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Standard & Poor?s Downgrade Outlook on US Sovereign Debt ? Initial Reflections
by Asha Bangalore of Northern Trust,
S&Ps changed in its outlook on US debt to negative but reaffirmed the AAA rating of the nation's debt. Todays market response to this action includes equity prices viewing this in negative light. The markets response is not entirely consistent with a downgrading of sovereign debt because the decline in rating implies that the financial situation of the federal government is less secure and there are doubts creeping in about the federal governments ability to meet its debt obligations. If this was the case, the dollar should have declined and Treasury security yields should have risen.
Why the Doves of the FOMC Have an Advantage at the April FOMC Meeting
by Asha Bangalore of Northern Trust,
There are differences of opinion among members of the FOMC that have emerged in speeches of several Fed officials in recent weeks. A line is being drawn between those who favor the Fed's current accommodative monetary policy and those who are supportive of policy actions to curb demand and contain future inflationary pressures. Based on evidence present here, the doves appear to have a strong advantage at the April 26-27 FOMC meeting to stay the course and complete the $600 billion asset purchase and watch the evolution of economic conditions.
One Man?s Fiscal Austerity is Another?s Prosperity?
by Paul Kasriel of Northern Trust,
Fiscal austerity is the rage in the developed economies. The proponents of fiscal austerity argue that it will lead to economic prosperity. The opponents of fiscal austerity argue that it will lead to poverty. If the government decides to spend less, then, it will need less funding. This, in turn, implies that the government will either cut back on its current taxation or cut back on its current borrowing. The former recipients of the cut-back government expenditures will indeed experience a decline in their spendable funds. However, taxpayers will find themselves with extra spendable funds.
Near-term Outlook For A Troubled World
Although 2011 is only three months old, the world has changed dramatically. Along with the evolving European debt crisis, seemingly -isolated Tunisian protests grew to varying levels of upheaval throughout the Arab world, and an historic earthquake and subsequent tsunami have left Japan?s outlook under a cloud of uncertainty. Each of these situations is significant in its scope and magnitude, but by focusing on just the key elements, the main risks can be appreciated.
To QE or Not to QE? That is the Question
Historically, % changes in MFI credit "explain" a large proportion changes in nominal GDP. Commercial bank credit accounts for the largest component of private MFI credit. Since the FOMC commenced its second round of easing in early November 2010, the increase in Federal Reserve and commercial bank credit has been dominated by the increases in Federal Reserve credit. If the FOMC terminates its easing policy in June and private MFI credit creation does not pick up, total MFI credit growth will slow. All else the same, this would augur poorly for nominal GDP growth in the second half of 2011.
Key Market Trends between QE1 and QE2
by Asha Bangalore of Northern Trust,
QE1 provided support to the U.S. economy and revived economic activity. In the months before QE2 was put in place, a turnaround of the U.S. economy from a severe recession was a vote of confidence which lifted equity prices. If economic reports in the months ahead plant seeds of doubt about the durability of economic growth, equity prices are most likely to post declines and a drop in interest rates is possible, irrespective of whether QE2 has expired.
Fisher Could Dissent if Oil Prices Maintain Upward Trend
by Asha Bangalore of Northern Trust,
Dallas Fed President Fisher indicated yesterday that he would vote to scale back/discontinue the Fed's Treasury securities buying program of $600 billion at the March 15 FOMC meeting. Last week, Chairman Bernanke indicated that only under conditions of sustained growth, expanding payrolls, and inflation readings that are consistent with price stability would the Fed consider terminating the program. Economic data indicate that the Fed is not close to meeting these. In his opinion, the Fed's job "is done" and continued purchases of Treasuries may result in raising inflation expectations
Equity Markets and Oil Prices
by Asha Bangalore of Northern Trust,
The turmoil in the Middle East and North Africa has led to higher oil prices. Brent crude oil was trading at $116.99 ($113.07 on 3/1/2011) as of this writing and West Texas Crude was quoted at $101.68 ($99.63 on 3/1/2011). The Libyan crisis has raised oil prices significantly in the last three trading days. The crisis in the region commenced the day after a Tunisian man set fire to himself on January 21, 2011.
Musings on Proposed Government Spending Cuts and Current Energy Price Increases
by Paul Kasriel of Northern Trust,
Just as labor is an important input in the production of goods and services, so is energy(E). An increase in the price of E reflects a relative shortage of E from what was the case. Just as the price of labor can increase from an increase in demand or a decrease in supply, so, too, can the price of E. Assume that before an increase in the price of E, the economy was set to go from 3% growth to 4% growth. Assume that the increase in the price of E has resulted from an increase in the demand for E. At the higher price of E due to demand, the economy will not be able to rise from 3% to 4%.
Don?t Know Much about Geography, Don?t Know Much Trigonometry, But Sarah Palin Does Know Her ...
by Paul Kasriel of Northern Trust,
On November 8, 2010, Sarah Palin commented that the Fed?s quantitative easing monetary policy was tantamount to printing money out of thin air. Sarah Palin may not know much about geography, but she does know her Fed policy. I would phrase quantitative easing a little differently. It is the Federal Reserve creating a specific amount of credit figuratively out of thin air. Theoretically, the Federal Reserve can create an unlimited amount of credit out of thin air. Of course, there would be dire economic consequences if the Fed were to create an unlimited amount of credit out of thin air.
Changing Perception of the Economy - Food for Thought
by Asha Bangalore of Northern Trust,
The bond market essentially signals the U.S. economy is turning around and is most likely to establish sustained growth in 2011. A part of the bullish sentiment commenced after Bernanke's speech in the last week of August 2010 when the Fed signaled that a second round of support was on its way. Inflation expectations have moved up (see Chart 3) from lows in the summer of 2010. But, they are yet to surpass the levels seen prior to the onset of the crisis. Actual inflation measures also do not represent a threat.
January Employment Report ? Pace of Job Growth Inadequate for Fed to Change Current Stance
by Asha Bangalore of Northern Trust,
The number of jobs created since the recovery commenced in June 2009 is troubling and raises the level of concern for policymakers. The level of employment, irrespective of how it is measured, is still significantly below the prior peak even after 19 months of economic growth. Job creation is proceeding in the desirable direction but at a tepid pace such that it is does not offer sufficient justification for the Fed to end the $600 billion purchase of Treasury securities (also known as QE2) before the planned expiration date of June 2011.
U.S. Real GDP vs. Potential GDP ? Time to Assess this Yardstick
by Asha Bangalore of Northern Trust,
The U.S. economy has registered six quarters of economic growth, inclusive of the projected increase in real GDP during the fourth quarter of 2010. There is enormous room for growth before inflation becomes a concern. The recovery phase ended in 2010 and expansionary phase of the current business cycle should commence in 2011. Cognizant of this information, markets will evaluate the performance of the economy in a different light going forward.
The 2011 Economic Outlook ? Credit Given Where Credit Is Due
by Paul Kasriel of Northern Trust,
With regard to 2011 real GDP growth, we now expect Q4/Q4 growth of 3.3% vs. 3.0%. An upward revision of 2011 Q4/Q4 real consumption growth to 2.9% from 2.5% in November is the primary factor accounting for the upward revision to the real GDP growth forecast. We are more optimistic about 2011 real GDP growth primarily because QE2 implies that the Fed will be purchasing all of the additional Treasury debt issued in conjunction with the Obama-McConnell tax and unemployment insurance compromise. We currently see more upside risk to our 2011 real GDP growth forecast than downside risk.
Deciphering Debt
2011 is likely to raise more issues about debt, with periodic market panics about debt sustainability and bailouts. We offer this primer on the issue of debt ? specifically the various measures and the roles they play in determining a country?s risk of facing some form of debt-related crisis. Metrics to assess indebtedness of nations are classified as solvency and liquidity measures. Each are discussed, as is the special topic of the banking sector and its relation to public debt. We give our view of global public-debt-related challenges in 2011.
Treasury Market's Perception of Recovery Path is Strongly Bullish, But Mind the Hurdles
by Asha Bangalore of Northern Trust,
The 10-year Treasury note yield has climbed from a recent low of 2.41% (October 6-8, 2010) to 3.27% as of this writing. The 86 bps increase in yield in a short span reflects the market's assessment of likely improvements in economic conditions during the months ahead and the impact of a projected increase in supply of Treasury debt as a result of the compromise tax deal President Obama announced yesterday.
Corporations, Give Thanks - With 'Enemies' Like This, Who Needs Friends?
by Paul Kasriel of Northern Trust,
On November 23, the Bureau of Economic Analysis updated its analysis of U.S. corporate profits. After-tax corporate profits from current operations hit their highest level, $1.221 trillion, since the beginning of this data series, 1947:Q1. Paul Kasriel gives further analysis.
Commodity Prices: What is Likely Impact in the United States?
by Asha Bangalore of Northern Trust,
The S&P GSCI commodity index has moved up 11.3% from a year ago on November 19, 2010 (see Chart 1). The trade weighted dollar declined 1.2% from a year ago as of November 12, 2010. The immediate inference is that the extent of gains in the commodity price index is larger than the decline of the dollar. By implication, commodity price gains reflect more than the depreciation of the greenback.
Is Inflation Lurking Around the Corner?
by Asha Bangalore of Northern Trust,
An inflationary threat is not lurking and nor are the current readings of inflation at levels the Fed needs to fret about in the near term. The Fed has traditional tools (raise reserve requirements, raise the federal funds rate or undertake open market sales of securities) and a new instrument, raising the rate paid on excess reserves. The probability of delayed action to address rising prices is small and will occur only if unemployment continues at an unacceptably high level. Inflation hawks cannot support their contention that QE2 is tinder for future inflation.
I Wonder What Milton Friedman and Karl Drunner Would Say About Allan Meltzer
by Paul Kasriel of Northern Trust,
On November 9, I wrote a commentary entitled ''Quantitative Easing in the mid 1930s Appeared to be Successful''. In my commentary, I did not mention what happened to the U.S. unemployment rate as a variation on quantitative easing was taking place. So, let?s do this now.
I Am Shocked, Shocked that the QE2 is Akin to Printing Money and Public Debt Monetization!
by Paul Kasriel of Northern Trust,
Whenever the sum of Federal Reserve and commercial banking system credit increases, credit is being created out of thin air and debt is being monetized. The magnitude of the credit creation being contemplated by the Fed is not extraordinary in an historical context. It is not an extraordinary increase in credit creation given the current amount of resource underutilization in the U.S. economy. Being shocked by the implications of QE2 with respect to ?printing money? and the ?monetization of debt? would appear to be either nave or hypocritical.
They Just Don't Get It
by Paul Kasriel of Northern Trust,
Had the Fed said that QE2 would involve the purchase of $600 billion of Treasury bills rather than Treasury coupon securities, we could have avoided this phase of uninformed criticism of the policy. Of course, the chorus of critics would have complained that by the Fed purchasing bills rather than coupons it was not affecting the ?important? part of the yield curve.
The Quantitative Easing in the mid 1930s Appeared to have been Successful
by Paul Kasriel of Northern Trust,
There is much skepticism as to whether the Fed?s second round of quantitative easing, QE2, will be effective in stimulating the nominal demand for goods and services in the U.S. economy. Keying off Mark Twain?s aphorism that although history may not repeat, it often rhymes, perhaps we can get some guidance as to whether QE2 will be successful from the results of the quantitative easing that was initiated in the second half of 1933.
QE2 Is Likely to Be More Successful than QE1
by Paul Kasriel of Northern Trust,
The theory behind quantitative easing is that an increase in the quantity of combined central and commercial bank credit will lead to an increase in nominal aggregate spending on goods, services and assets. Indeed, the correlation coefficient between percentage changes in the annual average of combined Federal Reserve and commercial banking system credit and the percentage changes in nominal U.S. GDP from 1960 through 2006 is relatively high, at 0.62. This correlation coefficient is reduced to 0.49, however, when the period is extended through 2009. Northern Trust explains why.
A Refresher Before Fed's Announcement of Second Round of Quantitative Easing
by Asha Bangalore of Northern Trust,
The Federal Reserve is widely expected to announce the second round of quantitative easing after the Federal Open Market Committee meeting on November 4. The goal of QE2 will be to bring about an increase in real GDP above the tepid 2.0 percent pace reported for the third quarter, as well as bring down the 9.6 percent unemployment rate. The reputation of the Bernanke Fed largely rests on the success of this new policy. Northern Trust present charts of Treasury bond yields since 2007, with markers for major monetary policy events.
Employment is Main Focus of Fed Policy
by Asha Bangalore of Northern Trust,
The Fed is widely expected to announce the details of the second round of quantitative easing following its two-day meeting ending November 3. Advocates of QE2 expect lower interest rates to lift all interest-sensitive expenditures, including home purchases, mortgage refinances and business expenditures. In addition, bankers could be more likely to lend given paltry earnings from excess reserves and Treasury securities. Finally, the benefit of increased exports from a depreciation of the dollar may reflect in headline GDP.
The Effectiveness of QE2 Depends on Quantities, Not Interest Rates or Exchange Rates
by Paul Kasriel of Northern Trust,
The level of U.S Treasury security interest rates or the level of the U.S. dollar foreign-exchange rate are not the correct way to think about the prospective effectiveness of QE2. What transpires with respect to commercial bank credit will determine the effectiveness of QE2 in increasing aggregate demand for U.S. goods and services.
The Real Economic Cost of Government Is Spending - So, What Do You Want to Cut?
by Paul Kasriel of Northern Trust,
Because the private sector generally uses productive resources more efficiently than the government does due to competitive pressures, the economy's long-run potential real economic growth rate is hurt by increases in federal spending. The largest projected increase in spending by an order of magnitude over the next decade is for entitlement programs - Social Security, Medicare and Medicaid. Millions of baby boomers will become eligible for Social Security and Medicare benefits over the next 10 years. Northern Trust also discusses home sales, employment and leading economic indicators.
Ten Questions: USA vs. Japan
The combination of lackluster growth and disinflation in the U.S. has led to comparisons with Japan's dire experience following the collapse of asset prices in the 1990s. A frequent question is whether Japan's 'lost decade' will play out in the United States. The Q&A included in this commentary identifies similarities and differences between the experiences of the two countries, with an emphasis on the recovery path. It appears that the U.S. is unlikely to mimic the economic path of Japan in the 1990s.
Michael Boskin?s Summer of Economic History Amnesia
by Paul Kasriel of Northern Trust,
Michael Boskin, former chairman of the President?s Council of Economic Advisers under George H.W. Bush, argues in a recent editorial for the Wall Street Journal that the current economic recovery is so feeble because of economic policies pursued by the current presidential administration. There is another reason for the relative weakness in the first year of this current recovery, however: the unprecedented contraction in nominal and real bank credit in the post-WWII era.
I Renounce Monetarism (with apologies to Mr. Lippman of Pendant Publishing)
by Paul Kasriel of Northern Trust,
Monetarists such as Milton Friedman hold that the M2 money supply is a leading indicator of aggregate demand. Indeed, from 1960 through 1989, the price-adjusted M2 money supply had a relatively high correlation with real aggregate demand for goods and services. As charts presented in this commentary illustrate, however, from 1990 through the second quarter of 2010 the correlation between real M2 and real final sales of domestic product deteriorated dramatically.
Nitty Gritty Details of the Labor Market Make Headlines
by Asha Bangalore of Northern Trust,
The elevated 9.5 percent official unemployment rate and the broader 16.5 percent jobless rate highlight the dire status of the labor market even after four quarters of economic growth. Financial markets have yet to follow closely the report on job openings, however, which contains information each month about the total number of job openings, the pace of hiring and separations in the economy. Harvard economics professor Robert Barro discusses the implications of the job openings report in a recent article for the Wall Street Journal.
Why Hasn't the Stimulus Been More Stimulative?
by Paul Kasriel of Northern Trust,
The $790 billion stimulus package was supposed to put the economy firmly on a trajectory toward recovery. As one Obama administration economic advisor has said, however, the economy is still having trouble reaching 'escape velocity.' This is because fiscal policy must be accompanied by bank financing in order to stimulate aggregate demand. Otherwise, fiscal policy just reallocates total aggregate demand toward government spending and away from private spending. Policymakers should therefore concentrate more on invigorating bank credit if they want faster economic growth.
'Federal Debt and the Risk of a Fiscal Crisis' - Important Takeaway
by Asha Bangalore of Northern Trust,
U.S. government debt held has reached a level not seen since World War II. There will be consequences to this elevated level of public debt. In addition to the well-known outcomes of higher interest rates and the crowding out of private investment, at the extreme, high debt levels could trigger a sovereign debt crisis similar to the recent situation in Europe. Northern Trust presents charts of federal debt as a percentage of GDP, with projections extending to 2020.
Bank Credit ? One Month Does Not Make a Trend, But...
by Paul Kasriel of Northern Trust,
U.S. commercial bank total credit increased at an annualized rate of 8.3 percent in July. If this is the beginning of an upward trend in bank credit, then we can feel a lot more confident about the prospects of rising real GDP growth rates in 2011. Subsequently, if bank credit continues to grow on a sustained basis and aggregate demand growth starts to pick up in the first half of 2011, then the Fed would be expected to begin raising policy interest rates around mid-year.
The Fed Has Not Run Out of Options, As Yet
by Asha Bangalore of Northern Trust,
The worst of the financial crisis is history, but the U.S. economy is still struggling to establish self-sustained economic growth. There is an ongoing debate among economists and policy advisors as to what is the best course -- fiscal austerity or stimulus -- to restore financial and economic tranquility. Discussions about the Fed's options in the event of further weakening of economic conditions in a deflationary environment have also surfaced.
Deflation and Credit Crunch ? Possible Themes for Chairman Bernanke?s Testimony
by Asha Bangalore of Northern Trust,
Federal Reserve chairman Ben Bernanke is scheduled for his semi-annual testimony about the economy at the Senate Banking Committee on Wednesday, July 21. The U.S. economy is in the throes of an economic recovery but the risk of deflation has entered the picture. As of now financial accommodation from the Fed has resulted in excess reserves in the banking system and is not being converted to loans. The chairman's thoughts about the severe credit contraction should be the most important topic of the testimony, in addition to deflation.
Potholes in the Recovery Road ? Reduce Speed Ahead
by Paul Kasriel of Northern Trust,
The second-half GDP growth forecast has been lowered to 1.8 percent and Q4/Q4 GDP growth in 2011 will be 3.2 percent. This is a business cycle unlike any other in the post-war era. In prior cycles, as the Fed raised the funds rate, growth in bank credit slowed. In the current environment, even with the Fed holding the funds rate at less than 25 basis points, bank credit continues to contract. Thus, we are going to utter the six most dangerous words in economic forecasting: This time it might be different.
Time For a Proactive Approach to Replace Lament of 'Anti-business Stance'
by Asha Bangalore of Northern Trust,
A recent Washington Post article cites members of the Business Roundtable who claim that new financial regulations and health care legislation are creating an 'anti-business' environment. This allegation, however, is superficial. Irrespective of the political party in power, new financial regulation should have been anticipated following the global financial crisis. And health care legislation of some sort would have been part of the Congressional agenda in the near term, anyway, given projected health care costs in the medium and long term.
When It Comes to Increasing Aggregate Demand, What?s Fiscal Policy Without Monetary Policy?
by Paul Kasriel of Northern Trust,
In order for an increase in government spending to result in an increase in total aggregate demand, the government's spending needs to be financed by the central bank and the commercial banking systems. Although the Fed and the banking system have helped fiscal policy to stimulate total aggregate demand through a cumulative increase in Treasury borrowing of $1,455 billion, the help was not all that spectacular. No wonder the results of the recent fiscal stimulus program were something less than awe-inspiring with regard to increasing aggregate demand.
Recipe for a Lost Decade, or Two
by Paul Kasriel of Northern Trust,
There are legitimate concerns that the U.S. could catch the 'Japanese' disease and endure a lost decade in terms of normal economic growth. As has been the case in Japan, weak U.S. money and bank credit growth is occurring in the context of very low monetary policy interest rates. The private financial system is not transforming the inexpensive credit being offered it by the Fed into credit for the private nonfinancial sector of the U.S. economy. Until this transmission mechanism between the Fed and the economy gets mended, we are unlikely to experience potential economic growth.
Navigating Fears of the Bond Market
by James Pressler of Northern Trust,
The need to keep the bond market happy while implementing often far-reaching fiscal reforms is most acute across Europe, where the outlook is for weak real GDP growth into 2011 ? albeit with significant variations between countries. Conversely, the recoveries in Asia and in the Americas have effectively eliminated fears of sovereign defaults but now concerns over economic overheating will dominate. The U.S will eventually have to address its own public debt overhang, but for now is enjoying a temporary safe-haven status.
Airplane Musings - Part Deux
by Paul Kasriel of Northern Trust,
Although U.S. federal government spending continues to increase, the rate of growth in that spending has slowed enormously. In the 12 months ended May 2010, accumulated spending by the federal government totaled $3.437 trillion, just 2.6 percent higher than the 12-month accumulated total federal spending for May 2009. This is quite a deceleration in growth from the 15.3 percent registered for the 12 months ended 2009 vs. 2008, near the trough of the last recession.
An Evaluation of the Threat of Near-Term Inflation
by Asha Bangalore of Northern Trust,
There is plenty of room for the economy to grow before the Fed slams the monetary policy brakes. Inflation expectations have moved down to 195 basis points as of June 11, from a high of 245 basis points at market close on April 29. Meanwhile, the money supply is barely growing. The ballooning of the Fed's balance sheet has not translated into rising inflation expectations. And final retail sales grew only 1.4 percent in the first quarter.
"Missing Elements" of Mr. Laffer's Incomplete Story
by Asha Bangalore of Northern Trust,
Supply-side economist Arthur Laffer recounts his experience with the Reagan administration to illustrate his arguments about the positive impact of tax cuts on economic growth with in a piece for the June 7 Wall Street Journal. Laffer predicts dire economic consequences if the Bush tax cuts are allowed to expire at the close of 2010. If Laffer's thesis is correct, however, then why, for example, did the economy post noticeable growth after the tax increases of 1993? And why did the U.S. economy undergo such a weak period of economic expansion following the Bush tax cuts of 2001 and 2003?
All We Are Sayin' Is Give Free Markets A Chance
by Paul Kasriel of Northern Trust,
Before we can determine whether or notfree markets have failed, we must actually have free markets. Central banks currently create or destroy credit by by holding a key short-term interest rate below or above the unobservable free-market equilibrium. The Securities & Exchange Commission determines which credit rating agencies receive official 'approval.' Lastly, without their debt being implicitly guaranteed by the federal government, Fannie and Freddie would not have been able to have consistently fund themselves at interest rates below other financial institutions.
Gold: Early 1930s vs. Early 2010s
by Paul Kasriel of Northern Trust,
Some argue that gold will outperform general stocks in the early 2010s, as it did in the 1930s. If this is true, then it will be for entirely different reasons. Investors currently gravitate toward gold as a hedge against future inflation, or because of a loss of faith in the fiat currency. U.S. gold mining stocks were strong performers in the 1930s, by contrast, because the U.S. Treasury was guaranteeing gold miners a steady or rising price as production costs were falling.
Greece, Portugal and Spain Are the Least of Our Economic/Financial Challenges
The debt problems that Greece, Portugal and Spain are currently facing have undoubtedly had a negative effect on global financial markets, and will probably have some negative effect on global economic activity. Problems with these countries, however, will not derail the global economic recovery that is currently underway. The biggest threat to the continuation of the global economic recovery would be some policy mistake by the Chinese economic policymakers resulting in a rapid deflation of the Chinese real estate bubble, which, in turn, would reduce Chinese real GDP growth.
Financial Regulation - The New Landscape
by Asha Bangalore of Northern Trust,
The Senate passed a new financial reform bill on May 20, while the House passed its own version in December. The next step is a reconciliation of the two bills, which should be ready for the president's signature by July 4th. The bills contain elements that will affect consumer protection, systemic risk, ?too big to fail,? derivatives, bank regulation, the Federal Reserve, credit rating agencies and securitization, and represent the biggest overhaul of financial regulation since the 1930s.
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