Economy Stalling Out

We think the global growth outlook is deteriorating due to lack of structural reforms, under-investment and contractionary U.S. monetary policy.

• Interest rates are set below-market, limiting credit growth and channeling it to the government and established corporations.
   This rationing process causes the same problems experienced with other types of price controls. In the case of credit rationing, it leaves labor growth and dynamism weak.
• While many of the assets favored by the Fed’s policy have been pushed up in price on the theory that the Fed is creating extra credit, we think non-favored activities (like new business formation, a critical factor in job growth) are harmed, leaving a sluggish and disinflationary environment despite inflation in government-favored assets.  

With interest rates artificial, we’re skeptical of some of the normal leading indicators. Initial weekly claims fell to 316,000 today, normally an indicator of a strengthening labor environment, but we note the unusually low turnover in the current labor force (gross hiring in the JOLTS report at 4.6 million in September has been relatively flat since May 2012 when it was at 4.5 million.) Today’s leading indicators (up 0.2% in October after a strong upward revision to 0.9% for September) have been lifted by distortions in financial markets. Credit spreads are narrowing and small-cap stocks outperforming, but those sectors are prime beneficiaries of Fed policy and don’t generate a big share of job growth.

• The Fed’s policy isn’t a free lunch. To buy bonds, it borrows from the banking system, pushing bank reserves to a staggering 25% of bank deposits. Other parts of the economy are paying for the gains in corporate margins and bond issuance. With U.S. and global GDP growth prospects weak, we think corporate earnings will disappoint, weighing on equities and other asset prices.

Recent data shows several key parts of the U.S. economy stalling out.

• C&I loan growth has slowed sharply in recent months (three-month annualized growth at 3.8%). New business formation is weak and many other indicators are also at or near recession levels.
• Today’s data on durable goods orders during October showed notable weakness. Headline orders fell 2% in October from September. A measure of business investment (capital goods orders excluding volatile defense and aircraft) fell 1.2% in October in nominal terms and are only up 3.6% from the depressed fiscal cliff level in October 2012. Some of the October decline is due to the federal shutdown, but orders have been falling sharply since June. Shipments by this measure fell 0.2% in the month of October and are up only 2.1% from a year ago. Orders are only a little above shipments, reducing the need for new investment.
• Pending home sales peaked in May at 111.3 and have declined for five straight months to 102.1 in October. Pending home sales are now negative on a year-over-year basis and generally lead existing home sales by several months. This may weigh on consumption. Two of the principal contributors to recent moderate consumption growth have been furniture and video equipment including televisions (up 21% in real terms year-over-year), segments that we expect to soften in coming months with the pause in housing growth.

Regarding new-home construction, Tuesday’s data showed that building permits rose to 1.0 million in October from 974,000 in September. However, almost all of the increase was in multi-family permits, reflecting the availability of financing for bigger projects. Single-family permits gained strongly through May but have stalled. Part of this is due to the increase in mortgage rates, but we think it also reflects caution about the outlook.

• Data on housing starts for September-November won’t be available until December 18. We think single-family data will show the same flattening as the data on permits. Housing enjoyed a rebound in 2012 and the first part of 2013, but is now growing slower, paralleling flatness in the economy and labor markets (see Moderate Housing Recovery, 5-25-12 and Housing Update: Rebound Phase Ending; Slower Growth Ahead, 8-21-13.)
• Recent consumer confidence indicators have dropped off sharply. While today’s University of Michigan sentiment indicator was revised up to 75.1 from the preliminary reading, it is down 10 points from July.  Yesterday’s consumer confidence data from the Conference Board showed a decline to 70.4 in November from 72.4 in October. It peaked at 82.1 in June.  Lower levels of sentiment and confidence do not bode well for durables spending.
• Auto sales growth has stalled, with October sales the lowest since October 2012. Auto dealers are reporting weakness in lower-priced models. We think this trend (weakness for low- and mid-incomes) is of concern to overall economic growth, especially given the weakness in business investment. Real consumer discretionary spending is up 2.3% year over year through September (the most recent breakdown available). Real consumer nondiscretionary spending as of September is up 0.5% year over year.  It was 0% in July and August, levels that are associated with recessions.