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Another Round Of QE Is Inevitable
For the past several months we were one of the few to predict economic weakness as the effects from the warmest winter in 65 years, which was skewing the underlying data, came to end. We have been consistently reporting on this very issue from retail sales, inflation, exports, small business, international trade, ISM, manufacturing, and durable goods. Today’s economic data dump further confirms our premise that the economy is weakening much faster than the mainstream media and most economists currently estimate and that the U.S. economy will not be able to withstand the drag from a recessionary Eurozone economy indefinitely.
The 4-week moving average of claims continues to rise in recent weeks as employment is showing signs of stagnation. In our report yesterday on the Job Opening and Labor Turnover survey we showed that the 4-month average of hires less job openings has now fallen to levels that are consistent with past peaks in employment. Today’s report on initial claims missed expectations of 383,000 by showing 387,000 new claims. It is also the highest 4-week average since December. A very important data point in today’s release was the number of individuals who are collecting extended claims which declined by 42,000. The number of individuals that are without financial assistance and no longer counted as part of the labor pool continues to grow. So, while the BLS continues to report a decline in the unemployment rate, which many have now caught onto the fact that it is complete fiction, the drag on the economy continues to grow.
Philadelphia Federal Reserve Manufacturing Survey
Econoday summed it up nicely this morning: “The alarm you hear is the Philly Fed’s monthly report where contraction is gripping the Mid-Atlantic manufacturing sector this month. The general business conditions index shows contraction for a second month and, at a minus 16.6 level, much more severe contraction than May’s minus 5.8, a reading that in itself was a shock.” The report showed that nearly 40 percent of the firms surveyed reported declines in activity this month which almost doubled the 22 percent previously. Indexes for new orders and shipments showed notable declines, falling 18 and 20 points, respectively. Indexes for current unfilled orders and delivery times both registered negative readings for a second month in a row suggesting lower levels of unfilled orders and faster deliveries. The declines in new orders and backlogs are a negative for future employment and while firms reported steady employment this month they cut hours which is the first step before terminating employment. The report, in its entirety, was not good.
While it was a shock to most economists who were expecting an improvement from last month’s negative reading – the reality is that the trends in many of the major manufacturing surveys have been on the decline for the last few months. As we have stated repeatedly in the past – it is the “trend” of the numbers that is more important than just the current report. For the Philly Fed report the 6-month average, as shown in the chart, has now begun to trend down towards the zero line which has been indicative of recessionary economic pressures in the past.
The issues with the Philly Fed are not isolated. Manufacturing has been showing weakness in many of the regional indexes as of late, and while not signaling an immediate recessionary event in the economy, there is clear deterioration. Our composite economic indicator which combines the CFNAI, several of the major regional Fed indexes, ISM and the NFIB has been showing deterioration over the last couple of months confirming the drawdown in the report from the Philly Fed today. Over the next couple of months we suspect that the weight of evidence will show up in our composite index that the economy is indeed not strong enough to sustain the drag from the Eurozone recession.
Leading Economic Indicators
The leading economic indicators showed a small uptick 0.3 percent in today’s release. Strength in the latest month was in building permits (+0.21 percent contribution), the Treasury/fed funds spread (+0.18 percent contribution), and in the ISM new orders index (+0.10 percent contribution). The key negatives were the factory workweek (-0.13 percentage contribution) and stock prices (-0.13 percentage contribution).
While the leading indicators are still holding ground on a monthly basis the immediate conclusion is that everything is fine. However, when stepping back to view the longer term trend, using a year-over-year growth rate and comparing it to the market and the economy, we begin to get a much different picture. While the monthly LEI has shown very subtle increases – the rate of growth has declined noticeably in recent months which is currently coinciding with a weaker stock market performance.
The same is true when the LEI is compared to the economy. As you can see there is a very high correlation between the annual growth rate of the LEI and Real GDP. Currently GDP has been sustaining a rise over the last couple of quarters on the back of the unseasonably warm winter weather, Fed and ECB interventions and a restart of manufacturing post the Japanese earthquake. Since then those temporary influences have now run their course. It is very likely that future reports on GDP will begin to show weakness as predicted by the current growth rate of the LEI.
This analysis is further confirmed by the Coincident to Lagging indicator which has slipped to levels that are normally associated with economic recessions.
The weight of evidence is mounting that the economy is slowing. While the economy will not slide off the cliff into a recession today – the trend is clearly negative.
As the replay of the summer of 2011 continues to play out before us – the potential for a July-August swoon lurks just ahead. As the Eurozone crisis continues to loom both unresolved and without any plan of action, combined with a weakening economic environment in the U.S. and mounting deflationary pressures, it is only a function of time before Bernanke launches further stimulative action. I was recently quoted in USA Today: “Without the Fed doing something, the economy will slip into recession.” That is very much the case today. For Bernanke another round of QE is inevitable – however, in order to justify a further balance sheet expansion program at this juncture it will require a weaker market and economy. That justification will likely come sooner rather than later.