By Rich Miller and Simon Kennedy | 2 September 2010
The U.S. economy is so bad that the chance of avoiding a double dip back into recession may actually be pretty good. The sectors of the economy that traditionally drive it into recession are already so depressed it's difficult to see them getting a lot worse, said Ethan Harris, head of developed markets economics research at BofA Merrill Lynch Global Research in New York. Inventories are near record lows in proportion to sales, residential construction is less than half the level of the housing boom, and vehicle sales are more than 30 percent below five years ago.
"It doesn't rule out a recession," Harris said. "It just makes it less likely than otherwise". The possibility of the economy lapsing into another contraction during the next year is 25 percent, he said in a Sept. 1 report. Harris cut his forecast for growth this year by 0.1 percentage point to 2.6 percent and lowered his 2011 estimate by a half point to 1.8 percent, according to the report.
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Federal Reserve policy makers agree that a renewed contraction is unlikely, although the risks have risen. "I expect the economy to continue to expand in the second half of this year, albeit at a relatively modest pace," Fed Chairman Ben S. Bernanke said in an Aug. 27 speech. [[But note that GDP may already be negative in Q3.: normxxx]]
Rising Yield
The Standard & Poor's 500 Index might increase to about 1,300, while the yield on the 10-year Treasury note would rise toward 4 percent during the next six months or so if the U.S. steers clear of another decline, said James Paulsen, chief investment strategist at Minneapolis-based Wells Capital Management, which manages $342 billion. The S&P index closed at 1,080.29 yesterday in New York, while the yield on the 10-year Treasury note was 2.56 percent at 8:59 a.m. in London today, according to BGCantor Market Data. "We could have a really violent move," Paulsen said. "The markets have a lot of 'double dip' priced in," he added. "But, I think the idea of that happening is pretty remote.
The risks of a renewed economic contraction have risen due to a spate of disappointing economic data, said Lyle Gramley, a former Fed governor who's now a senior economic adviser for the Potomac Research Group in Washington. He reckons the chance of a relapse is 35 percent, up from 10 to 20 percent a month ago. "We will probably avoid a double dip," Gramley said. "But we're in for a prolonged period of subpar growth of 2 percent or less."
Falling Orders
Orders for nondefense capital goods excluding aircraft, a proxy for future business investment, fell 8 percent in July, the biggest decline in one-and-a-half years, while sales of new homes dropped unexpectedly to an annual pace of 276,000, the lowest level on record, according to Commerce Department figures released last week. The department also reduced its estimate of second-quarter growth on Aug. 27 to 1.6 percent from 2.4 percent. The unemployment rate probably rose to 9.6 percent this month from 9.5 percent in July as employers reduced payrolls by 100,000, according to the median forecasts of more than 70 economists surveyed by Bloomberg News. The Labor Department is scheduled to release the jobs data tomorrow.
Bernanke described the recovery in the job market as "painfully slow" and said in his Aug. 27 speech at Jackson Hole, Wyoming, that it had "damped confidence."
Slow Pace
"Things can get worse," said Martin Feldstein, a professor at Harvard University in Cambridge, Massachusetts, and president emeritus of the National Bureau of Economic Research. "When the economy is moving forward at a very slow pace, very close to zero, the risk is that we could slip over into the negative side of zero". Feldstein served as chairman of the White House Council of Economic Advisers from 1982 to 1984, around the time of the last double dip in the U.S.
He put the possibility of a contraction at one in three and also voiced doubts about the Fed's ability to combat it, given how low interest rates already are. "I think there is very little that the Fed can do," Feldstein, a member of the NBER committee that determines when recessions start and stop, said in a Bloomberg television interview on Aug. 27.
"With growth at a stall speed of 1 percent or below, the stock markets could sharply correct, and credit spreads and interbank spreads widen while global risk aversion sharply increases," said Nouriel Roubini, the New York University economist who predicted the global financial crisis of 2008-2009.
Negative Feedback Loop
"A negative feedback loop between the real economy and risky asset prices can then easily tip the economy into a formal double dip," Roubini, chairman of Roubini Global Economics LLC, said in an Aug. 25 e-mail message. But history argues against such a setback now, said Randall Kroszner, a former Fed governor who is now a professor at the University of Chicago Booth School of Business. Other industrial nations that experienced major financial crises, such as Spain in 1977 and Sweden in 1991, avoided double dips, though their recoveries were slow.
Even Japan, which suffered a 'lost decade' [[although not from their own objective/perspective, which was to maintain high employment, which they largely did: normxxx]] of minimal growth after a real-estate bubble burst in the early 1990s, managed to stage a three-year rebound before its economy was knocked back down by the 1997-98 Asian financial crisis. "My overview is that we have a very disappointing recovery rather than a double dip," said Carmen Reinhart, a professor at the University of Maryland in College Park who co-wrote a book on crises with Harvard professor Kenneth Rogoff.
Credit Controls
The only double dip in the U.S. since the end of World War II occurred 30 years ago, when the economy turned up in mid-1980 only to fall back into recession a year later. That situation isn't applicable today, said Gramley, who was at the Fed at the time. The initial decline in 1980 was triggered when President Jimmy Carter imposed credit controls. He quickly reversed himself when the economy collapsed in response.
Postwar recessions traditionally have been prompted by the Fed boosting rates to fight inflation, oil prices rising sharply or businesses suddenly reducing inventories, Gramley said. None of that looks likely this time, he added. The Fed cut the overnight bank lending rate to close to zero percent in December 2008 and has signaled it intends to keep it there for an extended period. The central bank "will do all that it can to ensure continuation of the economic recovery," Bernanke said in his Jackson Hole speech.
[[On the other hand, the 2007-? recession is the first credit induced recession since the '30s, and the NBER has yet to declare its end date!: normxxx]]
Falling Oil Prices
Oil prices have fallen as growth has slowed. Crude oil for October delivery settled at $73.91 a barrel yesterday on the New York Mercantile Exchange, down from the 2010 high of $86.84 set on April 6. The inventory/sales ratio for U.S. businesses was 1.26 in June, just above its all-time low of 1.23 in March and April and below 1.37 a year ago, according to Commerce data.
The housing market, whose collapse kicked off the economic decline that began in December 2007, also looks to be stabilizing, albeit at a depressed level, after factoring out the ups and downs in sales prompted by the home-buyers' tax credit and its expiration in April, Paulsen said. Residential construction totaled $358.1 billion at a seasonally adjusted annual rate in the second quarter, compared with $813.3 billion in the first quarter of 2006, at the height of the housing boom, Commerce Department data shows.
Postponable Purchases
What Harris calls "postponable purchases"— housing, spending on durable goods such as cars, and business investment in equipment and software— stood at 16.8 percent of gross domestic product in the second quarter. That compares with a postwar low of 16 percent in the same period a year earlier and the post-war average of 20.6 percent, according to calculations by Bank of America-Merrill Lynch. "Even if they fall back down, you probably wouldn't get a recession; you'd get a period of stagnation," Harris said.
Vehicle sales in the U.S. clocked in at a seasonally adjusted annual rate of 11.46 million in August, off 32.4 percent from 16.95 million in August 2005, according to statistics from Autodata Corp., a research company based in Woodcliff Lake, New Jersey. It would probably take a flare-up of the financial crisis to push the economy back down and that's less likely than it was prior to 2007, said Jacob Frenkel, chairman of JPMorgan Chase International in New York. "The likelihood of a financial meltdown is now much lower than it was in the past," he said.
Banking Capital
The U.S. banking industry "has more capital as a percentage of assets right now than in any time since 1935," Richard Bove, an analyst with Rochdale Securities in Lutz, Florida, said in an Aug. 26 interview with Tom Keene on Bloomberg Radio. [[Not a good omen, considering what happened a bare 18 months later in 1937.: normxxx]] The positive yield curve— with long-term interest rates higher than short-term rates— also argues against a fall back into recession, according to Arturo Estrella, professor of economics and department head at Rensselaer Polytechnic Institute in Troy, New York. The yield curve has turned negative prior to each of the last seven recessions, with no false signals since 1967, his research shows.
Bernanke said in Jackson Hole that U.S. households have also made "greater progress in the repair of their balance sheets." He pointed in particular to the rise in the personal savings rate, which was 5.9 percent in July, compared with a 3.3 percent average since the start of 2000. Fed policy makers have also highlighted the strength of demand overseas as a plus for the U.S. economy, especially for manufacturing companies. [[But this is rapidly dropping off.: normxxx]]
Faster Pace
Manufacturing in the U.S. expanded at a faster pace than forecast in August as the Institute for Supply Management's factory index rose to a three-month high of 56.3 from 55.5 in July. Readings greater than 50 in the Tempe, Arizona-based group's index signal growth. The figure had been projected to drop to 52.8, according to the median forecast in a Bloomberg News survey. "I tend to be cautiously optimistic about growth," said Harvard professor James Stock, who is also a member of the NBER's Business Cycle Dating Committee. "All the excesses have been corrected". A double dip is "quite unlikely," he added.
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Normxxx
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