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Everywhere you turn, recession is staring you in the
face.
The
Sunday New York Times featured a story on the prospects
for recession on the front page of the Week in Review
section. The following day, the Wall Street Journal ran
a recession article on Page One.
Across
the pond, Harvard’s Larry Summers made waves in a
November 26 Financial Times column, in which he said
“the odds now favor a US recession.” Newspapers in
Europe and Asia are commenting on comments on recession.
Economists are scurrying to pencil in another reduction
in the Federal Reserve’s benchmark rate on December 11
and to pare their expected target for next year,
comments by policy- makers notwithstanding.
Less
than two weeks ago, Fed Governor Randall Kroszner was
surprisingly blunt when he told an industry conference
that “the current stance of monetary policy should help
the economy get through the rough patch during the next
year.” Data consistent with the slow growth he foresees
won’t suggest monetary policy is “inappropriate,” he
said.
The
message was about as clear as it gets when it comes to
central bankers: No rate cut in December. Unfortunately,
the market’s outlook isn’t aligned with the Fed’s
forecast.
The Fed
funds futures market is placing the odds of a
25-basis-point cut on December 11 at 98 percent.
Economists had initially put their faith in the Fed’s
words. Now they’re siding with the market’s action.
Markets
talk
So is
all this recession talk overblown, a good story to
explain teetering world stock markets? What hard
evidence is there the economy is rolling over?
“The
thing that makes it most compelling is that the
consensus of economists is still looking for growth,”
says Paul Kasriel, director of economic research at the
Northern Trust Corp. in
Chicago.
For
those putting their faith in markets, one glance at the
US Treasury yield curve tells you something is amiss.
The yield on every issue, from bill out to bond, is
below the Fed’s target rate. That’s an unnatural state
of affairs that violates Rule No. 1 of banking: borrow
short, lend long. It makes it harder to turn a profit,
which is one of the reasons financial stocks have been
the biggest losers this year.
The
spread between the funds rate and 10-year Treasury
yield, which is one of 10 components in the Index of
Leading Economic Indicators, has been inverted since
July 2006 on a monthly average basis. Given that the US
economy was still expanding in the third quarter—at
close to a 5-percent pace, if estimates for tomorrow’s
revision are correct—the spread’s lead-time looks to be
long.
Credit
spreads
All the
talk about why long rates have been low—dollar-related
buying by the People’s Bank of China, the global savings
glut, and now a panicked flight-to-quality—is beside the
point. The message of the yield curve is that the Fed is
keeping the overnight rate too high relative to
market-determined long-term rates.
There
are other troublesome signals emanating from the market.
The spread between high-yield bonds and gilt-edged
government securities has more than doubled since June
to about 500 basis points.
“Credit
spreads are usually a coincident to lagging indicator,”
Kasriel said. “The fact that they’ve widened may suggest
we’re already in” recession.
Three-month interbank lending rates are rising, and
central banks in both the United States and Europe are
acting to ease anticipated year-end funding pressures.
The Fed
announced earlier this week that it plans to conduct
“term- repurchase agreements,” which are collateralized
loans to primary dealers that will extend into the new
year. Ever since credit concerns arose in August, the
effective Fed funds rate has been wide of the Fed’s
target.
Leaders’
reckoning?
What
else is sending a worrying sign? The LEI has been going
sideways for an unprecedented two years. That suggests
the US economy doesn’t have “significant upward momentum
going forward,” said Ataman Ozyildirim, an economist
with the Conference Board’s business cycle indicators
group. “It highlights the risk in the economy.”
It is
not, in his view, sending a recession signal. Of the two
measures whose readings presage a slump—the six-month
annualized change in the LEI and the six-month diffusion
index—only one is in danger territory.
The
six-month diffusion index was at the threshold of 50 in
September and October, indicating that half of the 10
components were rising in the last half-year. That index
stood at 40 for the entire first half of 2007, seemingly
without any untoward effects.
Final
straw
The
six-month change in the LEI has been hovering near zero
for a year-and-a-half, well shy of the 4-percent to
4.5-percent decline Ozyildirim says meets the threshold
for a recession signal.
The
recent trend in the LEI is not encouraging: The index
posted steep declines in two of the last three months.
Falling home prices, rising default rates, sagging
consumer confidence and tighter lending standards may
prove to be the proverbial straw that broke the
economy’s back.
“Banks
are buying old credit, not making new loans,” Kasriel
said. “You could say there’s a reintermediation going
on. Banks are buying the assets no one wants.”
That’s
not the making of a healthy economy. |
