Entries from January 1, 2008 - January 31, 2008
US data suggesting flat economy not recession
On the last reading my probability indicator suggested a 45% chance of a US recession (I shall provide an update soon). While below the “trigger” level, such a high reading clearly implies a weak economy, with GDP growing negligibly. The data this week have been consistent with this picture.
Take today’s employment report for December. I think the index of aggregate hours worked in the private sector is a better cyclical indicator than headline non-farm payrolls. As the first chart shows, this measure has shown little growth over the last three months but is not yet contracting – a necessary but not sufficient condition for a recession.
A similar message comes from another sensitive indicator – the new orders index from the ISM manufacturing report. This index plunged to 46 in December but has fallen to 43 or below in recessions historically – see second chart.
If the US economy does fall into recession the culprit will be not the “credit crunch” but soaring energy prices. At the risk of labouring the point, I think premature Fed easing has been a significant contributor to this surge.
Why the Fed needs to emphasise inflation not "credit crunch" risks
My last post suggested the Fed’s “pre-emptive” rate cuts have been counterproductive. Yesterday’s market action illustrates the dilemma the central bank now faces. A shockingly weak ISM manufacturing report caused market players to discount greater future rate cuts, with some even speculating about a move before the next scheduled FOMC meeting on 30th/31st January. These expectations contributed to a sharp drop in the dollar and a surge in commodity prices, with oil and gold hitting new peaks. Yet higher commodity costs will further squeeze consumer budgets and corporate profit margins, offsetting any support to the economy from lower rates.
The way out of this unproductive cycle is for the Fed to make clear that its primary focus is inflation. Further rate cuts should be made conditional on a stabilisation of the dollar and softer commodity prices. Until inflation expectations moderate, policy easing will continue to have little traction on the real economy.