So, out of the four segments of the NBER business cycle, we have two that have been negative for two months (sales and employment), and two that have slowed to stall-speed (+0.1%), which are production and organic incomes. This is not normal. And, it is hardly normal to have the Fed shave its economic forecast twice in six weeks, at a time of the cycle when normally the economy is growing well above trend and still feeding off the prior doses of government stimulus. As Atlanta Fed Lockhart said recently, there is no “sustainability” to private final demand. Indeed, when the government moves to stimulate the private sector, that is what is typical in a recession; but when the government has to sustain the private sector, that is really characteristic of a depression. This is a modern-day depression and if you want to see what it looks like, go see the picture of the masses lining up for housing vouchers on page A3 of the weekend WSJ (Crowds Chase Scarce Housing Vouchers) — it looks just like the soup lines you see in those photographs from the 1930s.
Moreover, not only did the Fed cut its forecast, but so did the Bank of England, as well as the OPEC oil cartel (and the IEA). Germany’s ripping Q2 GDP growth rate was a nice surprise, but likely to be followed by a much softer trend and the amount of fiscal tightening that is destined to take place across Europe in the coming year or two is going to put the economies there under wraps. If you didn’t catch this on Friday, sovereign yield spreads on the continent of Europe are starting to widen out again and the euro now seems set to falter from its three-month highs.
On the China file, we now have a situation that bears watching as its economy slows along with the U.S. — the latter of course is seeing the softer tone to the data as the midterm elections approach. So, it is with interest and a dose of trepidation that we see China begin to intervene in the FX market to reverse the earlier appreciation of the yuan just as the U.S. trade deficit balloons and makes the headline GDP data look even worse for the White House not to mention Congressional incumbents — and the fact that China just printed its highest bilateral surplus on record (for June) at $28 billion. China could really care less about the U.S. elections and is probably more focused on what the recent drought-related surge in global food prices is going to mean in terms of inflation and possible social unrest — not exactly a time to sanction currency strength. So, it would seem logical to assume that trade frictions with China will heat up as summer moves into fall and the election draws closer (and one reason to maintain exposures to gold).
Of course, as we said above, maybe this is a single scoop and not a double dip — the recession never ended and the bounce in GDP off last year’s lows was merely noise along a downward trend. Is a reflexive rebound, a brief response to tremendous stimulus, really the end of the prior down-cycle? Or is it part of a continuum — all of this from the mild start to the recession in early 2008, to the temporary stabilization of the Bush tax rebates in early 2008, to the steep decline in late 2008, to the detonation of early 2009 and then the mild recovery phase of the second of last year to the first quarter of 2010, to the sudden slowing in the second quarter and what appears to be stagnation this quarter and likely contraction next quarter not all part of the same cycle? We don’t envy how the NBER ultimately deals with this, but then again, maybe it is only an academic exercise. The reality is that the equity market and other risk assets believed the recession ended through much of last year and went on to price in a sustainable and vigorous recovery as everything peaked out in early spring, and the history books cannot be re-written. Right or wrong, the markets priced in something really good even if we never did buy into the “sustainability” story. It was akin to the premature 50% rally off the interim lows in the opening months of 1930 — the huge rally that nobody seems to recall. Already, the memory of the 80% dead-cat bounce this time around is starting to fade.
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