Month-end fireworks

It's been a slow start to the week thus far, but today could well see an explosion of fireworks. Take your pick as to what could move the market: the ADP survey, giving an early bead on Friday's payroll figures; the Q1 GDP report, which could suggest that the US has indeed slid into recession; the 4 p.m. London fixing in foreign exchange, which should generate some considerable short-term volatility; and oh, yeah, the Fed announcement this evening.

Ultimately, it's the latter of these that is the most significant, with the million- or billion-dollar question being whether the Fed will signal "one and done" or opt for a more open-ended statement. Market consensus is overwhelmingly in favour of the former, at least in the currency and fixed income space; common sense might suggest having thrown his lot in with the reflationist crowd, it would be a bit foolish for Bernanke to close off his options while the economic data is still deteriorating.

Having been relatively constructive on the US economy over the course of 2007, Macro Man has been forced to change his view over the past few months as circumstances have changed. Simply put, the deterioration in the labour market, combined with the rise in the cost of living, has hit disposable income growth to the extent that Macro Man is now looking for the end of the Great Consumer Boom that has characterized the US economy for the past quarter-century.

That the current environment will not mimic 2001-02, despite the aggressive Fed cuts, is apparent from the consumer confidence data. Both the Conference Board and Michigan indicators have plumbed to depths not heretofore witnessed during Macro Man's fifteen year career, a change in circumstance that he is forced to respect.

Yesterday's Conference Board release showed another uptick in one of Macro Man's favourite indicators, the "jobs hard to get" component, which tracks the unemployment rate quite closely. As the chart below illustrates, this data suggests another new high in the U-rate on Friday.
However, you can see that the overall level of the indicator is still well below the peak of the last recession. So why is Macro Man so worried? Well, the Conferene Board survey also contains a less-followed indicator on the outlook for employment six months' hence. The balance between "more jobs" and "fewer jobs" has collapsed over the past several months down to levels not observed since early 1991. What's interesting is that the "more jobs" subcomponent is at its lowest level since the early 80's...the last time there was a genuine consumer recession.
Given that household spending is currently 71.5% of US GDP, it will be a very big deal indeed if Joe Sixpack reins in his spending. Longtime readers may recall a simple consumption model that Macro Man has constructed, which explains nominal consumption growth in terms of changes in disposable income and wealth. (The model would work just as well on real income, but there is a greater data history for nominal income/spending.)

The chart below shows the model output along with actual consumption data. The upshot of the model is that if, over the next couple of quarters, disposable income growth slows a percent and a half and y/y changes in net wealth go to zero, real consumer spending growth will go to flat y/y. And that's with a steady savings rate. Given that it may be reasonable to expect y/y net wealth to turn negative (as indeed it did in 2001) , there should be downside risks to this forecast.
Of course, the coming stimulus check bounty will raise disposable income growth, though higher food and energy prices will sap some of those gains. Of course, there also remains the risk that consumers finally look to rebuild their balance sheets and decrease debt/increase savings. Every single poll that Macro Man has seen on the stimulus checks suggest that a majority of respondents plan to pay down debt or boost savings with their windfall.

The residual of the model above correlates very well with changes in the US household savings rate. This is useful, as it allows us to postulate what a given change in savings will mean for actual spending. If, for example, the savings rate were to rise 1% over the course of a year, it would shave 2/3 of a percent off of spending.
If Macro Man is correct about the state of the US consumer, then the savings rate could rise even more over the course of the next year or two. And that, Macro Man would suggest, would produce a period of sustained low interest rates and high 1970's style inflation, such is the Fed's apparent intolerance of below-trend growth.

Ultimately, this would be a poor environment for both stocks and duration. It's not hard to see the new President, whoever it may be, replacing Bernanke at the end of his term with a 21st century Volcker-type figure.