As another leg down to the economy is starting to be telegraphed by even the official data set, particularly in unemployment, and housing, and with industrial production slowing down, Goldman is once again beating the QE 2 "non-lite" drums. As such, all eyes turn to this week's Jackson Hole Kansas City Fed Economic Symposium (the same Kansas City where the sole dissenter to the Fed's ZIRP "bubbles4eva" policy, Tom Hoenig, rules over rational thought with an iron fist, even as other Fed intellectual midgets scribble pre-paid papers describing how stable the economy of soon to be bankrupt countries is). As we pointed out in the days following Hatzius' reduction in GDP estimates, the Goldman strategist was hoping for a $1 trillion QE announcement. The Fed decided against it, and the market sold off. Which is why at this very public Fed venue (and last) before the September 21 FOMC meeting, many will be focused on Bernanke's speech to see if he will telegraph the purchases of even more securities, which as Hatzius highlighted before, could include more "exotic" credit, including private label MBS, munis and even corporates. As Sven Jari Stehn says, "it will be worth watching whether Fed Chairman Bernanke will comment in his opening remarks on the recent data disappointments and/or the ongoing debate on the appropriate stance of monetary policy." And nobody is more concerned than Angela Merkel - now that the EUR has finally started to dip once again to the delight of an insolvent Europe, Germany will do all it can to keep the USD on its upward trend, as the ECB would prove much harder to manipulate into another round of QE. Or maybe not - all it would take is for Greece to be declared bankrupt again. Which is why the next big geopolitical instability cycle may start off anew depending on the first few sentences uttered by Bernanke in the August 26-28 meeting. And finally something quite odd about this year's meeting - as Bloomberg's Scott Lanman points out, the head of the FRBNY's trading desk, better known as the PPT, Brian Sack, is not invited to this meeting for the first time. We will keep a close eye on this very peculiar regime change.
One thing is certain: the ever more clamorous disagreement between the uber-Hawk (Hoenig) and the uber-money printing advocate (Bullard) is about to reach new heights.
More from Goldman:
Industrial Activity Set to Slow…
On the face of it, the stronger-than-expected performance of industrial production in July was good news. Following a decline in June, overall production was up 1.0% on the month, with manufacturing rising 1.1%. Output of motor vehicles and parts—which rose 10%—made a sizable contribution to this increase. While GM’s decision to operate most of its plants during the usual shutdown period in July was partly responsible for this, our calculations suggest that the effect was small (worth around 0.1 percentage point). The key question is thus whether this welcome surprise in industrial production is sustainable.
This week’s manufacturing surveys suggest not. The Philadelphia Fed’s headline index fell sharply into negative territory in August, and indexes for both new orders and shipments declined from already low levels. While the headline Empire index rose slightly in August, new orders and shipments also fell sharply into the red. The new orders components thus point to substantial slowing in industrial activity going forward. In this vein we expect a roughly flat reading for next week’s durable goods orders ex transportation.
The one positive aspect of these manufacturing surveys was that the inventory indexes fell. This suggests that the moderation in activity is not just driven by slow demand but by efforts to control inventory accumulation. Consistent with this, actual inventory data in June—including manufacturing, wholesale and retail—have consistently fallen short of expectations. (Together with a larger-than-expected trade deficit, these underlie our forecast for a revision of second-quarter GDP growth to 1.1%.)
…While Initial Claims Hit a New 2010 High…
Meanwhile, Thursday’s claims for jobless benefits underscored the dire state of the labor market. Initial claims rose to 500,000 in the week of August 14—a level not seen since November 2009. Furthermore, the total number of people receiving jobless benefits—including those on extended/ emergency programs—rose back above 10 million, not far from its all-time high of 10.7 million set earlier in the year. Although special factors such as the discharge of temporary Census workers or the renewal of the lapsed extended/emergency programs may have contributed to the run-up in initial filings, we do not think these distortions fully explain the increase in recent weeks, as discussed in yesterday’s Daily Comment. If they do, then claims should revert quickly to lower levels in coming weeks, as both distortions fade. Thus, the next couple of reports will be particularly important.
…And Housing Continues To Languish
This week’s housing data were not much better. Although housing starts in July rose in line with the median expectation (+1.7%, mom), the report was disappointing in that its composition was weak (single-family starts fell), data for June were revised down, and permits declined. Meanwhile, the National Association of Home Builders reported that builder sentiment dropped one point further this month, to an index level of 13. This is one more piece of evidence that excess supply is hanging over this market, preventing sustained recovery from a level of production that looks basically frictional in nature. In this latest survey, the assessments of future sales were mainly responsible for the drop. Consistent with this bleak outlook for sales, we expect large declines in next week’s new and existing home sales (-5% and -25%, respectively).
The Fed Could Act
A number of economists—including Fed officials—will gather in Jackson Hole for the annual Kansas City Fed Economic Symposium next week. In particular, it will be worth watching whether Fed Chairman Bernanke will comment in his opening remarks on the recent data disappointments and/or the ongoing debate on the appropriate stance of monetary policy.
Two themes have dominated Fed officials’ remarks on this debate in recent weeks. First, a number of regional presidents, most recently including Minneapolis Fed president Kocherlakota, voiced concern that the Fed’s current low interest-rate policy risks leading to deflation. While we agree that there is a non-negligible risk of deflation, we attribute this to the enormous amount of slack in the economy rather than the Fed’s low interest rate policy (which we think should be continued until at least end 2011).
Second, St. Louis Fed president Bullard reaffirmed his view that additional Treasury purchases may be warranted "should economic developments suggest increased disinflation risk." Skeptics of this view point to the mixed market reaction to last week’s Federal Open Market Committee (FOMC) decision to keep the Fed’s balance sheet constant through additional purchases of Treasury securities, as both bond yields and equities have fallen since.
Our analysis this week suggests that the Fed’s unconventional policies have been effective in supporting the economy through easier financial conditions. Our estimates suggest that financial conditions are around 200 basis points easier with the Fed’s asset purchases and the "extended period" language. This accounts for roughly half of the 450 basis points easing in financial conditions seen since the peak of the crisis has been due to the Fed’s unconventional policies. Moreover, the bulk of the impact seems to stem from the asset purchase announcements.
Given the short history on which these estimates are based, they are necessarily approximate. Nevertheless, they imply that the Fed still has the ability to boost the economy through easier financial conditions, even with a near-zero fed funds rate. This conclusion reinforces our view that the Fed will opt for more stimulus should the data continue to disappoint.