Friday's GDP and revisions indicate that the economy was deeper than originally believed and the recovery more modest than originally expected. Why anyone was surprised be this is beyond me. Employment data has been consistent with a lackluster recover. Yes it is true that employment is a lagging indicator, but knowing where you have been helps you determine where you are going. It appears as though we have been through a deeper recession than anyone (anyone other than Americans actually suffering through the poor economic conditions believed.
I have been active in Scouting since 1978. Several Scout camps I have had the pleasure of visiting has a "weather rock". A weather rock is an impressive weather analysis tool. It works like this:
If rock is wet, it is raining.
If rock is white, it is snowing.
If rock is shaking, there is an earthquake.
If rock is dry, the weather is fair.
If rock is swinging, it's windy.
If rock is warm, the sun is out.
If rock is not visible, it's dark outside.
If rock is under water, there is a flood.
If rock is gone, there is a tornado (Run!!)
There are times I wish economists, analysts, strategists and market participants would include weather rock principles in their analysis. Most of the aforementioned professionals do not live in areas which were hard hit by the deep recession. Yes, many of them and their friends and neighbors have seen the values of their homes and investments drop, but few of them are concerned about putting food on their tables, paying their mortgages or finding jobs. However, many Americans are experiencing such hardships.
What appears to be escaping those predicting a sharp V-shaped recovery is that the economy immediately preceding the recession was way over stimulated. This wasn't a case where a fundamentally strong economy became a little overheated. This was a modestly hot economy that was fueled into a conflagration by very low rates and very easy borrowing terms. Consumers became overextended beyond any measure of common sense. The Fed and Wall Street reaped the wind with low rates, creative securitization and easy lending standards. Now they are reaping the whirlwind.
I agree with the majority opinion that the U.S. economy is not likely to fall into a double-dip recession, but I believe that that U.S. consumption is closer to sustainable levels than most would like to admit or believe. Experts continue to be perplexed why strong profits are not resulting in job growth (which is needed to push the economy higher). The answer is that there is no advantage in adding any workers which are not absolutely needed. It is much easier to spend on productivity increases, such as new equipment and software. This was born out in last week's durable goods numbers and by the Fed's Beige Book report.
This has put the government in a tight spot. New tax policies and heath care laws make it disadvantageous to hire workers. The Fed can only do what it can do and is already pushing on a string. Banks are more than happy to lend if it is to borrowers with solid credit scores, preferably via GSE-qualifying mortgages which can be easily securitized.
Face it folks, this is the recovery. Truthfully it has been a kind of V. The problem is that the left side of the V was 10 feet tall, but the right side is 5 feet tall. How do we get the right side to 10 feet? I don't believe we can, at least not any time soon and certainly not based on fundamentals.
This brings to interest rates. There has been renewed interest among investors into floating rate and interest rate adjustable bonds. Not as hedges mind you, but as ways to score big when interest rates and inflation explode higher. I have one question to ask: What in God's name are you thinking? I agree that rates cannot stay down here or trend much lower, but a move higher is likely to be limited. The cost of insuring against inflation and as measured by the low current rates of return versus similar fixed rate securities is prohibitively high. It is like insuring your house against flood damage when living on a tall hill. Sure flood waters may reach you after a bad storm, but the odds of that happening it makes little sense to purchase flood insurance (assuming you could qualify in the first place).
Bank of America announced that it dropped its CD rates in response to lower interest rates across the board. Other banks are likely to follow suit. The carry trade (borrowing on the short end of the yield curve and lending (in this case to the government by purchasing treasuries) on the long end of the curve) has been among the most profitable activities for banks. The bond market and the Fed have been warning us for some time that the economy is in for a slow recovery. Ignore them at your own peril.
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