It Has Been a Long, Cold Summer
John Canally, CFA
Economist
LPL Financial
Highlights
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A busy week for data capped off by the August employment report.
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While temperatures have been well above normal this summer, the economic data has been downright chilly, raising the odds of more policy action from the Federal Reserve later this year.
The week before the Labor Day holiday is traditionally a slow week for financial markets, which is not likely to be the case this week, as there are plenty of key reports on the economy for July and August to keep market participants’ minds off their vacations. Markets are still buzzing about what Fed Chairman Ben Bernanke did or did not say at a speech in Wyoming on Friday, August 27, and while Bernanke is in vacation mode this week, several of his colleagues on the Federal Open Market Committee (FOMC), the Fed’s monetary policymaking arm, are on the docket. Data on both the manufacturing and service sectors in August are due out in China, as policymakers in Beijing debate whether the Chinese economy needs another dose of stimulus. In Europe this week, the economic data calendar remains busy, as market participants try to gauge whether or not the recent series of better-than-expected economic data was a head fake prior to the onset of the fiscal tightening that is just now taking place. [Chart 1]
In the United States, the week kicks off with data on spending and incomes in July, and by mid-week, the market will be focusing on the Institute of Supply Management’s (ISM) manufacturing index for August. The economic reports over the final two days of the week are dominated by the labor market, with the August employment report due out on Friday, September 3. Because temporary workers hired to conduct the 2010 Census are still being laid off as the Census-taking process winds down, the market will again be focused on employment in the private sector, where more than 600,000 jobs have been created since the start of the year. The economist consensus expectation is that the private sector added about 50,000 jobs in August, a slightly slower pace of job growth than the 71,000 jobs added in July. As of Monday, August 30, the highest economist estimate for job creation in August is 120,000. The lowest estimate is -17,000. A change in private sector payrolls in August within that range is not likely to move markets. The unemployment rate is expected to tick up to 9.6% in August from 9.5% in July.
Is Another Round of Quantitative Easing in the Cards?
The economic data released last week was once again on the wrong side of consensus, and continued to show that the recovery in the U.S. economy that began in mid-2009 had slowed noticeably by mid-2010. For most of the late spring and summer of 2010, a significant portion of the U.S. economic data released last week (August 23-27) fell short of expectations, and represented a downshift in activity from the prior month. As we detailed in the Weekly Economic Commentary of August 16, our view remains that economic growth in the second half of 2010 will be slower than growth in the first half.
While the odds of a double-dip recession have risen (to around 20% in our view), the main preconditions for a double dip are not in place now.
In a much-anticipated speech last week at the Fed’s annual summer symposium in Jackson Hole, Wyoming, Fed Chairman Bernanke agreed with our assessment of the economic outlook: no double dip. However, the Fed remains far more optimistic about the economy in 2011 than most private forecasters, ourselves included. The Fed’s forecast of 3.5% to 4.2% for Gross Domestic Product (GDP) in 2011 is well above the 2.8% consensus of private sector economic forecasters. In his Jackson Hole speech, Bernanke stated that the preconditions for a pickup in growth in 2011 “appear to be in place”, citing a variety of factors that we note often in this and other publications, including:
- Monetary policy remains very accommodative.
- Financial conditions have become more supportive of growth.
- Banks are improving their balance sheets and appear more willing to lend.
- Consumers are reducing their debt and building savings, returning household wealth-to-income ratios near to longer-term historical norms.
- Stronger household finances, rising incomes, and some easing of credit conditions will provide the basis for more-rapid growth in household spending next year.
- Business investing in equipment and software should continue to grow at a healthy pace in the coming year, driven by rising demand for products and services, the continuing need to replace or update existing equipment, strong corporate balance sheets, and the low cost of financing, at least for those firms with access to public capital markets.
- On the fiscal front, state and local governments continue to be under pressure; but with tax receipts showing signs of recovery, their spending should decline less rapidly than it has in the past few years.
- Federal fiscal stimulus seems set to continue to fade but likely not so quickly as to derail growth in coming quarters.
However, Bernanke also hinted that if the economic outlook were to “deteriorate further” (i.e. the daily, weekly, and monthly drumbeat of economic data continues to come in on the weak side of expectations), the Fed stands ready to embark on another round of stimulus, which could includes:
- Additional Quantitative Easing (QE): large scale purchases by the Fed of agency debt, agency Mortgage-Backed Securities (MBS), and longerterm Treasury securities
- Modifying communication to suggest “extended period” means the Fed is on hold for an even longer period of time than currently believed
- Reducing the interest rate paid on excess reserves held by banks at the Federal Reserve.
Of the three, Bernanke’s speech suggested that the Fed would prefer to use QE to stimulate the economy. The Fed’s first foray into quantitative easing began in March 2009, and saw the Fed purchase $1.25 trillion of MBS, $175 billion of agency debt and $300 billion in Treasuries by the end of March 2010. The result was lower borrowing costs for businesses, and importantly, homeowners and households looking to repair their balance sheets.
Market participants are likely to have several questions about the next round of QE, including:
- When will it occur?
- How much additional agency, MBS, and Treasury debt will the Fed buy?
- Will it be effective in keeping the economy out of a double-dip recession?
As to when QE might commence, the next FOMC meeting is September 21, and the market will focus on that date in the near term. In our view, there is probably not enough data on the economy due out between now and then to force the Fed’s hand. November 3, the day after the 2010-midterm elections, is the next FOMC meeting, and by then the Fed will have digested two more jobs reports, two more months of retail sales and inflation data, and perhaps another Senior Loan Officers survey.
As to the size of the action, the market seems to be focused on the $1 trillion mark, smaller than the first round of QE, but enough to be felt in the targeted markets and in the economy.
The real debate among market participants will be around the effectiveness of any additional QE. Some will argue that the Fed is merely “pushing on a string”, by pushing rates on mortgages and bank loans even lower, because the issue is not the cost of the financing for businesses and households, it is the availability of financing. Our view is that credit is becoming more readily available in the system, and that lower rates will help eligible businesses to continue to lower their borrowing costs, and that lower consumer financing rates will further hasten the repair of consumer balance sheets, which has progressed nicely over the past 18 months, but may have another 12 to 18 months to go.
To download the full article click below
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
Investing in international and emerging markets may entail additional risks such as currency fluctuation and political instability. Investing in small-cap stocks includes specific risks such as greater volatility and potentially less liquidity.
Stock investing involves risk including loss of principal Past performance is not a guarantee of future results.
The ISM index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders, and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.
Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of a fund shares is not guaranteed and will fluctuate.
Mortgage Backed Securities are subject to credit, default risk, prepayment risk that acts much like call risk when you get your principal back sooner than the stated maturity, extension risk, the opposite of prepayment risk, and interest rate risk.
Bank Loans are loans issued by below investment-grade companies for short-term funding purposes with higher yield than short-term debt and involve risk.
Tagged as:
Financial News,
John Canally,
LPL Financial,
LPL Financial Research,
Weekly Economic Commentary
LPL Financial Weekly Economic Commentary for August 30, 2010
by Rose Greene, CFP on August 31, 2010
It Has Been a Long, Cold Summer
John Canally, CFA
Economist
LPL Financial
The week before the Labor Day holiday is traditionally a slow week for financial markets, which is not likely to be the case this week, as there are plenty of key reports on the economy for July and August to keep market participants’ minds off their vacations. Markets are still buzzing about what Fed Chairman Ben Bernanke did or did not say at a speech in Wyoming on Friday, August 27, and while Bernanke is in vacation mode this week, several of his colleagues on the Federal Open Market Committee (FOMC), the Fed’s monetary policymaking arm, are on the docket. Data on both the manufacturing and service sectors in August are due out in China, as policymakers in Beijing debate whether the Chinese economy needs another dose of stimulus. In Europe this week, the economic data calendar remains busy, as market participants try to gauge whether or not the recent series of better-than-expected economic data was a head fake prior to the onset of the fiscal tightening that is just now taking place. [Chart 1]
In the United States, the week kicks off with data on spending and incomes in July, and by mid-week, the market will be focusing on the Institute of Supply Management’s (ISM) manufacturing index for August. The economic reports over the final two days of the week are dominated by the labor market, with the August employment report due out on Friday, September 3. Because temporary workers hired to conduct the 2010 Census are still being laid off as the Census-taking process winds down, the market will again be focused on employment in the private sector, where more than 600,000 jobs have been created since the start of the year. The economist consensus expectation is that the private sector added about 50,000 jobs in August, a slightly slower pace of job growth than the 71,000 jobs added in July. As of Monday, August 30, the highest economist estimate for job creation in August is 120,000. The lowest estimate is -17,000. A change in private sector payrolls in August within that range is not likely to move markets. The unemployment rate is expected to tick up to 9.6% in August from 9.5% in July.
Is Another Round of Quantitative Easing in the Cards?
The economic data released last week was once again on the wrong side of consensus, and continued to show that the recovery in the U.S. economy that began in mid-2009 had slowed noticeably by mid-2010. For most of the late spring and summer of 2010, a significant portion of the U.S. economic data released last week (August 23-27) fell short of expectations, and represented a downshift in activity from the prior month. As we detailed in the Weekly Economic Commentary of August 16, our view remains that economic growth in the second half of 2010 will be slower than growth in the first half.
While the odds of a double-dip recession have risen (to around 20% in our view), the main preconditions for a double dip are not in place now.
In a much-anticipated speech last week at the Fed’s annual summer symposium in Jackson Hole, Wyoming, Fed Chairman Bernanke agreed with our assessment of the economic outlook: no double dip. However, the Fed remains far more optimistic about the economy in 2011 than most private forecasters, ourselves included. The Fed’s forecast of 3.5% to 4.2% for Gross Domestic Product (GDP) in 2011 is well above the 2.8% consensus of private sector economic forecasters. In his Jackson Hole speech, Bernanke stated that the preconditions for a pickup in growth in 2011 “appear to be in place”, citing a variety of factors that we note often in this and other publications, including:
However, Bernanke also hinted that if the economic outlook were to “deteriorate further” (i.e. the daily, weekly, and monthly drumbeat of economic data continues to come in on the weak side of expectations), the Fed stands ready to embark on another round of stimulus, which could includes:
Of the three, Bernanke’s speech suggested that the Fed would prefer to use QE to stimulate the economy. The Fed’s first foray into quantitative easing began in March 2009, and saw the Fed purchase $1.25 trillion of MBS, $175 billion of agency debt and $300 billion in Treasuries by the end of March 2010. The result was lower borrowing costs for businesses, and importantly, homeowners and households looking to repair their balance sheets.
Market participants are likely to have several questions about the next round of QE, including:
As to when QE might commence, the next FOMC meeting is September 21, and the market will focus on that date in the near term. In our view, there is probably not enough data on the economy due out between now and then to force the Fed’s hand. November 3, the day after the 2010-midterm elections, is the next FOMC meeting, and by then the Fed will have digested two more jobs reports, two more months of retail sales and inflation data, and perhaps another Senior Loan Officers survey.
As to the size of the action, the market seems to be focused on the $1 trillion mark, smaller than the first round of QE, but enough to be felt in the targeted markets and in the economy.
The real debate among market participants will be around the effectiveness of any additional QE. Some will argue that the Fed is merely “pushing on a string”, by pushing rates on mortgages and bank loans even lower, because the issue is not the cost of the financing for businesses and households, it is the availability of financing. Our view is that credit is becoming more readily available in the system, and that lower rates will help eligible businesses to continue to lower their borrowing costs, and that lower consumer financing rates will further hasten the repair of consumer balance sheets, which has progressed nicely over the past 18 months, but may have another 12 to 18 months to go.
To download the full article click below
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
Investing in international and emerging markets may entail additional risks such as currency fluctuation and political instability. Investing in small-cap stocks includes specific risks such as greater volatility and potentially less liquidity.
Stock investing involves risk including loss of principal Past performance is not a guarantee of future results.
The ISM index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders, and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.
Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of a fund shares is not guaranteed and will fluctuate.
Mortgage Backed Securities are subject to credit, default risk, prepayment risk that acts much like call risk when you get your principal back sooner than the stated maturity, extension risk, the opposite of prepayment risk, and interest rate risk.
Bank Loans are loans issued by below investment-grade companies for short-term funding purposes with higher yield than short-term debt and involve risk.
Tagged as: Financial News, John Canally, LPL Financial, LPL Financial Research, Weekly Economic Commentary