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.
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Anonymous
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April 30, 2008 at 2:08 PM ×

If the new president were really smart, Ben would be gone long before his term was up

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Anonymous
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April 30, 2008 at 2:09 PM ×

GDP grows at 0.6%. Rally time. Bull is on the way back and we will see 14000 in summer...

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April 30, 2008 at 2:13 PM ×

Achtung, GPD has been helped by a +0,8% in inventories, otherwise -0,2%.. it isn't so bullish.

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Anonymous
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April 30, 2008 at 2:19 PM ×

I don't follow why you think an increase in the U.S. savings rate would lead to 1970's style inflation. Wouldn't the decrease in consumer spending reign in prices?

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Macro Man
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April 30, 2008 at 2:30 PM ×

Anon,

The presumption is that this Fed would counter tepid consumption with maintaining very low interest rates for an extended period of time, which to my mind would spur exactly the sort of outcome we've seen over the past six months.

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Anantha
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April 30, 2008 at 4:52 PM ×

a very good analysis. thanks for the heads-up on future job availability components of consumer confidence.

ABC News/Washington Post Weekly consumer comfort index is plumbing new depths at -41.

you hit it right on the head with your concluding sentences on consumer outlook, outlook for rates and inflation, ending up validating Mr. Volcker's reported comment on Mr. Bernanke as a one-termer.

Some wonderful macro opportunities are coming up. great time to buy CALLs on EDM9 or EDZ9.

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martin
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April 30, 2008 at 7:46 PM ×

Don't in any way see the connection between high savings and inflation. If anything, it would be an inverse correlation with excessive savings depressing demand and pricing. Thus the concern for deflation. The inflationary pressures, if they surfgace, will come from the falling dollar and rising commodity pricing. Perhaps that is what you meant

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Macro Man
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April 30, 2008 at 8:04 PM ×

Yes...the Fed's response to increased savings/decreased consumption will be to keep rates low...which should produce a weaker dollar and higher commodities.

The US is not the marginal buyer of that stuff anymore, and as such is a price taker, rather than price setter, for the first time since the 70's.

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Mr. Prop
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April 30, 2008 at 8:29 PM ×

I have two thoughts. First, it is hard to get excited about inflation when the core is just 2.2%, just barely above the unofficial target band. Also, 5y5y breakevens are crashing. One has to go with the Phillips curve view at least from a cyclical perspective even if one has time for the secular argument that inflationary pressures are on the way up. Of course, this may be difficult without the Fed overtly printing money or a rise in protectionist pressures. Secondly, I note the gap opening up between the unemployment rate and the job hard-to-get component. One explanation is the dichotomy between the highly leveraged financial sector and the lack of leverage in the non-financials. In recent years financials are responsible for a huge slice of earnings (I think 40%) but only employ 5%. This cycle the non-financials are not likely to deleverage and that is one reason why they wont have to cut investment or jobs like they did in previous ones of 1991 or 2001. Unemployment may not go up as fast as many expect. This is a positive and why I would reject the worst case scenario for the US economy.

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