Monday, 8 December 2008

US in recession, end not looking imminent

There is now practically no doubt that not only is the United States economy in a recession, it is in one of the most severe recessions in many decades.

On 28 November, the National Bureau of Economic Research confirmed that a peak in US economic activity occurred in December 2007, meaning that a recession started then.

Over the next week, indicators released for the US economy showed that the recession was not coming to an end, at least not in November.

The decline in manufacturing activity accelerated in November. On 1 December, the Institute for Supply Management (ISM) reported that its manufacturing PMI fell from 38.9 in October to 36.2 in November, the lowest reading since May 1982. According to the ISM, this level of PMI corresponds to a 1.5 percent decrease in real GDP annually. The new orders index fell from 32.2 in October to 27.9 in November, the lowest reading for this index since June 1980.

The contraction in economic activity was not restricted to manufacturing. On 3 December, the ISM reported that its non-manufacturing index fell from 44.4 in October to 37.3 in November. The non-manufacturing business activity index fell from 44.2 in October to 33.0 in November, the lowest reading for this index since it was first reported in 1997. The new orders index fell from 44.0 in October to 35.4 in November, also the lowest level since the index was first reported in 1997.

The job numbers reported on 5 December by the Labor Department made it even clearer that the US economy is in bad shape. According to the report, the US economy lost 533,000 jobs in November, the biggest one-month loss in 34 years. The unemployment rate rose to 6.7 percent, the highest level since 1993.

Probably more than any other single report, the employment report has been instrumental in getting many economists to declare that this will be the worst recession in the US since the Great Depression.

For all the obsession over the job numbers, however, it should be remembered that employment is not a leading indicator of the economy. The latest job numbers may be telling us that the recession did not end recently but it cannot by itself tell us whether the recession is about to end soon.

To tell us that, we have recognised leading indicators. Unfortunately, these are mostly not showing us an optimistic picture either.

The Conference Board's leading index decreased 0.8 percent in October and 2.4 percent in the six-month span through October.

The Economic Cycle Research Institute's weekly leading index rose to 109.9 in the week ending 28 November from 106.9 in the previous week but this still left its annualised growth rate at minus 28.5 percent compared with the previous week's minus 29.2 percent. According to Lakshman Achuthan, managing director at the institute, the index is "suggesting that the recession will deepen further in the coming months".

This means that the recession looks likely to last over a year, making it worse, at least in terms of duration, than the last two recessions in 1990-91 and 2001.

Still, if you look far enough into the tunnel, you may be able to see a bit of light.

In "US economy shrinks, time to revisit the yield curve", I had suggested using the yield curve to get an early read on where the economy is headed. Usually, this is done by comparing the yield on the 10-year Treasury note with a short-term Treasury yield, for example, the 3-month Treasury yield. This spread usually reflects how accommodative monetary policy is. The larger the spread, the better the prospect for economic growth.

At the moment, this spread is looking relatively large. According to Bloomberg, as at the end of last week, the 10-year Treasury yields 2.7 percent while the 3-month Treasury yields practically nothing.

However, in today's conditions, impaired bank balance sheets and risk aversion mean that the zero yield on short-term Treasuries currently being seen is a gross exaggeration of how accommodative monetary conditions are. Rather, the London interbank offered rate (LIBOR) for three-month US dollar loans may provide a better indicator.

The spread between the 10-year Treasury yield and the 3-month US dollar LIBOR shows a less optimistic picture. The latter was fixed at 2.19 percent on Friday, so the spread is only about 50 basis points.

Nevertheless, the spread is positive and an improvement over October when it was negative, suggesting at least some degree of stabilisation in the economic outlook. If and when we see the spread widening beyond current levels in a sustained manner, there is a good chance that the recession could be coming to an end.

However, continued widening of the spread cannot be taken for granted. Financial markets remain volatile and the spread has actually begun to narrow again recently.

Still, it is possible that the outlook may improve even without much further widening of the spread. The Federal Reserve now appears to be embarking on a policy of quantitative easing. This would add yet another layer of monetary easing, one that may not be fully captured by the spread between the 10-year Treasury yield and 3-month LIBOR or other term spreads.

Recent Federal Reserve announcements indicate that quantitative easing is indeed becoming part of its policy. On 1 December, Fed Chairman Ben Bernanke said in a speech that he was considering buying longer-term Treasuries on the open market in substantial quantities. This followed an announcement the previous week that the Federal Reserve planned to buy hundreds of billions of dollars' worth of debt and mortgage-backed securities from government-sponsored enterprises over the next few quarters.

However, for the moment, the US economy looks to be firmly in recession. While the actions being taken by policymakers will eventually help the economy recover, it still looks too soon to say that such a recovery is imminent.

No comments:

Post a Comment