We end this busy day of economic buffoonery with Goldman's scorecard for August ("
the US economy has not fallen off a cliff", which we translate as a B+, and "far better than expected"), which in turn explains why Goldman, and everyone else, now assumes QE3 (yes, Op Twist is QE3; get over it) is not only a given, but why in Goldman's esteemed opinion, the Fed has at least 3 rationales for pushing for more QEasing. Incidentally, these are as follows: "First, unemployment is far above the Fed’s long-term forecast in the low 5% range; the longer high unemployment persists, the greater the risk that an erosion of skills and labor force attachment will result in permanent supply-side damage. Second, economic growth has been woeful this year and there is no convincing sign of the second-half pickup in growth that the majority of Fed officials seem to expect. The payroll report in particular will weigh heavily in the minds of many Federal Open Market Committee members. Third, there is limited prospect for near-term fiscal stimulus from a gridlocked Washington." The only thing Goldman is avoiding, of course, is the wipe out in stocks that will make QE3 a virtual certainty, as we have been predicting ever since
March. Goldman is also avoiding to mention that the only outcome of more QE will be another record year of Wall Street bonuses, all at the expense of more joblessness, higher gas prices, a 120% debt/GDP ratio, and overall sovereign insolvency. Oh well - in the meantime we continue, as we have for the
past 2.5 years, to buy gold... or spam for the
Econ PhDs out there.
Incidentally, just as amusing is our prediction from
November 2010:
Zero Hedge now believes a $5 trillion QE3 program will be announced by July 2011, when gold is trading at $10,000, the entire Treasury curve is at zero, and stock prices are meaningless courtesy of a DXY sub 50, and every commodity opening limit up daily.
Oddly enough, it was supposed to be a grotesque form of hyperbole. We are stunned to reread just how close we came to predicting everything to the dot.
From Goldman's Keynesian acolytes:
- The US economy has not fallen off a cliff, despite the “confidence shock” precipitated by the debt ceiling impasse, the downgrade of the US sovereign rating, and the financial market turmoil of recent weeks.
- The August employment report was weak but not recessionary. The payroll survey was very disappointing, with no job growth, a drop in weekly hours, and a decline in hourly earnings. But the household survey posted a decent gain and the unemployment rate held steady at 9.1%.
- So far in the third quarter, “hard” indicators of economic activity look a tad better than our forecast of 1% real GDP growth (annualized), while “soft” measures such as business surveys look weaker. Recession remains a substantial risk but not our base case forecast.
- The economy’s growth performance so far in 2011 would be disappointing in any year, and is woefully unacceptable given the high level of unemployment. So we expect the Fed to take further action at its September 20-21 meeting, most likely by announcing that it will extend the duration of its securities holdings by selling shorter-dated securities for longer-dated Treasuries.
- We expect the impact of such a balance sheet “twist” to be similar to QE2. Given widespread speculation of further Fed action, and a very dovish set of minutes from the August meeting, we believe this impact is largely (though not completely) “priced in” to markets at this point.
In Search of Labor Day, Fed to Ease Further
The US economy has not fallen off a cliff, despite the “confidence shock” precipitated by the debt ceiling impasse, the downgrade of the US sovereign rating, and the financial market turmoil of recent weeks.
The August employment report was weak but not recessionary. The payroll survey was very disappointing, with no job growth, a drop in weekly hours, and a decline in hourly earnings. But the household survey posted a decent gain and the unemployment rate held steady at 9.1%.
So far in the third quarter, “hard” indicators of economic activity look a tad better than our forecast of 1% real GDP growth (annualized), while “soft” measures such as business surveys look weaker. Recession remains a substantial risk but not our base case forecast.
The economy’s growth performance so far in 2011 would be disappointing in any year, and is woefully unacceptable given the high level of unemployment.
So we expect the Fed to take further action at its September 20-21 meeting, most likely by announcing that it will extend the duration of its securities holdings by selling shorter-dated securities for longer-dated Treasuries.
We expect the impact of such a balance sheet “twist” to be similar to QE2. Given widespread speculation of further Fed action, and a very dovish set of minutes from the August meeting,
we believe this impact is largely (though not completely) “priced in” to markets at this point.
Despite a “confidence shock” precipitated by the debt ceiling impasse, the downgrade of the US sovereign rating, and the financial market turmoil of recent weeks, the economy seems to have staggered through August without a collapse. But with unemployment at unacceptable levels, growth below trend, and no clear evidence of a second-half pickup, we expect the Federal Reserve to take another substantial easing step at its September 20-21 meeting.
A Stagnant Labor Market
“Labor Day” is anything but in 2011, as the August employment report showed no growth whatsoever in nonfarm payrolls. The workweek shortened, average hourly earnings declined, and prior months’ payroll gains were revised down, making for a substantial disappointment that we would characterize as near-recessionary.
In contrast, the household employment survey was somewhat more encouraging, featuring a gain of 331,000 jobs in August (134,000 when adjusted to the payroll employment definition) and a slight uptick in the labor force participation rate. The unemployment rate was steady at 9.1% (see top exhibit on cover page).
Though the payroll and household surveys often diverge in a given month, both send an unambiguous message of weakness over the past few months, with household employment down slightly and payroll growth barely positive.
Little if Any Growth
A labor market in the doldrums is the natural result of listless GDP growth so far in 2011. We expect 1% growth for the third quarter, roughly the same pace as the first half of the year.
Recent economic news has offered a mixed picture of growth, roughly divided between “hard” indicators of economic activity and “soft” measures of sentiment. The “hard” measures—which include data such as retail activity, industrial production, and durable goods orders—currently imply a bit (though only a bit) of upside risk to our third-quarter growth estimate. Most surprisingly, reports from major retailers showed an uptick in August activity despite dismal confidence.
In contrast, “soft” indicators that focus more on sentiment or opinion have been weak for the most part. In particular, surveys of consumer confidence from the Conference Board and University of Michigan are at 30-year lows excluding the depths of the financial crisis. A number of business surveys have been extremely soft as well, in particular the Philadelphia Fed’s mid-month manufacturing survey, which fell to recessionary levels. But the bellwether business survey, the Institute for Supply Management’s manufacturing index, held roughly steady at 50.6 in August, a level more consistent with the soft-but-not-recessionary “hard” indicators.
Our Current Activity Indicator reads -0.5% with the August data in hand. Note, however, that the available indicators are skewed towards “soft” measures thus far.
Still Skirting Recession
On balance, the economy seems to have skirted recession so far. We recently evaluated a number of “rules of thumb” for recession as well as more formal regression models. The lower exhibit on the cover page shows a model incorporating indicators from the labor market (the change in the unrounded unemployment rate and the three-month change in payrolls), cyclical sectors (housing starts and the ISM manufacturing index), and financial markets (the S&P 500 equity index, the Treasury-Eurodollar spread, and the spread between the Moody’s BAA corporate yield index and long-term Treasury yields), as well as the trailing two-quarter real GDP growth rate. This model currently estimates a nearly 40% probability that the economy was in recession in August.
For estimating the likelihood of recession a few months from now, financial market variables take on greater importance. Exhibit 2 illustrates our financial conditions index, with and without an adjustment for oil prices. Despite the selloff in equities and widening in credit spreads, lower long-term interest rates and a weaker dollar have kept financial conditions slightly easier than early this year, with little net change in recent months. Thus, forward recession probabilities are lower if policymakers successfully evade additional near-term shocks from fiscal tightening (i.e. the yearend expiration of the payroll tax holiday) or financial stress (in particular, credit shocks related to the European debt crisis).
Fed to Try a Further Boost
We expect the Federal Reserve to launch another round of quantitative easing beginning at the September 20-21 meeting. Fed officials can offer several rationales for doing more.
First, unemployment is far above the Fed’s long-term forecast in the low 5% range; the longer high unemployment persists, the greater the risk that an erosion of skills and labor force attachment will result in permanent supply-side damage. Second, economic growth has been woeful this year and there is no convincing sign of the second-half pickup in growth that the majority of Fed officials seem to expect. The payroll report in particular will weigh heavily in the minds of many Federal Open Market Committee members. Third, there is limited prospect for near-term fiscal stimulus from a gridlocked Washington.
Given the lack of unanimity on the FOMC and considerable opposition to asset purchases from some politicians, we think that “QE3” is likely to take the form of “going long” (extending the duration of the Fed’s balance sheet) rather than “going big” (expanding the balance sheet further), at least for now. We believe the impact of quantitative easing is proportional to the duration of Fed purchases. As we showed in a recent analysis, if the Fed sold all its securities maturing before mid-2013 and invested the proceeds in 10- and 30-year Treasuries based on the amounts available, it could achieve a market impact equal to 80%-90% that of QE2 without changing the size of the balance sheet. A further tilt towards 30-year securities could magnify the impact. Exhibit 3 (above) illustrates the current maturity structure of the Fed’s holdings and the market’s. Any manipulation of the portfolio is likely to take place over a period of a few months to minimize disruptions.
Further, QE is already priced into the market to a considerable extent. After all, the Fed went further than expected at its August 9 meeting, when it issued a conditional commitment to hold the funds rate at “exceptionally low” levels “at least through mid-2013”, and indicated the possibility of further action. The minutes from that meeting characterized this as a “measured” action and noted that “a few” members preferred a more aggressive move.
A CNBC survey taken shortly after the meeting suggested that roughly half of market participants expected more QE; given the data flow since then and our subjective assessment from conversations with clients, a clear majority now expects it before the end of the year.
