October Retail Sales Rise Slightly. Recession Coming?
The Commerce Department Report nets out as good news
By blackhedd Posted in Economy — Comments (12) / Email this page » / Leave a comment »
Retail sales (what consumers spend in the grocery, at Wal-Mart, on Amazon, and elsewhere) increased by 0.2% in October, according to the Commerce Department. This number is in line with analyst expectations, and it reflects an outlook for the American economy that is slightly better than expected.
Market reaction is likely to be positive overall. The dollar is stronger against the yen and holding at low levels against the euro this morning. Let's pick apart a few of the details.
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The question in everyone's mind is: will we have a recession?
Most analysts expect that the reduced value of people's homes (after the collapse of the real-estate bubble) will cause them to spend more cautiously. In other words, they're expecting a recession led by lower demand.
I've never quite bought this theory, and I'm not too surprised by the government's non-disastrous readings from October (retail sales ok, job growth better than expected, consumer sentiment lower but not terribly so, commodity prices moderating).
If anything, we're likely to get muted consumer activity because mortgage refinancings have dropped to near zero. This is not normal in a time of declining interest rates (the 10-year US Treasury note is now trading to yield around 4.30%). But even people with sterling credit are finding that the refinancing window has slammed shut due to risk aversion by traditional lenders. (The non-traditional lenders that fueled the bubble are essentially out of the business.)
My concern about business growth comes from the supply side. I've been very worried that global investors will dial down their risk tolerance in the wake of this year's disorders in the financial system (which are closely related to, but different from, the collapse in US housing values). That would lead to reduced credit formation and, some time later, reduced business activity.
If I'm right about that, then you would expect to see sharp inflation as we come out of whatever economic softness we experience in the next few months, and quite likely a quick reversal of the Federal Reserve's monetary easing. That in turn would create a big-time dollar rally, all else equal.
What wouldn't be equal? Economic conditions in Europe, which now look to be slowing rather sharply. Europe's economies are considerably more export-driven than ours is. If this trend holds up, it will mute the pressure for the euro to appreciate against the dollar.
The role of oil prices is very, very interesting. Oil is now about 10% down from its intraday peak over $98 a barrel, reached last week. Gold is also down below $800 an ounce. I stand by my theory, expressed in several RS posts, that the commodity strength was a technical reaction to lower US interest rates rather than market fundamentals.
One confirmation of that, is that prices for downstream products (gasoline and distillates) have not spiked nearly as much as crude prices. That may be signalling a slowdown in demand in response to the higher crude price. The next few weeks will tell us, so watch prices for gasoline and heating oil.
Additionally, if the economic stats continue to show resilience, the pressure will come off the Federal Reserve to reduce interest rates again when it meets in December. If the markets decide that the Fed will stop cutting rates, expect a dollar rally.
As has been the typical pattern in recent years (since the Federal Reserve more or less got its act together), any recession we experience will be short and shallow, and will probably be over before it even shows up in the stats.
Keep this in mind next summer when Hillary Clinton is screaming that we need a big dose of higher taxes and new Federal spending to improve economic conditions that she will characterize as worse than the Great Depression.
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October Retail Sales Rise Slightly. Recession Coming? 12 Comments (0 topical, 12 editorial, 0 hidden) Post a comment »
The "reduced home value leads to reduced consumer spending" notion: The home is a generally very un-liquid asset. So, how does the notion that a large portion of the populace borrows against their home for everyday spending work? I would assume that leveraging the value of the home is used for big ticket items or home improvement.
Is it that the borrowing against the home leads to an increase in secondary spending by those who receive such funds?
Or are there just a lot of people out there who have to regularly borrow against their home to pay off revolving debt?
PS: Has there been a discussion here about the bankruptcy reforms influence upon the housing market?
...to fund consumption. This can take several forms, including second mortgages and home-equity lines of credit.
For this to be true, you basically have to assume that the economy is in a state of pervasive and continuous inflation. That would make it rational to borrow rather than save.
Instead, I believe the reverse is true. The US economy is, if anything, closer to a state of disinflation than inflation. (The cause of that is globalization.)
If I'm right, then the "reverse wealth effect" will not significantly damp consumer spending. And since practically no one can refinance his mortgage now, there's no channel for home-equity extraction either.
And the thing to keep a close eye on is inflation in China. They've chosen to suffer massive inflation in order to disinflate our economy. I can't give you odds, but there's a non-zero likelihood that the strategy will backfire and tear China apart.
I can't really vouch for this, but I'm hearing that vegetables, cooking oil and pork are all costing about half again as much as they did a year ago.
And the government is cutting the taxes they charge on savings deposits in a vain attempt to keep that money out of the Shanghai stock market.
If there is a market crash in Shanghai, I wouldn't be surprised if something worse than Tiananmen happens.
Over the last week, foreigners have sharply marked down the "red-chip" shares of Chinese companies that trade in Hong Kong. And I mean sharply, like by tens of percent.
... the housing crunch will last. I would think that banks would have to loosen up their restrictions eventually.
I build houses on the side and currently have one that has been on the market since about the time the crunch started and it hasn't gotten much action. So i am very concerned about the housing market.
Would you say that the sub-prime mortgage business was fueled by low interest rates and once those rates went up, the people with those mortgages were the ones hardest hit? If that is the case, wouldn't the lower interest rates relieve that situation?
During the Depression, they clammed up early and stayed that way basically until after the 1937 recession. Steepening the yield curve, as the Fed's rate cuts have done, gives bankers an opportunity to earn not-bad returns on a much lower risk profile.
I don't think the subprime mortgage business was fueled by low rates.
I think low rates (around the world, by the way, not just here) combined with technological innovations in mortgage risk-analysis to lure huge amounts of money into the market from nontraditional (basically, non-bank and non-Fannie) lenders. This oversupply caused mortgage prices to fall dramatically, which was a good thing as long as it made home ownership possible for more people.
But in retrospect, the retail channel wasn't able to absorb the oversupply, and credit problems resulted. Thus the bubble and the crash.
The only people left in the mortgage business now are the ones who have been there all along. And they're at least as unwilling to lend now as ever before. Probably more so.
Lower rates are clearly not unfreezing the mortgage market.
There was an article in the WSJ last month (can't find the link right now), the jist of which was that real estate speculation was the leading cause of subprime defaults in many states. It seems that the combination of the long rise in real estate values and an almost unbridled availability of credit combined to bring every day people into real estate investing. When real estate values suddenly started to decline in some markets, many of these 'flippers' got caught holding property they could never pay for. Many of these people went into this game with near perfect credit and good income (not the low-income, bad credit borrowers typically associated with the term sub-prime) but relaxed documentation rules allowed them to play beyond their means. From what I read and those I know, these are everyday people, the shoe shine boys of our day.
In addition to making money directly in real estate, new mortgage-backed securities gave financial investors a way to participate in the growth. Subprime mortgages traded closer supervision for higher interest rates, fees, closing costs, and thus higher rates of return. The higher rates of return created a surplus of investment and created better and better deals in mortgages. That created more demand and a spiral. Irrational exhuberance has taken on a more rational flavor and what spirals up, spirals down.
I personally think it will take three to four years to work through the foreclosures, the unloading of undesirable property, and the bankruptcies. It will take five to ten years for the direct investors to restore their credit, limiting everything they do in that time. And, this spiral up created wealth and economic activity that is now gone. I have yet to find numbers to determine how much this will drag down the economy.
The direct connections between the housing fall and credit cards are second mortgages and HELOCs. The other parallel is the "subpriming" in the credit card market. Rules have been relaxed as fees have been increased and new investment instruments were created to bring fund credit card debt. I've read that investors are shying away from those investments now, too. The result, less credit to be had.
I don't have the numbers to back this up but I can't see how we can avoid a slow down given the decrease in credit formation. Economic expansion will suffer. How much, how fast, and for how long are the questions to be answered.
Oddly, low interest rates won't unfreeze the markets. Without subprimes and serial refi's, the rates of return overall are too low for financial investors. Subprimes and serial refi's only work with rising prices. Raising rates improves the outlook for financial investors but limits qualified borrowers. More money available, less people to use it. It's going to be a long slow slog.
We have become a credit-based, consumer-driven economy. If credit contracts, the economy will contract.
These are my thoughts only. I'm not a economic professional, though I enjoy it when I'm not busy shining shoes.
The subprime mortgage business was fueled with the same stuff that fueled the prime mortgages... housing inflation.
The "subprime crash" is a function of two things. First subs were typically written as two year fixed rates and then they adjust. The assumption was that the borrower would get his credit issues fixed in those two years, his house would appreciate 15-20% (or more) and he would refi into a conventional "A" paper loan. The housing bubble burst and the appreciation is not there. Very high LTV loans are difficult to get if your credit is challenged at all. When an ARM adjusts, your first adjustment is typically 2% which amounts to $377 per $100K of mortgage - a $300K mortgage raises your payment almost $1200 and most borrowers don't have an additional $1200 to toss at their mortgage.
What isn't talked about is the coming "prime crunch". We have billions in prime ARMS coming due now through next year. Guess what? No appreciation on those homes either. Same 2% bump when the ARM begins to adjust. Same $377 per $100K increase to your payment. Bottom line, same problem with prime ARMS as with subprimes.
Lower interest rates won't make any difference to these loans, either prime or subprime, because the issue isn't really rate, it's the value of the house and that will take a couple of years to sort out.
It's gonna be a rough ride for a while.
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CongressCritter™: Never have so few felt like they were owed so much by so many for so little.
As I understand the theory.... The effect is more a psychological effect than anything having to do with actual cash available. In fact on a previous thread the proponents of the wealth effect claimed that actual refinancings and second mortgages DON'T cause this effect, it's just the perception that matters.
In theory, a person who's home value is increasing will spend more and save less just because they perceive that they are wealthier even without extracting that increased value. The reverse wealth effect assumes that people will now feel poorer and therefor spend less money for the same reason. There doesn't seem to be much evidence of this happening yet.
Now I'm not a big believer in the imaginary wealth effect, but I can believe that availability of cash out refinancing and second mortgages can effect consumer spending. I just don't think that cash out refinancing was a large portion of our economy.
Socialism doesn't work. It looks nice on paper, but it's been tried and it's failed miserably every time (usually accompanied by widespread death and suffering).
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I'm with Fred!
What we've seen (I'm a mortgage banker) over the last several years is three basic things...
1. People view their primary residence as part of their investment portfolio. In many cases (if not most) it's the bulk of their investment portfolio. This relates to the "imaginary wealth effect" that is referred to by BrianH and it's very real. The biggest problem with it is that we've been conditioned to assume that double digit housing inflation would continue forever and that bigger houses will appreciate faster, and that we don't need to use any of "our" money to move in. Nasty set-up.
2. As equity became available in people's homes they would typically do one of two things, and neither was "nothing". The first was to buy expensive toys. Home improvement was generally pretty far down the list, at least here in the West where more homes fall into the "newer" category and don't really need much in the way of "improvement". Boats, ATV's, motorcycles of the higher end variety, really nice vacations, accounts for kids college funds (actually, no). Those were typically done with a home equity credit line.
3. Paying off credit cards. Purchases made that included low cost items that ran credit card balances into mid and high five figures were typically paid off with either a HELOC or a new first mortgage if there was enough equity there to avoid mortgage insurance.
Today, we've got bunches of people sitting with loans they can no longer refinance because the value of their home as dropped below their current mortgage balances. They've also got high credit card balances - or will after this Christmas.
The housing market will be about where it is for at least another two years if the Congress doesn't get involved in either bailing out people or increasing oversight and regulation on the mortgage industry. If they do either of those two things, you can expect a ten year dump in the housing industry.
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CongressCritter™: Never have so few felt like they were owed so much by so many for so little.
I think we could be looking at a recession that in stature is somewhere between 1982 and 1991. The housing/credit situation will cause some major slack in consumer spending and the arm resets that take off next year will really compound consumer problems. There is lovely data out there on home equity extractions (calculated risk has some good charts) that show consumers were in fact using home equity like an extra checking account, that is now overdrawn. Gas/oil prices will of course come down if the economy slows, but my guess is that they are already impacting spending (or will after Christmas) on the lower half of the population and that they will not come down as far as we would like even in a recession due to global demand and a general lack of refining capacity.
That is the ideal scenario if all works well. If not, we're in trouble--I am routing for you blackhedd.