+ Sales of existing homes fell 2.2% to 5.89 million in December.
+ The Congressional Budget Office projected a $219 billion deficit for fiscal 2008. However, when the costs of Iraq (another $30 billion) and the stimulus package are added, the deficit will be near the 2004 record of $413 billion.
+ Washington has apparently agreed on a $150 billion package of tax cuts, centered on rebates paid back to taxpayers and investment tax breaks for businesses.
+ US initial jobless claims fell by 1,000 to 301,000 in the week ended January 19. Continuing claims dropped by 75,000 to 2.672 million in the week ended January 12. The insured unemployment rate ticked back down to 2.0%. The January drop could imply that labour markets are not as soft as December indicated, or could just suggest that since retailers didn't hire in December, they don't have to lay off in January.
+ Oil prices recovered to $90/bbl (West Texas) on Friday.
+ The 10-year Treasury yield rose to 3.65%, but remains well below the 4.25% reached in early December. The dollar held near $1.468/euro and 107.3 yen. Stock prices rose sharply on the Fed cut and the stimulus package.
+ The Fed cut the federal funds rate 75bp before the opening of trading on January 22, amid concerns about the declines in overseas markets Monday and Tuesday morning.
Is This A Recession?
The economic data continue to point downward, but not consistently and not drastically. Our interpretation is that we are at the beginning of a mild recession, which looks on the underlying fundamentals to be similar to the
1991-1992 downturn. The weakness in housing is spreading into commercial construction and business equipment spending. The signs of a consumer slowdown are less clear, but the evidence suggests consumers are being squeezed
by falling home prices and high gasoline costs.
The freeze in financial markets, however, is showing signs of easing. The Libor rate has dropped back down to 3.3%, below the 3.5% federal funds rate. Libor remains high relative to the three-month Treasury bill rate, with a
spread of 93bp, but that is half what it was three months ago. Moreover, much of the cause is that the T-bill rate is low relative to federal funds, as the flight to quality has cut government bond yields.
Quality spreads remain high, with speculative-grade corporate bonds trading 660bp above equivalent Treasuries. Again, this is in part due to the low Treasury yields, with the 10-year at 3.7%. But the cost of funds to
all but the highest-rated borrowers remains far above where it was the middle of last year.
Mortgage rates have dropped down to the lowest level since 2004, with the 30-year conventional rate at 5.7%. But this only applies if the borrower qualifies for a conventional loan. Jumbo mortgages, even for prime borrowers, are running one percentage point above conventional mortgages, compared with a normal spread of about 25bp. The stimulus package contains some help for the jumbo market.
Besides capital spending, the major offset to last year's housing weakness was the improvement in the trade deficit. With Europe and Japan showing weaker growth, exports are likely to slow in 2008. However, the dollar remains
weak, and we expect the deficit to continue to narrow ù just not by quite as much as in 2007.
Stimulating The Economy: The Fed
Both fiscal and monetary stimuli are being applied to the economy. The Federal Reserve unexpectedly cut the federal funds rate 75 bps Tuesday before trading opened after the Martin Luther King Jr. holiday to 3.5%. The wording in the statement suggests further rate cuts are imminent. At this time, we expect another rate cut this week followed by a March cut, bringing the federal funds rate down to 2.5%.
The problem with monetary policy is the lag. The emergency rate cut was a confession by the Fed that they are behind the curve and are trying to catch up. The timing surprised us; we had expected a 75bp cut at the meeting this week. The melt-down in world stock markets last Monday, which continued into Tuesday in Asia, convinced them to move quickly to short-circuit the collapse. The tactic appeared to work, as stock indexes recovered from overnight lows in the futures market and soared in the afternoon. (An interesting question is whether last Monday's collapse in stock prices was influenced by the unwinding of Societe Generale positions. Since we don't know exactly how big the underlying positions were, only the total loss, or what indexes they were concentrated in, it is impossible to determine how big a factor they might have been.)
But even with this earlier action, the impact on the real economy comes only after a lag of about nine months; in other words, what the Fed did this week will help the economy in October, after the recession will be over. The cuts
did help stop the stock market slide, and can make the recession shorter and shallower, but it is too late for monetary policy to prevent the recession.
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