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Strategies & Market Trends : Mish's Global Economic Trend Analysis -- Ignore unavailable to you. Want to Upgrade?

To: Pogeu Mahone who wrote (17058)	11/29/2004 10:08:44 AM
From: mishedlo	Read Replies (1) \| Respond to of 116555

Global: The World's Biggest Excess Stephen Roach (New York) Global rebalancing has quickly turned into the global blame game. “It’s the other guy,” exclaim Asians, Europeans, and Americans, when the issue of responsibility comes up. America’s Bush Administration views the rest of the world as suffering from a growth deficiency, largely brought about by under-consumption and excess saving. Conversely, Asians and Europeans view the United States as suffering from a saving deficiency brought about by over-consumption and government budget deficits. Who’s got it right? The truth is, they probably all do. There can be no mistaking the extraordinary disparities in the global consumption dynamic in recent years. Over the 1996 to 2004 period, annual growth in US personal consumption expenditures averaged 3.9% -- nearly double the 2.2% pace recorded elsewhere in the so-called advanced world. Americans, for their part, have spent well beyond their means -- as those means are delineated by the US economy’s internal income generating capacity. Over the 1996 to 2004 period, annual growth in real disposable personal income averaged 3.4% -- fully 0.5 percentage point slower than average growth in consumer demand. As a result, the personal saving rate plunged from an already-depressed 4.6% level in 1995 to just 0.2% in September 2004. At the same time, the consumption share of US GDP surged to a record 71% by mid-2002 -- an extraordinary breakout from the 67% share that prevailed, on average, over the 25 years from 1975 to 2000. Never before has an advanced economy taken consumerism to such excess. There’s no deep secret as to how the American consumer pulled it off. It’s all about the emerging power of the asset economy -- namely, how US consumers have turned increasingly from income generation to wealth creation in order to sustain current consumption. At work since 1995 has been the strongest and most sustained surge of above-trend growth in real household sector net worth of the modern-day, post-World War II era. American consumers were quick to make use of this windfall as an increasingly important supplemental source of purchasing power. Moreover, there has been an important shift in the asset economy that took the US consumption dynamic to excess in recent years. The first wave came from the stock market, as household equity holdings surged from about 13% of total assets in 1991 to 35% at the peak in 2000. During the final stages of the equity bubble, individual stock portfolios supplanted real estate as the US household sector’s most important asset. By early 2000, residential property had fallen to less than 25% of total household sector assets, more than ten percentage points below the equity portion. It was only after the equity bubble popped that the asset economy took its most extraordinary twist. The increasingly wealth-dependent American consumer never skipped a beat. In large part, that was because the equity bubble immediately morphed into an even more powerful strain of asset appreciation -- a sustained burst of US house price appreciation that has continued to this very day. As a result, the real-estate share of total household assets rose back to 30% -- recapturing its role as the consumer’s leading asset class. According to Alan Greenspan, American households currently own some $14 trillion in real estate -- almost double their total equity holdings (see his February 23, 2004 speech, “Understanding Household Debt Obligations,” at the Credit Union National Association 2004 Governmental Affairs Conference, Washington, D.C.). This multi-bubble syndrome was largely an outgrowth of the Federal Reserve’s aggressive post-equity-bubble damage containment tactics -- some 550 bp of monetary easing from early 2001 through mid-2003. Housing markets benefited handsomely from the support of 45-year lows in interest rates. And consumers, who had first discovered the joys of asset-driven wealth effects during the stock market bubble of the late 1990s, quickly put their newfound skills to work in reaping the gains of the housing bubble. Not only did they benefit from the psychology of feeling wealthier, but US homeowners were aggressive in taking advantage of breakthroughs in the technology of home mortgage refinancing. It wasn’t just the reduction in interest expenses, but the so-called cash-outs from rapidly appreciating housing assets enabled consumers to uncover a new and important source of incremental purchasing power. Freddie Mac puts the peak rate of equity extraction and second mortgages from residential property at $224 billion in 2003 -- almost 3% of the total value of home equity investments. Over the 2001-04, annual cash-outs appeared to average around 2% of aggregate home equity -- suggesting that households may have liquidated as much as 8% of their equity in real estate in order to fund current consumption. For an aging US society that needs to build saving in order to fund the not-so-distant retirement of some 77 million baby-boomers, even this partial liquidation of asset-based saving is disturbing, to say the least. The asset economy does not just have its origins in America. It is very much a by-product of support from global investors and policy makers. One of the outgrowths of an increasingly asset-dependent economy is a shortfall in income-based national saving. America has taken this shortfall to an unprecedented extreme. The net national saving rate -- the combined saving of consumers, businesses, and the government sector after deducting for the depreciation of worn-out capacity -- fell to a record low in the 1-2% range in 2003-04. Lacking in domestic saving, American has had to import foreign saving from abroad -- and run massive current account deficits to attract that capital. This is where the global enablers enter the equation. First, it was private investors seeking to share in the returns of the world’s greatest productivity story. Then, when doubts surfaced on that front, foreign central banks rushed in to fill the void. Over the 12 months ending September 2004, the “official sector” accounted for 28% of total purchases of long-term US securities -- nearly double the 15% share over the prior 12 months and about four times the portion during the 2000-02 period. This was only the latest chapter in a foreign-inspired dollar-support campaign. Dollar-denominated official foreign exchange reserves surged from $1.1 trillion to $2.1 trillion over the 1998 to 2003 period (as estimated by the BIS at constant exchange rates). That left dollar-based assets with approximately a 70% weight in official reserve portfolios -- more than double America’s 30% share in the world economy and, quite possibly, the biggest overweight in world financial markets today. Nor is it difficult to discern the motive behind this foreign dollar-buying binge. It’s all about the lack of internal demand in Asia and Europe and the related need to draw support from export-oriented growth strategies. And, of course, central to such growth tactics are cheap currencies that underwrite export competitiveness. Asia has led the way in that regard -- with hard currency pegs in China, Hong Kong, and Malaysia and soft currency pegs in Japan, Korea, India, Taiwan, Thailand, and Indonesia. Asia’s official foreign exchange reserves surged to $2.2 trillion by mid-2004 -- more than double the holdings of early 2000. With the bulk of that incremental surge going into dollars, Americans enjoy a subsidy to domestic interest rates that is very much made in Asia. It’s hard to quantify the exact magnitude of that subsidy but my guess is anywhere from 100 to 150 bp at the intermediate and long portions of the yield curve. That means, in the absence of this foreign support campaign, yields on 10-year Treasuries would have been in the 5 to 5.5% zone -- implying a rate structure that would have been far more problematic in providing valuation support to US asset markets and concomitant wealth-driven support to America’s asset-dependent consumer. With the dollar appreciating over most of the past decade, this was a win-win strategy for Asia -- providing the region with competitive currencies, as well as portfolio gains on dollar holdings. Now that the dollar is going the other way, that calculus suddenly looks very problematic. As the world now grapples with the imperatives of rebalancing, it is important that all parties understand the roles they have played -- both in creating the problem and in forging the solution. Asset-dependent Americans truly have an excess consumption problem. It is still astonishing to me that the bursting of the equity bubble didn’t spawn a culture of prudence that weaned US consumers from the perils of an all too fickle wealth effect. With US house price inflation now at a 25-year high of 8.8% and with 15 states now experiencing double-digit house price inflation, this voracious appetite for risk is all the more disturbing. Similarly, Asian and European financiers -- be they private investors or central banks -- need to accept responsibility for the important role they have played in keeping the music going for saving-short, over-extended US consumers. They have taken the easy way out -- putting off the heavy lifting of structural reforms needed to unlock domestic demand and choosing, instead, to recycle foreign exchange reserves into dollars and rely on currency manipulation as a means to sell everything they can to America. In my view, America, Asia, and Europe are all equally guilty of opting for an extraordinarily reckless way to run the world. Financial markets have an uncanny knack in restoring a sense of order to a dysfunctional world. The dollar is now center stage in this global wake-up call -- as well it should be, in my view. But dollar depreciation is not the endgame of global rebalancing. It is the means toward the end -- a potential trigger for a long overdue realignment in the mix of global saving and consumption. By failing to face up to the imperatives of rebalancing, the world has collectively created the ultimate moral hazard -- a US consumer that is now “too big to fail.” This is a serious warning sign. The key to a successful global rebalancing, in my view, hinges critically on facing up to the risks of the world’s most serious excesses. The over-extended American consumer is at the top of that list. And a weaker dollar could well be key in forcing the interest rate adjustments that might well temper the asset-driven excesses of US consumption. This is a shared responsibility that the world must now collectively redress. Long ago, I learned that most of the time it doesn’t pay to bet against the American consumer. There are rare occasions, however, when that rule doesn’t apply. That was the case in the early 1970s in the aftermath of the first oil shock. Back then, as a young staffer at the Federal Reserve Board, I was chastised by Fed Chairman Arthur Burns for being too negative on the US consumer. He argued that I didn’t appreciate the unflinching cyclical resilience of the US consumer -- a resilience that, ironically, was about to give way to America’s first consumer-led recession. A lot has changed in the ensuing 30 years. But for very different reasons, I now believe that another exception is in the offing. The American consumer is an accident waiting to happen. The sooner the world comes to grips with this problem, the better the chances of a successful rebalancing.

To: Pogeu Mahone who wrote (17058)	11/29/2004 11:04:51 AM
From: mishedlo	Read Replies (1) \| Respond to of 116555

U.S.: Review and Preview Ted Wieseman/David Greenlaw (New York) The Treasury yield curve continued to flatten over the past holiday-shortened week, as a further run of better than expected economic data led investors to continue to price in more medium-term Fed tightening even as the long end remained well supported by a steady underlying extension bid. The relentless curve-flattening trend that has been seen throughout November saw a temporary reversal on Friday on disappointment at a lack of early month-end-related buying and concerns about possibly imminent FX intervention (which would typically be mostly reinvested at the front end) and potential shifts in Asian central bank portfolios. The volume of trading on Friday was negligible at best during New York hours, however, so we’ll have to wait until investors return from the Thanksgiving holiday in the coming week and month-end adjustments are made Monday and Tuesday to see the extent to which there really has been any break in the flattening trend. The run of better than expected economic news seen all this month continued in the latest week. Based on stronger than expected capital goods shipments and higher than expected home sales, we boosted our Q4 GDP estimate to +4.4% from +4.0%. This is a full percentage point stronger than we saw fourth quarter growth three weeks ago. Stronger than expected jobless claims figures also led us to up our estimate for November payrolls to +190,000 from +175,000. We remain concerned that there could be a lagged impact from higher energy prices on consumer spending in the months ahead as higher winter heating bills come due, and we believe that some of the expected surge in Q4 equipment investment is being borrowed from Q1 by front-loading ahead of the expiration of tax incentives, potentially leading to some temporary slowing in growth later this quarter and into Q1. But for now the economy clearly has significant momentum. The coming week is packed with key economic releases, with focus on Friday’s employment report. Investors will also be closely watching for early reports on the strength of Christmas sales, with focus on the monthly chain store reports on Thursday for indications of the strength in sales on “Black Friday.” Over the past week, 2’s-30’s flattened 8 basis points, as the old 2-year yield rose 9 bp to 3.01% and the long bond yield was up 1 bp to 4.88%. This was the sixth straight week that 2’s-30’s flattened, for a cumulative move of about 50 bp since mid-October. The new 2-year ended the week at 3.04% after being auctioned Tuesday at 2.945% ahead of Wednesday’s better than expected economic reports. The 10-year yield ended the week up 4 bp at 4.24% after some weakness Friday, while the 5-year yield rose 7 bp to 3.63% and the 3-year yield 9 bp to 3.25%. Near- and medium-term tightening expectations rose again, in line with the upside in the economic data. The rate on the January fed funds contract rose 1 bp to 1.24%, basically fully pricing in a 25 bp rate hike on December 14. The rate on the February contract was up 0.5 bp to 2.455%, nearly fully pricing in another 25 bp hike at the February 1–2 FOMC meeting. The rate on the April contract was up 1.5 bp to 2.675%, pricing in an even probability of a third move in March. The December 2005 and 2006 eurodollar contracts each sold off 10 bp, to 3.62% and 4.05%, respectively, with the rate on the former hitting its highest level since the disappointing July employment report was released on August 6. Economic data continued to surprise on the upside in the past week, with stronger than expected durable goods and home sales reports (mostly the former) leading us to raise our estimate of fourth quarter GDP growth to +4.4% from +4.0%. In our November 8 monthly forecast update, we had estimated fourth quarter growth of +3.4%, but subsequent upside surprises in consumer spending, capital spending, and housing market activity have pointed to significantly better growth in domestic demand than we had initially thought likely in the wake of the September/October energy price spike. Indeed, final domestic demand growth in Q4 now looks likely to show only a slight deceleration relative to the +4.6% jump seen in Q3. Overall durable goods orders fell 0.4% in October, but September was revised up to +0.9% from +0.2%. The key core gauge — nondefense capital goods ex aircraft orders — fell 3.6% in October, as a sharp rise in machinery was offset by weakness in computers and some other categories. However, September was revised sharply higher, to +5.2% from +2.8%, on a big upward revision in high tech products. These figures have shown a seasonal adjustment quirk recently of a big gain in the last month of a quarter followed by a correction in the first month of the next quarter, and we would focus more on the average 0.7% gain over September/October. Nondefense capital goods shipments surged 3.0% in October, and September was revised higher (to -0.4% from -1.4%). Sharp rises in machinery (+4.6%) and computers (+8.1%) led the October advance. Assuming some flattening out in shipments in November and incorporating the impact of a slightly smaller advance in October durable goods inventories (+0.5%) than we had assumed, we boosted our Q4 GDP estimate on this report to +4.3% from +4.0%. Business investment in equipment and software appears on pace for a rise near 18% — some of which we believe will be a result of businesses front-loading spending ahead of the expiration of bonus depreciation provisions at the end of the year, with a partial correction expected in Q1. Meanwhile, both new and existing home sales remained near record levels in October, as the support from very attractive long-term rates — with the average 30-year fixed mortgage rate having fallen to near 5 3/4% from 6 1/4% in June — more than offset any temporary weather-related disruptions in the South. With the South likely to see some rebound from weather disruptions in the months ahead, mortgage rates remaining depressed, and consumer income and sentiment on the upswing, home sales could move to new record levels. As a result, we boosted our assumption for residential investment and further marginally upped our GDP forecast to +4.4%. Meanwhile, a break lower in jobless claims led us to boost our expectations for Friday’s employment report. Initial unemployment claims fell 12,000 in the week of November 20 to 323,000, taking the four-week average down 6,750 to 332,000, the lowest reading since late 2000. Continuing claims in the prior week (the survey week for the employment report) fell 29,000 to 2.755 million, breaking clearly below the 2.8 million level they had been stuck close to for a couple months and leading us to raise our estimate for November nonfarm payrolls to +190,000 from +175,000. The economic calendar is very busy in the coming week, with focus on Friday’s employment report. Early readings on the start of the Christmas shopping season will also be closely watched, both in the monthly sales tallies from the various retail chains on Thursday (which for most companies should cover sales through Saturday, November 27) and in any individual company or anecdotal reports on the strength of post-Thanksgiving sales. Although there has been a tendency toward holiday shopping being concentrated in the last few days before Christmas in recent years, “Black Friday,” the day after Thanksgiving, was still the single biggest shopping day of the year in 2003. Several Fed officials will be making remarks in the coming week ahead of the “quiet period” before the December 14 meeting begins, and the Fed will also release the Beige Book prepared for that meeting on Wednesday. Other data releases due out include GDP, consumer confidence, and Chicago PMI Tuesday, personal income, ISM, construction spending, and auto sales Wednesday, factory orders Thursday, and nonmanufacturing ISM Friday: * We expect Q3 GDP growth to be revised up to +3.9% from the initial print of +3.7%, with positive adjustments to consumption, net exports, and equipment investment more than offsetting downward revisions to inventories and construction. Final sales are expected to be adjusted up from +4.2% to +4.7%. * We expect the Conference Board’s consumer confidence reading to rise to 96.0 in November. The weekly ABC index and the University of Michigan survey conducted during early November pointed to an improvement in sentiment. We look for about a three-point gain in the Conference Board index. Indeed, confidence appears to be unwinding the pre-election dip even though energy prices remain elevated. With the latest spot market quotes pointing to some relief at the gas pump, sentiment should continue to drift higher. * We forecast a 1.0% gain in October personal income and a 0.6% gain in spending. Uninsured losses related to the hurricanes have depressed income over the past couple of months. A return to more normal conditions is likely to lead to a sharp bounceback in income growth during October. However, it’s worth noting that even excluding the hurricane distortions, income appears likely to post a solid gain of +0.6%. On the spending side, a surge in retail control should more than offset a modest pullback in motor vehicle buying — although admittedly, much of the gain in nominal spending will be wiped out by a gasoline price-related jump of about 0.4% in the PCE chain-weight price index (with the core showing a tamer increase of 0.2%, in line with the CPI). At this point, we see consumer spending rising about 3% in Q4. * We expect the November ISM to dip to 56.0. The regional surveys that have been released to this point imply a slight deceleration in the pace of growth in the manufacturing sector. In particular, it appears that a return to more normal (i.e., post-hurricane) conditions has led to fewer transportation delays, implying some pullback in the vendor delivery component. Also, inventories appear to be moving lower — which could be interpreted as a positive sign, but is treated as a subtraction in the ISM methodology. * We look for an 0.8% gain in October construction spending. The labor market report showed a further rise in hours worked within the construction sector. Moreover, housing starts were quite strong in October, and surveys of homebuilders point to a very high level of optimism. So, we look for a solid bounceback in construction activity in October. Rebuilding activity in the wake of the hurricanes should provide a boost in coming months. * The latest surveys point to some slippage in motor vehicle sales in November on the heels of the strong September and October results. We look for the November sales rate to fall to a five-month low of 16.3 million units, somewhat below the year-to-date average of 16.7 million. Recently introduced financing schemes aimed at locking in low rates for future purchases appear to have had limited success. Still, with inventories continuing to run above desired levels, the push to unload 2004 model year vehicles should remain intense in the months ahead. * We expect October factory orders to rise 0.2%. The 0.4% dip in durable goods orders should be offset by a rebound in the nondurables component, leading to a slight gain in overall orders. Nondurable goods orders fell 1.0% in September, likely partly a result of hurricane disruptions. The I/S ratio should tick down to 1.24. * We look for a 190,000 increase in November nonfarm payrolls. In our view, most of the above-trend employment gain seen in October represented a catch-up for prior months. We look for payroll employment growth to revert in November to a pace a bit stronger than the year-to-date average of +200,000 — after adjusting for an expected modest decline in workers who temporarily aided in the post-hurricane cleanup. Unemployment claims have begun to show a gradual move lower of late, and weather conditions appear to have been relatively favorable across much of the nation during the survey week. The unemployment rate is expected to retrace the slight uptick seen in November, and we look for the long-awaited climb in the average workweek to start to unfold this month.