Friday, September 24, 2004

Weekly macro review 

I did a short presentation to a local civic group this week on the local economy. The title of my section of the new St. Cloud Area Quarterly Business Report (which should be up some time next week) is "Two Steps Forward, a Pause, and then ..."

The more I see of the early fall figures, the less I know about what happens after the ellipsis.

If you want to find bad news, it's not hard to acquire. One could start with the Index of Leading Economic Indicators, which fell for the third straight month. Existing home sales is backing off a bit, which I guess is bad, but with mortgage rates diving below 5.9% for 30-year fixeds, I think there should be some strength their going out. New housing starts look good. Local people I'm talking to in commercial real estate said their summers were OK but not great, but they expect to do better.

Most worrisome to most of us is the flattening of the yield curve, which is often a signal of economic weakness ahead. A 42 basis point drop in the spread between 3-month and 10-year Treasuries is a big red flag as the flattening yield curve kicked in 0.13% of the 0.3% drop in leading economic indicators last month.

There's of course oil, where dwindling inventories thanks to Ivan are pushing up prices around town to near $1.90 from $1.75 about ten days ago. Steve thinks this won't matter much, and as long as people think the increase is temporary as it appears to be, I agree. Nonetheless, there's room for worry.

Neither is good news hard to find. Today we got the durable goods data, which came in largely positive. The Washington Post plays it negatively looking at new orders, but this is after a healthy rise in July and is solid when you remove the volatility from airplane orders. The shipment and unfilled data look pretty good. Yesterday's Chicago Fed National Activity Index number for August indicates that we're set for an above average quarter.

I'm a relative optimist compared to many on the near-term GDP forecast, and today Morgan Stanley upped their forecast for third-quarter GDP to 4.2%, which is exactly where my own was three weeks ago. I think that when that number comes out, two things will happen: First, long interest rates go back up. People are thinking the economy is softening and that the run of interest rate hikes from the Fed won't last. Don't believe them. The Fed has decided its policy is to not surprise anyone, and you aren't hearing anything from them to indicate a pause just yet. I lightened today, for the second time this year, my savings plan's contribution to my bond fund. (Where did it go? Index fund. I'm mostly out of the stockpicking business.) I do think they'll pull up in early 2005 at about 2.5% to see what comes next. Elections will do that to you. The increase in long rates won't mean much outside the housing market, which is probably on the last leg of a good run. (I'll regret this sentence, perhaps, but I'll more regret not buying housing stocks in early '04 when I could see they were going so well. You know what they say about bulls, bears and pigs?)

The other thing likely to happen is on the trade deficit. At some point the continued weakness of the dollar versus the euro and thereby the yuan has to come into play; it's worth remembering how strong imports were in the second quarter. If my interest rate guess is right (and some disagree) I think money turns around and starts pushing the dollar back up. That will make it quite likely that the trade deficit stays over $500 billion through 2005. This in turn will keep GDP growth in 2005 below 4%.

That's not a call for a recession, at least not yet. But sniffing the wind more frequently is advised, in case my optimism needs more tempering.