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Is the Hard Part Over…Or Just Starting?On to the Recovery, Fingers Crossed
Strictly Private and Confidential
David WattSeptember 20090
2
The Good News
US Economy About to Emerge From Period of Darkness
The Bad News …. Things Still Look Pretty Dim
The recession is ending. It might already be over…maybe.
US GDP: Poised to expand in Q3 and beyond. Pace to be steady, unspectacular, at best.
The rebound still seems to have shaky foundations
Aggregate demand might do ok, but private demand to struggle.
The US consumer: No longer able to carry the burden of growth. Headwinds to consumer are stiffer than they have been in decades, but the US consumer is unlikely to disappear.
But Times Have Changed.
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0
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4
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2004 2005 2006 2007 2008 2009 2010
US GDP q/q (annualized)RBC Forecast
The Square Root
Recovery!
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There is More Good News
The US is Not Alone…The Global Downturn is Losing Momentum
The Bad News …. Things Still Look Quite Shaky
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China India Latin
America
World US Canada UK EZ Japan World
Trade
2009p
2010p
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0
5
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Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09
U.KJapan:Germany :Mainland Norw aySw eden:Canada:
GDP (q/q, saar)
Likely to rise from 2.5% to 3.0%
The global recession is ending.
Growth is starting to appear in many countries.
Financial Market Stress: Not Normal, But Less Systemic Risk
Policymakers Went Full Force to Backstop Financial Stability,They Had No Other Option
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CA 3m OIS-Libor Spread
UK 3m Libor-OIS Spread
US 3m Libor-OIS Spread
JP 3m OIS-Libor Spread
EU 3m Libor-OIS Spread
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02 03 04 05 06 07 08 09
MSCI World Financials / MSCI World IndexFunding markets are functioning again, and financial stocks are outperforming after two years of pressure.
Markets Have Been In Risk Seeking Mode For A Lengthy Period
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Risk Temperature Gauge Variant One
Risk Temperature Gauget Variant Tw o
Risk Aversion
Risk Seeking 50
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Market Risk Index * LHS
*Equally -w eighted index of 10-y ear Treasury sw ap spread and VIX
From the peak of risk aversion, markets have been in a lengthy period of risk seeking. There has not really been a period serious re-examination of the upswing. Even in bull markets, a 90-day period of risk seeking is lengthy. The current period has been twice that length.
Is A Correction Due?
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Trade: Still the Weak Link of the Global Economic Outlook
Many Signs of Improvement, Global Trade Not Yet One of Them
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84 86 88 90 92 94 96 98 00 02 04 06 08
Emerging Asia* Exports (US$bn)
* China, Hong Kong, India, Indonesia, South Korea, Malaysia, Pakistan, Philippines, Singapore, Taiwan, Thailand
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72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
World Trade Growth y/y (quarterly)
.
Range of estimates of global trade growth in 2009: -9% y/y to -16% y/y. For 2010 estimates range from 1.0% y/y to +3.8% y/y.
Concerns About Protectionism Linger
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How Far Have We Come, How Close Were We To Catastrophe
Japan’s Economy Seemed to Nearly Unravel, South Korea’s Dramatic Trade Slide
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70 73 76 79 82 85 88 91 94 97 00 03 06 09
Japan: Industrial Production (3mannualized % change)
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70 73 76 79 82 85 88 91 94 97 00 03 06 09
Korea Merchandise Exports (US$ bn)
Almost As Spectacular Have Been the Rebounds
Japan came close to the Abyss. The collapse was absolutely startling
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95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
-30
-20
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10
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30ISM New Orders Index
Durable Goods New Orders (y /y )
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Economy: Yin and Yang
Fewer States are Contracting, Some Positive Signs, Some Challenging Developments
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40
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80
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79 81 83 85 87 89 91 93 95 97 99 01 03 05 07
Philly Fed State Coincident Diffusion Index
+100 = All States Expanding-100 = All States Contracting
According to the Philly Fed, 29 US States are still contracting. That is not great, but in February, all 50 were contracting. That had never happened before. Other signs of “less bad” developments is the bounce in ISM manufacturing new orders. However, we have yet to see surveys of new orders morph into actual new orders. Durable goods new orders, which tend to track ISM MFG new orders closely, have barely started to improve.
Yawning Gap
The Recovery is Still Taking its Own Sweet Time…..Much Longer, And Optimism Will Want Anew
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Things Are Not Getting Worse, But They Aren’t Getting Better Fast
Manufacturing Activity is Rebounding, But Other Signs Point to Lingering Struggles.
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85 87 89 91 93 95 97 99 01 03 05 07 09
DJ-BTMU U.S. Business Barometer
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91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
ATA Truck Tonnage Index
DoT TSI Freight
* Components: Car production, truck production, raw steel production, coal production, electricity output index, railroad carloadings, home purchase index, real weekly chain store sales, box office receipts.
*
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The Assault in US Wealth Easing, The Sting to Linger
Sunk Costs and Resetting Expectations for One’s Retirement
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52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 06 09
Change in value of Household Net Worth ($bn, 4qms)
-30-25-20-15-10
-505
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52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 06 09
Change in value of Household NetWorth (% PDI, 4q ma)
This is Not the Typical Market Downturn, This Time Really is Different
The Tech bubble collapse was bad for US wealth.
It can’t hold a candle.
The hit to US household net worth from the housing bubble collapse was three times longer.
That time, the Fed cut rates to 1% and left them there for a year.
This time, merely cutting rates was nowhere near enough.
Bad!
Worse, Much Worse!
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When A Historic Relationship Changes: Either Fundamentals Changed
Equities Have Historically Driven Household Net Worth
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52 56 60 64 68 72 76 80 84 88 92 96 00 04 080
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100
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250Household Net Worth (% of PersonalDisposable Income) LHSTobin's Q*
Or Fundamentals Eventually Reassert Themselves Violently
A tight historical relationship broke down in 2004.
Suddenly, US household net worth was no longer linked with equity market performance. Why?
The housing boom, or the housing bubble.
Suddenly, US household net worth was linked with housing. The home as ATM.
That was fine…while it lasted.
The past two years have seen the historical equity/net worth relationship reasserted.
In many ways, things are back to normal, though the adjustment was painful and disheartening.
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59 62 65 68 71 74 77 80 83 86 89 92 95 98 01 04 07 100.2
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1.0Single Family Housing Starts (saar, millions)
Single Family Units Under Construction (millions)
Fingers Crossed that the Worst of the Housing Downturn is Past
Too Many Carpenters?
There are some hopeful signs that the condition of the US housing market is no longer deteriorating.
However, starts remain at a historic low.
As well, one can presume that there has rarely been fewer US houses under construction, a steep, steep slide from the 2006 peak.
Residential Construction Activity Has Not Been This Low in Memory
13
In Some Ways It is the Best of Times for Potential Homebuyers
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73 76 79 82 85 88 91 94 97 00 03 06 09
US Housing Affordability Index
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73 76 79 82 85 88 91 94 97 00 03 06 09
Freddie Mac: 30-yr FRM
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95 96 97 98 99 00 01 02 03 04 05 06 07 08
New and Existing Single Family Home Sales (mns)
Homes are more affordable than in a generation
Interest rates are at rock bottom levels … and there are no teaser rates surprises in the fine print.
It is thus not a surprise to see new and existing home sales bottoming.
Even so, signs of recovery come across as demostrably tepid.
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Jobs Market: Its Bad, but No Longer Getting Worse
Adjusted Household Employment Tumbled by 1 million in August
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75 78 81 84 87 90 93 96 99 02 05 08
Unemploy ment Rate (16-19 y ear olds)
Prime Jobless (Unemploy ment rate 25-54 y ear olds)
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70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08
Nonfarm Pay rolls (Monthly Change 000s)
A staggering pace of job cuts.
It has rarely been more a more challenging job market for:
Youth
24-54 year olds
University Students
Men
Everyone else
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97 99 01 03 05 07 09
2530354045505560657075Priv ate nonfarm pay rolls diffusion index (1-month)
ISM Employ ment (Av g MFG and Non-MFG)
Payrolls Not As Worrisome, But Household Survey Still Cause for Concern
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US: Never Have So Many Been Unemployed for So Long
A Record 5% of the US Labour Force is Considered Long-term Unemployed
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48 53 58 63 68 73 78 83 88 93 98 03 08
Long-term unemployed (% of total unemployed)
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73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09
Exhaustion Rate (12m ma)
A record 50.7% in July 2009
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Extended Benefits Claimants (thousands)
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Emergency UnemploymentCompensation (thousands)
Up to 13 additional weeks of benefits
Skills Deterioration A Risk
Over one-half of those who are unemployed have exhausted their benefits and moved onto other programs.
16
Fiscal and Monetary Policy in US and Elsewhere Responded Aggressively
Joined Forces to Fight Recession, Less Agreed on What to do Next
For Exit Strategies Still Theoretical, For Some, An Active Debate
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US 6m OISUS 12m OISFed Funds Target
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AU 6m OISAU 12m OISRBA Cash Target
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UK 6m OIS UK 12m OIS UK Base Rate
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Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09
EU 6m OIS EU 12m OIS ECB Repo Rate
Coordinated rate cuts
October 8
Staring into the abyss is a powerful force to prompt coordination.
There is less agreement on when or how to exit aggressively easy policy stances.
Parsing the Fed’s Balance Sheet and the Exit Strategy
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Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09
Treasuries Repos TAF+ Dis Window
Agencies Merrill Lynch Swap Lines
Other Fed Assets AIG PDCF
CPFF AMLF MMIFF
MBS TALF
USD bn
The first wave —designed to restore financial stability and prevent catastrophe.
The programs were designed to unwind naturally as stability returned.
Count that a success.
The more recent programs will take more time to unwind. The Fed’s balance sheet will eventually decline, but it will take some work and it won’t likely get back to where it was.
Monetary policy and central banking will be unrecognizable in a few years.
The Dramatic Transition
USD — What’s Next As the Mad-Dash to USD Fades?
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EUR 1-y r cross currency basis sw ap
GBP 1-y r cross currency basis sw ap
DXY Index
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Still a Premium on USD Funding, But Well Off Peak … So is USD
USD back to pre-Lehman levels.
What Next?
Tension was building all Summer.
Was the next move to be upward….
Or downward.
Market seems to have made up its mind.
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US: Deflation Risks Have Declined, But Inflation … Not There Yet
Unlike the 1990s, the Global Backdrop is Not Set to Help the Fed Control Inflation
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US Core Goods 5-yr annualized % LHS
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US 5yr/5yr Forward Inflation Expectation %
Is Deflation set to occur?Is Inflation set to explode?
Neither deflation nor rampant inflation seem likely in the next few years.
Core goods prices reflected disinflation in 1990s and deflation risks in 2002-2003.
They are not on the way up, but won’t ring inflation alarm bells for some time.
Meantime, while longer-term deflation fears were credible late last year and into 2009, they have dissipated.
Long-term inflation expectations are back near historic norms.
Age of Disinflation
When Can the Fed Be Sure that Deflation Risks Have Passed and that It is Time to Wind Down QE Programs?
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Global Markets and the China Effect
Global stocks on a roll, but the indicators of shipping activity have faded, after a China-led pop
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MSCI Emerging Market Equity Index(Local Currency) RHS 500
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Copper (US$/lb) LHS
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China Imports of Iron Ore & Concentratess(million tons)
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China Imports of Aluminum(thousand tons)
Yawning Gap
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A Staggering and Sobering Erosion in US Fiscal Backdrop
Foreign Investors Snapping Up Record Volume of Treasuries…Can’t Keep Up With Supply
Foreign investors purchased a record US$756bn of Treasuries (4Q total) to Q1.
Issuance totalled US$1.5tn.
US Domestic investors stepped in, the first major foray into the Treasury market in over a decade.
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Treasury Issuance (US$bn, 4qma)
Foreign Purchases of Treasuries (US$bn, 4qma)
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Treasury Issuance (US$bn, 4qma)Domestic Purchases of Treasuries (US$bn, 4qma)
The CBO and the White House Indicate that the Federal Surplus Will Top US$9tnOver the Next Decade…… US$9 Trillion
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US Federal Deficit (US$ bn, 12mms)
US$1 trillion
Foreign Investors Now Primarily Interested in Treasuries
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US Treasuries (12-m ms)
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Foreign Holdings of US Treasuriesheld in longer-term securities (% oftotal)
However, foreigners have modified what they buy.
In the past, they had a strong preference for longer-term Treasuries, which used to make up 90% of foreign holdings.
There has been a dramatic shift toward Treasury bills.
Long term Treasuries now account for 75% of holdings.
This occurred even though foreigners were heavy buyers of Treasuries, but reflected lingering concern about heavy US deficits.
A Shake Out of Global Finance
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Net Foreign Purchases of US Corporates(USD bn, 12m ms)
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95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
US Agencies (12-m ms)
Foreign Investors Revealed Preference — They No Longer Like US Corporates or Agencies
Over much of the past decade, foreign investors were heavy buyers of US corporate debt (largely ABS), and Agencies.
Net inflows into these sectors were near US$850bn in June 2007, and had helped fund the US current account deficit and thus global imbalances.
They have turned into net seller of both sectors.
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-2
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8US Share of G7 GDP (%) LHS
US Current Account Deficit (% GDP) RHS
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Lingering Imbalances in the Global Economy
Increasingly Unsustainable
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61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 06 09
US (consumption, share of GDP)
Atlanta Fed President Lacker notes that the US consumer has been traumatized.
One might wonder what he is talking about.
In 2009 Q2 consumption’s share of GDP hit a record high, well above levels seen in 2004 to mid-2007 a period of housing bubble-induced spending.
US consumers are not going to disappear, but the US economy has to become less dependent on the consumer.
So too, the overall G7 economy is still too dependent on the US, and thus on the US consumer too.
So long as spending does not depend on wealth, income, jobs, or credit …. This is fine
Yawning Gap
US 10-Year Yields, Not Doing Much to Attract Interest
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US GDP (%, 10-y ear annualized)
10-y r Treasury Yield %
Fear of Loss Might Do More To Prompt Support
10-year Treasuries closer to 4% is reasonable based on the long-term growth rate of nominal GDP.
26
Exit Strategies: Whose First, Whose to be Last
Trying to Find the Right Route
Central Bankers Have Few Rulebooks for What They Are (Still) Up Against
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US 6m OISUS 12m OISFed Funds Target
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Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09
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Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09
EU 6m OIS EU 12m OIS ECB Repo Rate
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