September 29, 2004
Second Quarter GDP Growth: Better Than We Thought
The Bureau of Economic Analysis announced today that second quarter real GDP growth has been revised upward to 3.3 percent (annualized), from the previous estimate of 2.8 percent. Why the change? We'll let the BEA do the talking:
The upward revision to the percent change in real GDP primarily reflected a downward revision to imports and upward revisions to private inventory investment and to exports.
The gory details can be found here.
Consumers Become Less Confident (Again)
The Conference Board’s Consumer Confidence Index declined again in September, the second consecutive monthly dip.
That from the horse's mouth. Wariness about the jobs picture seems to be the culprit.
Those saying business conditions are “good” edged up to 23.6 percent from 23.0 percent. Those claiming conditions are “bad” remained flat at 20.3 percent, compared to 20.2 percent last month. The job situation was less favorable than in August. Consumers saying jobs are “plentiful” declined to 16.8 percent from 18.4 percent. Those claiming jobs are “hard to get” rose to 28.3 percent from 26.0 percent in August.
Looking forward, average opinions haven't changed much, but expectations appear to have become a bit more disperse:
Those anticipating conditions to worsen in the next six months increased to 9.4 percent from 8.8 percent. But those expecting business conditions to improve increased to 21.4 percent from 20.2 percent last month....
Consumers expecting fewer jobs increased to 16.1 percent from 15.1 percent, while those anticipating more jobs to become available rose to 17.7 percent from 16.3 percent.
September 27, 2004
Are House Prices Bubbly?
John Krainer and Chishen Wei of the San Francisco Fed discuss housing prices in the latest FRBSF Economic Letter:
The finance paradigm holds that an asset has a fundamental value that equals the sum of its future payoffs, each discounted back to the present by investors using rates that reflect their preferences. For stocks, the payoffs requiring discounting are the expected dividends. This approach can extend to housing by recognizing that a house yields a dividend in the form of the roof over the head of the occupant. The fundamental value of a house is the present value of the future housing service flows that it provides to the marginal buyer. In a well-functioning market, the value of the housing service flow should be approximated by the rental value of the house.
In other words, valuation in the housing market can be usefully characterized in terms of price-rent ratios:
Although the price-rent ratio is high by historical standards, Krainer and Wei don't see no stinking bubbles (except maybe here and there).
... almost all of the movement in the aggregate U.S. price-rent ratio was accounted for by two factors—the proxy for future growth in rents and the proxy for future returns. Put another way, other factors, such as bubbles, do not appear to be empirically important for explaining the behavior of the aggregate price-rent ratio. At the same time, when applied to local real estate markets, in many cases the movement in the price-rent ratio predicted by the model is much greater than the actual movement; specifically, the results indicate that something other than our measures of future rent growth and returns explains price-rent ratios.
If, however, you are convinced that house-price/rent ratios must fall, the authors suggest you think in terms of prices, and not rents.
The price-rent ratio for the U.S. and many regional markets is now much higher than its historical average value. We used a model from the finance literature to describe how the price-rent ratio can move over time. We found that most of the variance in the price-rent ratio is due to changes in future returns and not to changes in rents. This is relevant because it suggests the likely future path of the ratio. If the ratio is to return to its average level, it will probably do so through slower house price appreciation.
Where Is Neutral? A Little Help From The WaPo
Yesterday, the online version of The Washington Post had this short article offering several helpful definitions of the so-called neutral federal funds rate. Here's the text, in its entirety:
• The level at which the Federal Reserve's federal funds rate, the overnight rate charged between banks, neither stimulates nor slows economic growth.
• A rate that varies depending on economic conditions.
• A number that several Fed officials have recently pegged at between 3 percent and 5 percent.
• The subject of intense speculation as traders, investors and analysts guess how far the Fed will go in raising the rate over the next year or so.
• "A moving target," according to Fed Bank of Cleveland President Sandra Pianalto.
• A number that Fed Chairman Alan Greenspan has declined to specify, saying, "When we arrive at neutral, we will know it."
Actually, Sandy (my boss) had a little more to say on the subject. Here's an excerpt from a speech that I linked to in a previous post:
What do I mean by “neutral”? Well, in simple terms this means a federal funds rate that is no longer either accommodative or restraining. There is not one specific value for the federal funds rate that always equals a neutral policy stance. It’s a little like aiming at a moving target, and one that can seem a bit blurry at times.
The neutral range for the federal funds rate during the next several quarters and beyond will depend on how economic conditions unfold, but our experience suggests that during extended periods of reasonably sound and sustained economic performance, the neutral federal funds rate will almost certainly be above today’s level of 1.5 percent.
In fact, historical experience suggests that when our economy is operating soundly and when resources are at high levels of capacity utilization, the neutral range is likely to be 3 to 5 percent. Where does this estimate come from? Without going into the exact formula, the most important components in the equation are the rates of productivity growth and expected inflation. As either one of these factors moves up or down, so too will the neutral federal funds rate.
Chicago Fed: Not a Bad August
The Chicago Fed has released its National Activity Index for August. The index indicates that growth continued above-trend in August -- the index is constructed so that zero equals trend growth -- but weakened relative to July.
The Chicago Fed National Activity Index was +0.19 in August, down sharply from an upward revised +0.53 in July. The drop in the monthly index was due to smaller positive contributions from production-related data and, to a lesser extent, housing and consumption-related data. The employment-related category made a small negative contribution to the CFNAI in August for the third month in a row.
September 24, 2004
The World Economic Forecast From the OECD
Here's another take on the gloabl economy, this time from the OECD.
The momentum of the recovery projected in our Spring Economic Outlook has been only marginally dented by higher-than-assumed oil prices. By and large, the recovery continues to unfold as foreseen, with real GDP set to expand by around 3½ per cent in 2004 on a year-average basis in the six largest OECD economies as a group – somewhat weaker in the United States and somewhat stronger in the euro area and Japan than what had been projected in Spring. Rising energy prices have also exerted upward pressure on headline inflation but their pass-through into core inflation and wages is limited...
I'm not sure I want to endorse all the storytelling in the report, but it does have lots of cool pictures.
September 23, 2004
Why Did Long Bonds Rally -- Part II
Yesterday I posted a snippet from the Wall Street Journal offering the eminently sensible suggestion that the bond market rallied, despite the indication that more FOMC rate hikes are likely, because the Committee's statement drew a picture of a relatively benign inflationary landscape. Then this morning brought this analysis from a New York Times article:
... it appeared that the drop below 4 percent was less a result of economic fundamentals than of technical factors in the Treasury market. Those included hedging against losses from a potential new surge in home mortgage refinancing if the yield on the 10-year note, which has a major impact on mortgage rates, falls even further.
If there is another refinancing surge, mortgages held by investors would be paid off and replaced with mortgages at lower interest rates. To hedge against this loss, the managers of big mortgage portfolios buy Treasury securities or similar instruments. The prices of these securities will rise if rates fall further, offsetting some of the losses from taking on new, lower-rate mortgages. This buying to hedge, however, also sends overall rates lower.
One analyst said Treasury yields were also being pushed lower by investors who had bet that longer-term rates would rise when the Federal Reserve began raising its benchmark rate. To reduce the losses from this bet, investors have to buy Treasury securities.
"These things tend to feed on themselves, and you get these swings in the market that get exaggerated," said William Prophet, an interest rate strategist at UBS.
Because of these technical factors, rates could fall further for a while and go much lower than expected. Rates, however, could pick up again when the technical buying slows down.
Now my head hurts. I'm sticking with the WSJ analysis over the NYT. But then again, that's my default position on almost every topic.
Bush vs. Kerry on Fiscal Policy
Economy.com -- and its affiliated site "The Dismal Scientist" -- has some pretty useful stuff. Unfortunately, a lot of isn't free, but I've added a permanent link to it anyway. It's worth a quick look.
September 22, 2004
Why Did Long Bonds Rally...
... as a result of yesterday's FOMC policy announcement? This, from today's Wall Street Journal "Credit Markets" column (page C6), seems like a pretty reasonable explanation:
"The [Fed's] downgrading of inflation risk was bullish for longer-dated Treasurys," which are highly sensitive to the risk posed by inflation, said Richard Gilhooley, senior bond-market strategist at BNP Paribus.
At least I can't think of a better explanation. Let's see if it holds.
As Promised, A Market Post-Mortem
Subsequent to the FOMC announcement yesterday afternoon, options on federal funds futures were indicating that the implied probability of another 25 basis point increase in the federal funds rate at the November meeting rose to 78% (from 68% on Monday).
Interestingly enough, as these charts from CNNmoney indicate, yields on long-term bonds fell,
and equity markets liked what they saw
Of course, there will be a lot of news between now and November 10.