While the markets anticipate more aggressive cuts in target Fed funds rates soon, the central bank’s task is complicated considerably by rising inflationary pressures. A Wall Street Journal story says that remarks Fed officials show worry that monetary policy may become too expansive:
Federal Reserve officials are acknowledging increasing weakness in the economy, signaling a willingness to cut rates again at their next meeting. But inflation concerns are rising among some officials, indicating the magnitude of their next move may be a matter of contention….
Some officials…. expect growth to rebound in the second half, and they are wary of cutting rates so low now that they would spur higher inflation as the economy recovers. Monetary policy works with a lag, so interest-rate cuts tend to boost the economy six months to a year after they are implemented.
Oddly, there is no mention of the possibility of stagflation.
Another oversight is the omission of the most concrete sign of inflation concerns: the lousy results at the latest Treasury bond auction. The 30 year bond sale Thursday did badly. Investors are crowding to the short end of the yield curve at the expense of current income, rather than risk principal losses at the long end. As the blog Across the Curve said,
Prices of Treasury coupon securities plummeted in a tumultuos trading session which was reminiscent of trading in the 1980s. The outstanding 30 year bond traded early in the day with a 111 handle and trades now late in the day with a 107 handle. That’s the way stocks trade! As I wrote earlier the Treasury conducted a 30 year bond auction and the results were less than festive. Trading since that time has been volatile and the issue continues in a downward (price) spiral…..
On the day yields have backed up rather dramatcally and the yield curve continues to steepen. The fickle benchmark 2 year note ended its sub 2.00 percent flirtation and is back at 2.03 percent as its yield increased by 11 basis points today. The 5 year yield increased by 16 basis points as did the yield on the 10 year note. The issues yield 2.81 percent and 3.76 percent, respectively. The bete noir for the day, the 30 year bond, suffered ignominy and misfortune as its yield soared by 18 basis points to 4.53 percent.
The yield curve as measured by the 2 year/10 year spread hit another record wide for the cycle at 173 basis points. That is 33 basis points wider than where it was before the Fed ease a little over a week ago.
Yet as inflation indicators are flashing red, so too are recession warnings. In “Credit Card Spree May Be Ending,” the Journal reported another sign of economic weakness, a sharp fall in consumer credit in December, in tandem with rising credit card defaults:
Credit-card delinquencies are rising across the nation, a sign that some Americans are at the end of their rope financially. And these mounting delinquencies, in turn, have prompted banks to tighten lending standards, keeping people who have maxed out their cards from finding new sources of credit….
Such a pullback may already be taking shape. Yesterday, the Federal Reserve reported an abrupt slowdown in consumers’ credit-card borrowings. In December, Americans had $944 billion in total revolving debt, most of it on credit cards, a seasonally adjusted annualized increase of 2.7%….
Evidence is mounting that the plastic-fueled spending spree won’t last. In December, an average of 7.6% of credit-card loans were either at least 60 days delinquent or had gone into default, up from 6.4% a year earlier, according to research firm RiskMetrics Group…..
Yesterday, card issuer Discover Financial Services said 49% of consumers it surveyed in January plan to reduce their discretionary spending this month. That was an increase of five percentage points from its December survey and a 10-point jump since September.
It goes without saying that consumer retrenchment is a negative for growth. Further confirmation comes from another Journal story on poor retail sales in January:
A dismal January at the mall offered the latest sign that the U.S. economy is in or near a recession — and is already sending ripples that reach well beyond the retailers to commercial-property landlords, construction companies and container ports.
Retailers turned in their worst monthly sales results in nearly five years, and big chains appeared to be girding themselves for a prolonged slowdown in consumer spending by announcing plans to close hundreds of stores and cut thousands of jobs.
Even gift-card redemptions, which were expected to give January sales figures a bigger lift, instead offered a glimpse at just how strapped consumers are. Wal-Mart Stores Inc. yesterday noted that redemptions were below its expections, and said consumers were holding onto the cards longer — or using them to buy groceries rather than treats like electronics.
As a result, a Bloomberg reports that the consensus view among economists is that the odds of a US recession have risen to 50%.
The Fed Funds market shows uncertainty as to what the central bank’s next move might be, although there is no doubt that more cuts are in order. Note that traders see a 100 basis point cut as a reasonable possibility, which would presumably come about as the result of another intermediate cut. Once you give the markets what they want, they only ask for more.
From the Cleveland Fed:
The $54 Trillion Budget Bomb
Consider the past four years. The federal budget deficits on a cash basis for 2004, 2005, 2006 and 2007 were reported as $412 billion, $319 billion, $248 billion and $163 billion, respectively. Prepared on an accrual basis, however, which is the way all U.S. public companies report, the deficits for these same years were $616 billion, $760 billion, $450 billion and $276 billion.
More worrisome, while the trend is quite good, the deficits would have been substantially greater if revenue from taxes had not increased more than 46% from $1.8 trillion in 2003 to $2.63 trillion in 2007, more than an average of $200 billion per year.
Substantial negative cash flow can be acceptable if it is offset by a strong balance sheet. Here the news is quite sobering. The U.S. has $1.6 trillion in assets and $10.8 trillion in liabilities, resulting in a negative net worth of $9.2 trillion as of the end of its Sept. 30, 2007, fiscal year. Of those liabilities, $5.1 trillion is owed to the public. Another $4.8 trillion is owed for federal employees and veteran benefits. The killer item, however, is $45 trillion in off-balance-sheet debt, which is the present value of future benefits owed for Medicare and Social Security.
As Citigroup (nyse: C – news – people ), Merrill Lynch (nyse: MER – news – people ), UBS (nyse: UBS – news – people ), HSBC (nyse: HBC – news – people ) and others recently discovered with their structured investment vehicles, these liabilities should be treated as real balance sheet liabilities. For the U.S., that would mean a net debt of $54 trillion, a figure 3.9 times our revenues, if we consider our $14 trillion economy as our figure for “sales.”
If home prices decline 20% over the next several years, a reasonable scenario, then American households will see a $4.2 trillion loss in their net worth and have significant difficulty adjusting to this decline.