Please see important disclaimers and disclosures at the end of the attached document
Piling On: The risks confronting the domestic recovery continue to accumulate. The lack of leadership in Washington DC and Europe is starting to become a real concern. The conventional wisdom that gridlock is good is starting to wear thin. Europe continues to kick the can down the road rather than grapple with important fundamental issues. The same can be said for the leadership vacuum in Washington. The budget deficit is out of control and government can’t seem to avoid the pending fiscal cliff and debt limit without it coming down to the wire. Moreover, recent political polls seem to suggest that the election may not solve the partisan problems confronting legislators. Even the cautious approach of monetary policy makers is becoming a source of additional concern. With the economy confronted by a global economic slowdown, concerns over possible cross border banking linkages, and the rapidly approaching fiscal cliff; market participants are starting to question whether monetary policy is being implemented effectively. The low level of long-term interest rates orchestrated by the Fed’s “Operation Twist” is failing to provide support to the housing market. It also the doubled the rate being paid on 2-year Treasury notes. Would the economy be better served by a third round of quantitative easing? Should the FOMC exploit the mortgage market directly to cut the cost of financing and increase the availability of funding? Evidence that the domestic economy has downshifted from 2.5- 3% growth to an estimated 1.5% in the current quarter undercuts the value of “Operation Twist”. The FOMC should not have extended this program.
In reality, the underlying balance sheet problems which surfaced in 2007-200 are still exerting a powerful drag on the economy. The household sector’s balance sheet may be improving but only at the expense of that of the public sector’s credit rating and the banking industry’s balance sheet. The Fed’s near-zero real interest rates, repeated rounds of quantitative easing and its portfolio duration extension initiative have distorted the financial markets and slowed the necessary adjustment process. Going forward, we expect the FOMC extend its short-term rate guidance and then a third round of quantitative easing. In fact, if the economy remains stuck, the late 2014 guidance may be pushed out by a year at next month’s deliberations.
Disappointing Data: The latest round of macro-economic data confirms that the economy is establishing a new, shallower growth trajectory. Specifically, labor market data suggest that the economy is struggling to create new jobs. The monthly JOLT’s data show that both new hiring and job openings have reversed the gains of the prior four months. New hiring, in fact, dropped 0.2% in April, pulling this index back down to it April 2011-level, while job openings fell to its lowest level of the year. None of the housing data this week show any signs of renewed vigor. New housing starts fell by 4.8% in May; also completely reversing the prior months gain Existing home sale fell by 1.5% for the month. Even manufacturing looks to be slowing. The regional Philadelphia output measure tumbled to -16.6 in June, after dropping below its boom/bust line in May. Back-to-back negative readings on the Philadelphia build on the already weak Empire State index. It suggests that auto assemblies are staring to lose their ability to boost the underlying economy.
Piling On: The risks confronting the domestic recovery continue to accumulate. The lack of leadership in Washington DC and Europe is starting to become a real concern. The conventional wisdom that gridlock is good is starting to wear thin. Europe continues to kick the can down the road rather than grapple with important fundamental issues. The same can be said for the leadership vacuum in Washington. The budget deficit is out of control and government can't seem to avoid the pending fiscal cliff and debt limit without it coming down to the wire. Moreover, recent political polls seem to suggest that the election may not solve the partisan problems confronting legislators. Even the cautious approach of monetary policy makers is becoming a source of additional concern. With the economy confronted by a global economic slowdown, concerns over possible cross border banking linkages, and the rapidly approaching fiscal cliff; market participants are starting to question whether monetary policy is being implemented effectively. The low level of long-term interest rates orchestrated by the Fed's "Operation Twist" is failing to provide support to the housing market. It also the doubled the rate being paid on 2-year Treasury notes. Would the economy be better served by a third round of quantitative easing? Should the FOMC exploit the mortgage market directly to cut the cost of financing and increase the availability of funding? Evidence that the domestic economy has downshifted from 2.5- 3% growth to an estimated 1.5% in the current quarter undercuts the value of "Operation Twist". The FOMC should not have extended this program.
In reality, the underlying balance sheet problems which surfaced in 2007-200 are still exerting a powerful drag on the economy. The household sector's balance sheet may be improving but only at the expense of that of the public sector's credit rating and the banking industry's balance sheet. The Fed's near-zero real interest rates, repeated rounds of quantitative easing and its portfolio duration extension initiative have distorted the financial markets and slowed the necessary adjustment process. Going forward, we expect the FOMC extend its short-term rate guidance and then a third round of quantitative easing. In fact, if the economy remains stuck, the late 2014 guidance may be pushed out by a year at next month's deliberations.
Disappointing Data: The latest round of macro-economic data confirms that the economy is establishing a new, shallower growth trajectory. Specifically, labor market data suggest that the economy is struggling to create new jobs. The monthly JOLT's data show that both new hiring and job openings have reversed the gains of the prior four months. New hiring, in fact, dropped 0.2% in April, pulling this index back down to it April 2011-level, while job openings fell to its lowest level of the year. None of the housing data this week show any signs of renewed vigor. New housing starts fell by 4.8% in May; also completely reversing the prior months gain Existing home sale fell by 1.5% for the month. Even manufacturing looks to be slowing. The regional Philadelphia output measure tumbled to -16.6 in June, after dropping below its boom/bust line in May. Back-to-back negative readings on the Philadelphia build on the already weak Empire State index. It suggests that auto assemblies are staring to lose their ability to boost the underlying economy.
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