration in real gross private domestic investment to create a sufficient downdraft in overall GDP figures to bring about a contraction. I do not believe government spending increased by a sufficiently large amount to offset those negative developments.

Right now, if I had to venture a guess, Q1 real GDP will likely contract by an annualized 0.8% +/- 0.5% from its Q4 figure. However, even a drop of somewhat greater than 1.0%, should it materialize, will not mark the kind of decline one has seen during severe recessions.

On a somewhat more positive note, average daily crude oil imports fell from January's excessive figures. Nevertheless, it remains far from clear whether U.S. oil imports will commence a decline. In March 2007, average daily oil imports set a record of almost 10.5 million barrels per day. In part, that increase stemmed from an extreme cold snap in eastern North America where some of the coldest March readings since 1967 were recorded in some major energy markets e.g., Metro New York.

donsutherland1 · 04-30-08, 09:16 AM

The 2008 Q1 GDP data has reinforced the idea that the U.S. likely does not face a severe recession. As the real GDP grew by 0.6% (the same as during 2007 Q4), it is possible that not only could the U.S. face only a mild recession, it could even skirt a recession altogether.

A closer look at the numbers shows personal consumption expenditures growing at an annualized 0.9% rate, the trade deficit shrinking at a 5.7% annualized rate, and government spending rising at an annualized 2.0% rate, which was led by increased federal spending, mainly in the Defense sector. The big change occurred in gross private domestic investment (GPDI), which includes the housing sector. That figure contracted at a 14.6% annualized rate in 2007 Q4. This time around, it contracted at only a 4.6% annualized rate, even as residential investment shrank at a 26.6% annualized rate. This decoupling between the larger GPDI figure and residential housing suggests that the shrinking residential investment sector (now 22.5% of GPDI vs. 27.7% of GPDI in 2007 Q1) is losing its capacity to put a drag on the economy. Increased software spending accounted for almost a third of the decline in residential investment. Overall, the relatively lower ability of declines in residential investment to put a drag on the economy leaves room for policymakers to allow the real estate bubble latitude to continue to unwind.

If the experience with the 1989-94 housing bubble holds true, the worst of the housing declines should be completed by the end of Q2. As a result, slow improvement in the growth rate should commence either in Q2 or probably Q3. Therefore, odds have continued to increase that the U.S. will avert a severe recession. Instead, a mild recession or near-miss appear far more likely.