November 15, 2009 – “Liquidity Everywhere, Credit Still Tight”
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Liquidity Everywhere, Credit Still Tight
The reality is that the Fed is very concerned about the deflationary consequences of a commercial real estate bust. On Tuesday, the Fed was quite vocal about this coast-to-coast. Janet Yellen, head of the San Francisco Federal Reserve Bank, in a speech: “The Outlook for the Economy and Real Estate” said “commercial real estate (CRE) will continue weighing down the recovery going forward.” Yellen characterized CRE prospects as “worrisome.” Since their peak, “values have plunged an estimated 35 to 40%, and vacancy rates are rising for office, retail, warehouse, and other income-producing properties. As I indicated, credit market conditions are weighing heavily on this sector. Risk premiums on commercial real estate financing remain elevated. ….Banks and thrifts, which account for more than half of commercial real estate financing, have significantly raised rates and tightened credit terms. That, combined with higher investor demands for returns and weakening operating income points to further downward pressure on property values. … The CRE problem is serious for parts of the banking industry…exposure is more concentrated in smaller banks….there could be an impact resulting from small banks’ impaired ability to support the small business sector – a sector I expect will be critically important to job creation.”
Yellen is also worried about deflation. “I believe that the more significant threat to price stability over the next several years stems from enormous slack in the economy that is pushing inflation lower.”
Also on November 10th, Atlanta Fed President, Dennis Lockhart gave a similar speech: “Economic Recovery, Small Business, and the Challenge of Commercial Real Estate.” Lockhart’ points were similar to Yellen’, but he was “particularly concerned about the interaction among bank lending, small business employment, and CRE values.”
On November 9th, the Fed revealed its October 2009 Senior Loan Officer Opinion Survey on Bank Lending Practices. “In the October survey, domestic banks indicated they continued to tighten standards and terms over the past three months on all major types of loans to businesses and households. However, the net percentages of banks that tightened standards and terms for most loan categories continued to decline from the peaks reached late last year,” per the Fed.
On the positive side, last week’s data saw a lower (better) jobless claims level than market expectations. Also, the import price index in October rose less than consensus expectations in October.
On the negative side, our September trade deficit widened more than expected. The import rise was driven by energy demand (volume) and prices. Since reaching their trough in April, exports have increased 5 months in a row, at better than a 24% annual rate over the 5 month period. Imports, however, have jumped at nearly a 33% annual rate over the same period, reflecting not only U.S. demand, but also inflation and the deteriorating dollar.
Friday’s preliminary November reading of the Reuters/University of Michigan Index of Consumer Sentiment showed a decline to 66.0 from 70.6 in October. While we had forecast a decline in November to 69.5, the consensus had forecast a rise in November to 71.0. Consumer assessments of current conditions and expectations both faltered.
Taken together, the weakness in commercial real estate, the drop in consumer sentiment, and the federal budget deficit, in the first month of the fiscal year, surging to $176.36 billion, combines to leave Chairman Bernanke in a most difficult situation. He is pursuing a reflationary stance, a strategy of avoiding a deflationary depression at all costs.
He has continued to extend the Federal Reserve’s posture of lending to money center banks at essentially a 0% interest rate. This means no end in sight to the monetary largesse of flooding the system with cheap dollars. Most countries seem to embrace the need for massive liquidity. The “dead banks walking” get zero cost money, make major sums of money from going out on the yield curve, and only grudgingly provide more credit. They hide toxic assets, have enormous exposure to bad consumer loans, mortgage defaults, and a commercial real estate time bomb. There is a seeming lack of sanity in the current practice of fiscal policy that troubles us greatly. It could lead to higher long-term interest rates..
The Fed’s easy money stance is matched by a fiscal house that is totally out of control. This is supposed to be the policy prescription for avoiding a deflationary depression. If it works, and that’s a big IF, the consequences seem to be the creation of more bubbles, an escalation of inflation in another year or so, and then a giant wringing out process. Could it be these intermediate and longer term risks that have caused India to buy 200 metric tons of gold from the IMF?
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Economic Indicators in the Week Ahead
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Monday, Nov. 16 8:30a.m. NY Fed Nov. Empire Mfg. Index
We look for the NY Fed Empire Manufacturing index to slip to 28.0 in November, from October’s level of 34.6, the highest in 5 years. Economic conditions are fragile and subdued, hence the pullback from October. Market consensus expectations see a November reading of 29.0
Monday, November 16 8:30a.m. October Retail Sales
We anticipate a gain in headline retail sales of 0.8% in October, following the 1.5% fall in September, which was driven by the expiration of the “Cash for Clunkers program at the end of August. Excluding auto sales, which could jump 4% from the weak September level, retail sales would only rise 0.3%. Market consensus expectations believe headline retail sales rose 0.9% in October, with retail sales ex-autos up 0.4%.
Monday, Nov. 16 10:00a.m. Sept. Business Inventories
In our estimation, September business inventories were pared 0.6%, the 14th consecutive month of inventory liquidation. Market consensus expectations see a 0.5% reduction in business inventories in September.
Tuesday, November 17 8:30a.m. October Producer Prices
We see a 0.6% rise in the headline finished goods PPI in October, driven by rising food and energy prices. The market consensus sees a 0.5% increase. The core PPI, ex food and energy, likely edged 0.1% higher. The key takeaways in our forecast are that the finished goods headline PPI is, in our judgment, still deflating 1.6% y/y in October, while the core PPI slows in October to a 1.4% y/y increase.
Tuesday, Nov. 17 9:15a.m. Oct. Industrial Product. & C.U.
Industrial production (IP) was likely up 0.8% in October. If we are correct, the market consensus will be very surprised on the upside, as the consensus call sees only a 0.4% increase in IP in October. Capacity Utilization (CU) likely rose from 70.5% in September to 71.4% in October. The consensus sees a rise to only 70.8%.
Tuesday, Nov. 17 1:00p.m. Nov. NAHB Housing Survey
The NAHB/Wells Fargo measure likely rose to 20 or even higher from 18 in October. A reading of 20 is still pessimistic. Affordability has improved with lower prices and lower mortgage rates, but homebuilders are still squeezed by an average of 12 months to sell a completed new home. Legislation extending the first-time home buyer tax credit and beginning a tax credit for current home owners to buy a new or an existing home will, we believe, significantly boost prospective buyer traffic and sales expectations. The consensus sees the NAHB survey at 19. We see a reading of 20, or even higher.
Wednesday, Nov. 18 8:30a.m. October Consumer Prices
We expect the headline consumer price index (CPI) to rise 0.3% in October,
faster than the 0.2% gain seen by the consensus. We agree with the consensus expectation of a 0.1% rise in the October core PPI m/m. The October CPI will likely still show deflation of 0.3% y/y. The October core CPI should show an increase of 1.6% y/y.
Wednesday, Nov. 18 8:30a.m. Oct. Housing Starts & Bldg.
Permits We feel housing starts in October rose 1.1% to 610,000 annualized. The consensus expectation has a milder gain from 590K in September to 599K in October. Building permits likely jumped to 610,000 annualized, a rise of 1.2% over September. The consensus expectations are more muted, having permits edge higher from 575K annualized in September to 580K in October. If we’re correct, the market will be surprised on the upside by the increases in starts and permits in October.
Thursday, Nov. 19 8:30a.m. Weekly Jobless Claims
Initial claims, by our estimation, broke below the 500,000 level, reaching 495,000 in the week ending November 14th. The consensus call is 502K, unchanged from the prior week.
Thursday, Nov. 19 10:00a.m. Oct. Leading Economic
Indicators (LEI) We project the October LEI advanced 0.5%, the 6th successive monthly increase. This gain is stronger than the consensus expectation of a 0.4% rise. Our estimate places the y/y gain in the LEI at 4.5%, the strongest since February 2005.
Thursday Nov. 19 10:00a.m. Nov. Phila. Fed Mfg. Index
The Philly Fed manufacturing index likely rose from 11.5 in October to 13.0 in November. The consensus sees a rise to 12.0. Keep in mind the 13.0 November call would surprise the consensus on the upside.
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Jack W. Lavery
CEO & Chief Economist of Lavery Consulting Group, Senior Executive Fellow in Financial Economics at the University of Maine