The optimism from Fed speakers this past weekend, essentially “recent data show growth, we won’t be dissuaded by market volatility”, is right out of the Central Banker’s playbook. We understand it is a central banker’s job to be upbeat about the economy, even when easing during a recession. The disparity between the statements in Jackson Hole and the slowdown in global growth driving capital market pricing caused us to drift back to early 2007, when the Fed acknowledged issues in the housing market but remained undaunted in their upbeat assessment of the US economy.
Below are some highlights from the minutes of the June 27/28, 2007 FOMC meeting --
“ . . . the members . . . submitted individual projections of the growth of nominal and real GDP, the rate of unemployment, and core consumer price inflation for the years 2007 and 2008 . . . Projections for the rate of expansion in real GDP in . . . . 2008 . . . ranged between 2-1/2 to 3 percent . . . . unemployment rates in the range of . . . 4-1/2 to 5 percent in the fourth quarter of 2008; [AUTHOR’S NOTE: IN 2008 REAL GDP DROPPED 2.8% 4Q/4Q AND THE UNEMPLOYMENT RATE ENDED 2008 AT 7.3%]
Participants generally agreed that the housing sector was likely to remain a drag on growth . . . . Spillovers . . . to consumption spending had apparently been quite limited to date. . . . A number of participants remarked that the recent data on business spending were more encouraging . . . . and survey indicators of business conditions had improved of late. . . . Strength in spending abroad and the decline in the . . . dollar were seen as factors boosting U.S. exports. . . . Most participants judged labor market conditions to remain rather tight . . . . Some participants further noted that the level of the unemployment rate consistent with stable inflation could be lower than previously thought--a possibility that would help to explain the absence of outsized wage pressures in the current environment. [AUTHOR’S NOTE: THE MORE THINGS CHANGE]
. . . Although the housing market remained a key source of uncertainty about the outlook, members thought it most likely that the overall economy would expand at a moderate pace over coming quarters. . . . . members agreed that maintaining the target federal funds rate at 5-1/4 percent for this meeting was appropriate . . . . “
We would like to believe this time around there are more realistic assessments being voiced around the FOMC table than there was in 2007, at least privately. Among those sitting around the table then and still are now are Yellen, Dudley, Lacker, and Lockhart.
The driving economic force today is not housing but the slow or not-so-slow implosion of the Chinese economy and its knock-on effect on global economic growth – market volatility is merely the messenger. Indeed, the US equity market is, in our view, finding its way, in its own dysfunctional manner, towards a level more in line with reduced expectations for growth in foreign earnings. At worst, equity prices drop too far for too long and negatively impact domestic consumer demand.
The general thought that equities don’t matter much to consumer spending is a historically accurate statement. The statement, however, ignores the determined mix-shift in household assets towards equities and corporate debt that marks this cycle -- thanks to the extended era of zero interest rates. We see this in the very high ratio of household financial assets to tangible assets. The ratio was last at this height, and only for a moment or two, during the dot.com bubble. The difference between then and now is that then the increase was essentially passive, driven by the rise in equity market values. In the current cycle, the increase is an active, determined effort to earn a yields on savings that are above zero.
There are only guesses as to the eventual impact of a faltering China on US growth, guesses better reflective of the bias of the guesser than anything else. It is likely that any fallout creating a negative shift in US economic data is not going to be truly evident anytime soon, and the full meaning of any such shift probably won’t be recognized for a while after that. The previous recession didn’t officially begin until December 2007 and we were well into 2008 before the mainstream was saying the economy was in a downturn, and even then most prognostications were calling for a short and shallow downturn.
We are not anticipating a recession, but the probability of slower growth (1%-1.5% real GDP growth) is greater than it was. Considering that the growing collection of good economic news wasn't good enough for the Fed to move in March or June, we are hard pressed to believe the FOMC will now go so that they can have 12.5 basis points to give back to the market if the economy falters.
