FRB SF: The Economic Outlook

John Fernald of the San Francisco Fed gives his view of the economic outlook. The bottom line?:

The relatively strong incoming data suggest that growth in the second quarter was close to trend, after two anemic quarters. Going forward, the continuing and, indeed, intensifying pressures from housing, credit markets, and commodity prices, are likely to weigh on activity for some time. However, the fiscal stimulus program should help support growth in the current quarter.

A more solid recovery should take root in 2009, reflecting some waning of the drags on the economy. In particular, housing should begin to stabilize; credit conditions should gradually ease; and energy and food prices are expected to level off. In addition, the earlier policy easing by the Federal Reserve should provide some cushion for the economy.

Here are more details. I suspect some of you will view the inflation forecast - the third graph from the bottom - with suspicion:

FedViews, by John Fernald, FRBSF: Housing and credit markets remain troubled, and commodity prices have risen further. These factors are likely to weigh on the outlook for some time. In addition, reflecting surging food and energy prices, inflation is an increasing concern.

Housing wealth has continued to plunge, with home prices down sharply over the past year. The Case-Shiller ten-city home-price index has fallen about 15 percent over the past year and about 20 percent since its peak. The futures market on this index suggests that prices have considerably further to fall before leveling off.

Inventories of both new and existing homes—measured as the supply of homes on the market relative to the current monthly sales pace—are very high. Falling prices and an overhang of home supply are a drag on new home construction.

Mounting losses on securities tied to sub-prime and other mortgages helped spark the ongoing financial turmoil and financial market stress still remains high. In general, risk-adjusted interest rates on private debts remain at, or above, their levels from last summer, despite substantial reductions in the federal funds rate and resulting declines in rates on Treasury securities.

Business surveys do not suggest a major deterioration in overall conditions. For example, the Institute for Supply Management surveys purchasing and supply executives each month. For both manufacturing and non-manufacturing, these diffusion indices are currently close to 50, which is below their typical values. Hence, current readings appear consistent with slightly below-trend growth.

In contrast, falling employment suggests more deterioration in economic conditions. Over the past year, employment in goods-producing industries (mainly construction and manufacturing) has fallen about 3-1/2 percent. In previous recessions, job losses have always been more severe than we’ve seen so far. Employment growth in services-producing industries has slowed, but employment remains above its year-ago level.

Through February, household spending appeared quite weak. For example, the year-over-year growth rate of non-durables consumption—a category that includes food, apparel, and gasoline—had slowed to levels comparable to the 2001 recession. The non-durables category omits the purchases of durable goods, which tend to be volatile, as well as services, where the monthly data are likely to be less reliable.

Since March, however, consumer spending has bounced up notably. Some of the bump-up in May presumably reflects the effects of the $50 billion in stimulus checks that were delivered that month. Although it is possible that the increases in March and April reflected consumers spending early—knowing that they would soon be receiving a stimulus check—it could also reflect resilience on the part of consumers.

Vehicle sales have plummeted in recent months, reflecting gasoline prices that have risen above $4/gallon as well as tighter credit conditions.

Business capital investment spending is holding up. Orders and shipments for non-defense capital goods excluding aircraft—i.e., durable equipment goods—have been edging steadily up over the past year and a half. Some of that strength appears to reflect exports of capital goods in addition to domestic capital formation. Exports, in general, have been a source of strength for the economy.

The relatively strong incoming data suggest that growth in the second quarter was close to trend, after two anemic quarters. Going forward, the continuing and, indeed, intensifying pressures from housing, credit markets, and commodity prices, are likely to weigh on activity for some time. However, the fiscal stimulus program should help support growth in the current quarter.

A more solid recovery should take root in 2009, reflecting some waning of the drags on the economy. In particular, housing should begin to stabilize; credit conditions should gradually ease; and energy and food prices are expected to level off. In addition, the earlier policy easing by the Federal Reserve should provide some cushion for the economy.

Soaring food and energy prices have pushed up overall consumer inflation. With the recent surge in energy prices, headline inflation is likely to spike further before coming down. Core inflation has been better contained, but has still been running a bit high. Some pass-through of input costs for energy and transportation, as well as increases in non-fuel import prices, is likely to put continued upward pressure on core inflation.

Assuming that commodity prices will level off, as implied by the futures markets, core as well as headline inflation should moderate next year, as more slack in labor and product markets emerges.

A risk to the inflation forecast is that inflation expectations could rise. Such an increase could lead to a wage-price spiral, in which workers demand wage increases in an attempt to cover their increased living expenses, and firms grant these wage increases in the expectation that they can pass on those costs by raising their own prices.

Have inflation expectations risen? The Michigan survey of households shows higher long-term inflation expectations. However, there is some evidence that the Michigan survey responses are highly sensitive to the current inflation rate, so it is likely that this measure will come down once oil and food prices stop rising. In contrast, the Survey of Professional Forecasters sees the same long-term inflation trend as they’ve been seeing since the late 1990s. And inflation compensation five-to-ten years out, derived from a comparison of nominal and inflation-indexed government securities, has come down from its highs earlier this year.

Since last month, markets have pared back expectations about the pace of monetary-policy tightening. A month ago, markets thought the federal funds rate would rise steadily over the course of 2008. They now expect only one rate increase this year.

Comments

[esb]

With regard to the chart that sits third from the bottom, the authors failed to disclose that Dr. Pangloss assisted in the preparation of the chart.

[Carlomagno]

Where is that growth in 2009 going to come from I wonder? More fiscal stimulus? Obamamagic?

[Ryan]

To me, the capital goods chart is somewhat comforting; the rest either looks ugly, or irks my suspicion.

"Where is that growth in 2009 going to come from I wonder? More fiscal stimulus? Obamamagic?"

Personally, I find GDP to be a contrived measure, designed moreso to expedite modelling than to actually capture the state of the economy. With that said, Fiscal Stimulus would necessarily boost GDP.

[save_the_rustbelt]

General Motors announces the next phase of its meltdown today.

Whatever one thinks of the auto industry, this can't be good.

[Ryan]

It is unfortunate that GMs may go the way of the DoDo; hopefully, the Saturn line will either be salvaged witha buyout, or can exist as its own entity.

[esb]

GM will be the subject of a Paulson/Bernanke "save the world weekend" in October.

GMAC is insolvent, and when it goes "in," GM necessarily goes with it.

[hari]

We shall know shortly after summer ends whether headline inflation is surging or not -> tendency upward. ECB (unlike Fed) has already taken the measure of oil and food prices spike and decided that price stability is fundamental to internal EU growth.

So, in reality, we are getting different signals from ECB and Fed and the Chinese CB is apparently not yet discounting higher inflation (meaning BoC will accomodate inflation for the short term).

[Lafayette]

Hubris

s_t_r: General Motors announces the next phase of its meltdown today. Whatever one thinks of the auto industry, this can't be good

Weren't you impressed by GM's recently stated full commitment to developing electric cars (the Volt) by 2010. And Chrysler's in "just " five years.

That makes both of them only a decade behind Toyota ...

Hubris is as hubris does. Too much of it for too long gets you in the sh*tcan.

[ddt]

oil just took a nose dive to $130
apparently the banks are deleveraging their oil bets

[ddt]

sorry - $140

[Ryan]

Pray tell, what massively produced and purchased electric Toyota vehicle are you talking about?

Electric have been around for near a century, and by and large aren't practical.

[Movie Guy]

"FRB SF: The Economic Outlook" almost stopped me right there.

Unfairly, perhaps, I have to say that believing any economic outlook from the government, Fed, or analysts cheering on the economy is a risk that I may no longer consider.

The fundamental problems in the financial industry are so huge that any hope or presentation of daylight at this juncture is not only premature, but bordering on sheer nonsense. The debt unwinding effort, if successful, will involve many, many years. There is the real possibility that the ship will go down in deep water.

Reading economic outlook presentations that fail to front load or address in some detail the scope of the fundamental problems in the financial industry is not on my "To Do" list anymore.

We're in one hell of a mess and some people, maybe most people, need to push the economic comic books off the table and focus on reality. And that reality should be fully reflected in economic outlook presentations. I am not seeing that happen.

[save_the_rustbelt]

Movie:

Did you catch Bush this morning.

Good God, the man is delusional.

Even factoring in a bit of cheerleading we should epxect from a President, he is still delusional.

[Movie Guy]

Which comic book did he read from today?

[Ryan]

I did catch Bush this morning; I was actually relatively impressed. Obviously he was spewing nonsense, but he said it with conviction and wasn't his usual bumbling self.

[Movie Guy]

I watched the White House video feed tonight. It wasn't that bad.

The President should have worn a blue suit, not a brown one. He appeared to have needed some rest. He didn't appear to have read his written text remarks many times prior to delivery. If anything, he was mentally down which is not his normal demeanor when engaging the news media is a press conference.

He overstated some things, but that was to be expected. Most importantly, though, he engaged the news media. It has been a while since he conducted a news conference.

I give him a grade of B- on this one.

[Lafayette]

Gross Negligence

Ryan: what massively produced and purchased electric Toyota vehicle are you talking about?

Pray read, what massively produced and purchased electric vehicle exists on the market today? None.

The hybrid Prius was in engineering development ten years ago. Which is where GM supposedly is today, is the point I was making.

Besides, the real electric car requires a engineering modification to the electrical grid for it to benefit from over-night recharging. Everybody coming home between 5 and 7PM and plugging in the electric car will spike the load and bring the grid down in most places in America (it is thought). This can be overcome by a timer that commences charging at some more opportune time over-night, when the demand-load is much lower. But, not all grids are (supposedly) up to scratch for such.

AND, catering to the massive step-function jump in energy needs means calling on more oil/coal generation, which is only going to worsen CO2 discharges into the atmosphere. So, what is the alternative?

Nuclear electricity generation (and near-eternal stocking of toxic waste).

As we've said on this forum, No solution is a quick-fix and we've dithered so long, it is neither any longer amusing or tolerable.

Whatever the inevitable policy decision, this administration deserves to be pursued for Gross Negligence.

[Ryan]

So you were ranting and raving about GMs lack of innovation for nothing, and your true beef is with "this administration." And, by "this administration" I assume you have your partisan blinders on, and specifically mean Bush and Co.

Well I have news for you, political dithering on alt energy has been the standard for a lot longer than 8 years, much like electric cars have been in development a lot longer than 10 years.

[Movie Guy]

Ryan is correct.

And Lafayette's "knowledge" of what GM has and hasn't done appears to be very limited.

Toyota's Prius technology is a spin off of GM's train locomotive technology. Moreover, the Prius model isn't very good to be frank. Many other hybrid models coming forward will be better and less expensive to maintain over the long term.

I'll go further...Europe's shift to hybrid technology was derived from U.S. technology and many of the existing products are being pursued in knowledge share agreements primarily with General Motors.

Europe has finally come around, addressing its vehicle emissions problems which were rampant during the 1980s (they dragged their feet terribly) and some improvements in vehicle safety. While Europe has jumped on diesel engines as one of their magic bullets, it should be noted that VW pleaded for waivers from the U.S. EPA on its most recent diesel vehicle entries into the USA, all of which were denied. VW had to regroup and improve their diesel engine technology in order to stay in the U.S. marketplace. And, again, Europe's emissions focus has been slightly different than that of the U.S., though its most recent efforts have tightened up some of their problems.

When it comes to gasoline engine technology, no OEM surpasses GM's technical knowledge on how to get torque and hp out of larger engines. Europe and Japan have not been able to achieve similar fuel efficiencies while satisfying U.S. fuel emission requirements.

While the Europeans have wrapped themselves in small vehicles (some of which are not the safest rides in the world, nor could some of that junk be sold in the USA), it should be noted that their engines actual fuel efficiencies are not particularly impressive on a horsepower to weight basis. The same problems exist in Asia, and this is well known in automotive engineering circles.

[Alex Tolley]

Lafayette: "... catering to the massive step-function jump in energy needs means calling on more oil/coal generation, which is only going to worsen CO2 discharges into the atmosphere."

Incorrect. Fixed power plant efficiencies are higher than automobile engines. Thus converting energy to electricity in a power station and then converting it back to mechanical energy via electric motors at very high efficiencies is a more efficient use of fossil fuel. Furthermore, as you point out,, the method of creating electricity can be varied, substituting nuclear, solar or wind, etc.

[Alex Tolley]

Movie_Guy: "it should be noted that their engines actual fuel efficiencies are not particularly impressive on a horsepower to weight basis."

So what? It is total fuel consumption to move a body around in a vehicle that counts. Europeans do that much more efficiently by:

1. Smaller vehicles (and no, they are not "junk")[As for safety, northern European road fatalities are comparable to the US - maybe they drive better?]
2. Shorter commute distances
3. More mass transit.

[Ryan]

Alex, Europeans live in Mono-centric cities, and drive far less than the average American because of it. As such, commutes, and mass transit are far more viable. Besides, the "look at Europe" argument is really neither here nor there, as America is not Europe, and never will be. We have to be serious about addressing our own unique situations, and copying Europe won't do the trick.

[Lafayette]

Such is business

MG: I'll go further...Europe's shift to hybrid technology was derived from U.S. technology and many of the existing products are being pursued in knowledge share agreements primarily with General Motors.

And, so what?

Europeans have had higher taxes on petroleum products in order to force efficient usage -- whereas the US has had just the opposite policy. Which is why hybrid car technology languished, until Toyota saw the opening some five years ago with the inevitability of higher prices at the pump that would make a paradigm shift from conventional technologies (meaning internal combustion engines).

OK, so, GM innovated hybrid technolgies. But, so what? It did not manifest either the foresight or the courage to bring the technology to market. (So, now it is behind the eight-ball.)

And Toyota did. So, Toyota and Honda are ahead of the eight-ball. Such is life. Such is business.

PS: Your comment prompted me to look for a "History of hybrid cars". Here's what I found. It's interesting, in an historical context.

[Lafayette]

Ryan: Besides, the "look at Europe" argument is really neither here nor there, as America is not Europe, and never will be. We have to be serious about addressing our own unique situations, and copying Europe won't do the trick.

Puerile nonsense and ostrich-hiding-its-head-in-the-sand kind of argumentation.

If the US had a higher-tax of energy usage, like Europe, perhaps it would be not in the energy mess that its in. For instance, the cost at the pump in Europe is easily 2 times as much as in the US. (Your cost at the pump is around $4 a gallon. Ours in France is 1.5€ a liter.) Yes, average distance driven annually in the US is longer than in Europe, by about 20%. (I reckon, from the fact that average annual miles driven in the US is 12000 and average kilometers driven in Europe is around 16800.)

Another example, France took the plunge into Nuclear Energy in the 1970s. Up until "Three-Mile Island", the US was competing fairly well in that industry. Then, after that event, all further building of nuclear electricity generators stopped dead. Today, France furnishes more than three-quarters of residential electricity usage by means of Nuclear Generation. And, it is far less dependent upon high-emission coal for electrical energy generation.

France has today a state-of-the-art Nuclear Generation technology (company called Areva) that it is selling installations around the world, competing well enough with Westinghouse, though being more expensive (due to the euro/dollar exchange rate).

The US, in terms of energy exploitation, is marked by a calamity of errors. Starting with Three-Mile Island and (hopefully) ending with lead-head's election in 2000.