Today’s Observation will be light on commentary as I will let the charts do most of the talking in terms of gauging where things stand currently. Let’s dive right in…
Wall Street’s Pulse
Despite all the efforts from the Federal Reserve, Treasury, and White House, the credit markets remain frozen as banks are afraid to lend to each other as well as the consumer and businesses. We are in a far more precarious position than at any point since the crisis began last year as the various spreads, bank willingness to lend, and bank borrowings from the Fed below illustrate. Below are various commercial paper credit spreads, with the first between low quality (A2/P2) and high quality (AA) commercial paper, followed by the spread between 90-day commercial paper and risk-free 90-day T-Bills.
Figure 1
Source: Federal Reserve Board
Figure 2
Source: Federal Reserve Board
Figure 3
Source: Federal Reserve Board
Figure 4
Source: St. Louis Fed
In the September 10th commentary I mentioned the following:
When the Transmission is Broken, Call a Tow Truck
While bank credit is contracting the stimulus package and GSE bailouts have more than offset the decline. We may begin to see the same turn of events if Chairman Bernanke begins to load up the helicopters for deployment to offset the asset deflation underway. We are seeing bleeding on several levels from contracting bank credit as well as falling asset prices. However, Uncle Sam and Helicopter Ben are giving the blood transfusions to stem the hemorrhaging and turn the economy and markets around. We have yet to see who the victor will be in this tug-of-war, though a determined government can accomplish near anything as Chairman Bernanke has said.
Deflation: Making Sure “It” Doesn’t Happen Here
Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of dollars in circulation, or even credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is the equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.
Bernanke, Ben S.
November 21, 2002
Time will tell, and you can be sure we will be checking on the data ahead and report any new developments.
As promised, below is an update of the Fed’s balance sheet as there most certainly have been some developments. I’ve often commented in previous WrapUps that I felt the Fed would pull every trick in the playbook, to Chairman Bernanke’s credit, to try and bring market stability with swapping the Fed’s balance sheet of US Treasuries for Wall Street securitized garbage and various lending facilities, before resorting to helicopter drops. US Treasuries as a percent of Fed Assets have plummeted from over 90% to now below 50% as the Fed continues to be the buyer of last resort for Wall Street’s waste.
Figure 5
Source: Federal Reserve Board
Houston We Have Lift Off!
The time has now arrived where the Fed has resorted to its last backdrop, increasing the money supply by expanding its balance sheet as B-52 Ben leads the paper bombing squad to drop its digital dollars on the markets and economy. Greenspan’s Y2K panic printing of US dollars is a mere pittance to Bernanke’s current bomb drops. The Fed had 5.7 billion in assets as of September 3rd. In less than four weeks the Fed has expanded its balance sheet to the tune of 8.2 billion dollars, or an increase of 34% in less than a month. It must be nice to expand one’s assets to the tune of 34% with a simple touch of a magic wand! Let’s revisit the Bernanke comment made above
But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.
Figure 6
Source: Federal Reserve Board
The extent of the increase in the Fed’s balance sheet is truly eye-popping, so too is the year-over-year (YOY) rate of change.
Figure 7
Source: Federal Reserve Board
While we wait to see if our elected officials will vote to expand the Federal Government’s treasure trough the Federal Reserve is wasting no time in flexing its muscles. The question remains, while the powers that be are pulling out all the stops, will it be enough to turn the economy around?
Main Street’s Pulse
My view remains that we are still headed towards a rather deep recession, regardless of what the government and Federal Reserve do, though their actions will determine the duration of the recession and whether we have an even more severe recession than what I see already in the cards.
An analogy I have given previously in terms of the economy is that it is similar to an oil tanker, where its sheer mass means that it cannot turn on a dime and its movements are gradual. As such, the economy’s momentum has already pushed it into a recession, despite the pundit debate still going on, and 2009 is likely to prove even uglier than 2008. Households are currently witnessing a decline in every major asset they own. The Fed’s Flow of Funds report has shown three straight quarters of declining real estate, mutual fund, and equity prices. Declining household net worth will be a major drag on consumption as the negative side of the wealth effect coin plays out.
Figure 8
Source: FRB Flow of Funds
Figure 9
Source: BEA/FRB Flow of Funds
Real estate losses are likely to continue as the S&P/Case-Shiller housing index continues to plummet, with surging unemployment likely to lead to more defaults and bankruptcies. Both of which will lead to further losses on Wall Street.
Figure 10
Source: Standard & Poor's, Fiserv Inc. and MacroMarkets LLC
Figure 11
Source: U.S. Bureau of Labor Statistics
Figure 12
Source: Federal Reserve Board
Also weighing down consumption trends are falling jobs and incomes. We have now had eight consecutive monthly job declines for a total of 605,000 jobs lost since January of this year, which is likely to mark the starting point for the current recession by NBER, the recession arbiters. Hourly wages from the retail sector, a major component of our service economy, are now virtually flat as laborers simply do not have bargaining power for the wages they receive in a recession. Another sign of labor and economic weakness is that manufacturing weekly overtime hours are being cut, which is why it’s not surprising to see the Institute for Supply Management’s (ISM) Manufacturing Index plummet from neutral territory (50) to contractionary territory, dropping from 49.5 to 43.5 in September.
Figure 13
Source: U.S. Bureau of Labor Statistics
Figure 14
Source: U.S. Bureau of Labor Statistics
Figure 15
Source: U.S. Bureau of Labor Statistics
Figure 16
Source: Standard & Poor's/Institute for Supply Management
So there you have it. Credit markets remain frozen, the Federal Reserve is dropping B-52 dollar bombs (devaluing our currency), household net worth is declining, incomes are falling, and jobs are being lost to the tune of over a half million year-to-date. The economic tanker is clearly in recessionary waters that will not be calming until at least next year. What the Federal Reserve and government do from here will decide the depth and duration of the current recession but make no mistake, an economic recovery will not take place until next year as the economy will not turn on a dime.
As such, any market bounce produced from reaction to the bailout legislation passing or some other government action will fade as quarterly earnings miss (losses), job losses, rising unemployment, and falling consumption reports come in. SELL STRENGTH!
