In Depth Analysis: CalculatedRisk Newsletter on Real Estate (Ad Free) Read it here.

Friday, November 16, 2007

Fed's Kroszner: Economic Outlook

by Calculated Risk on 11/16/2007 11:15:00 AM

From Fed Governor Randall S. Kroszner: Risk Management and the Economic Outlook. First, on monetary policy:

... one feature of monetary policy to keep in mind is that, all else equal, each successive action in the same direction tends to lower the incremental benefits and to raise the incremental costs of additional actions. ...

... in September and again in October ... the FOMC [lowered rates] ... With those actions, however, the downside risks to economic growth now appear to be roughly balanced by the upside risks to inflation.
That is the clearest statement yet that the Fed (at least Kroszner) does not expect a rate cut any time soon.

After saying that the risks are balanced, Kroszner then says the economy is heading for a "rough patch":
In the near term, the economy will probably go through a rough patch during which a number of economic data releases may be downbeat. Home sales seem likely to weaken further ... a further weakening of demand is likely to prompt additional cutbacks in construction.

... conditions for subprime borrowers will get worse before they get better. First, the bulk of the first interest rate resets for adjustable-rate subprime mortgages are yet to come. On average, from now until the end of 2008, nearly 450,000 subprime mortgages per quarter are scheduled to undergo their first reset, eventually causing a typical monthly payment to rise about $350, or 25 percent. Second, the weakness in house prices and the resulting limit on the build-up of home equity will hinder the ability of subprime borrowers to refinance out of their mortgages into less expensive loans; as a result, more borrowers will be left with a mortgage balance that exceeds the value of the house.

The likely consequences of these two factors--imminent interest rate resets and the difficulty of refinancing--will be yet higher rates of delinquencies and foreclosures over the next several quarters and, in turn, additional downward pressure on house prices. The overhang of unsold homes also will weigh heavily on the prices of newly built and existing homes. ...

Elsewhere in the economy, increases in consumer spending can be expected to be limited for a while by the effects of sluggish home prices on household balance sheets. Consumer spending will also be constrained, although probably to a lesser extent, by the drain on aggregate purchasing power caused by mortgage resets; that drain will likely be exacerbated by the current run-up in energy prices. Meanwhile, heightened uncertainty in the business sector could lead to reductions in capital spending plans.
This reminds me of a teeter totter; it can be balanced with a few pounds at each end, or with hundreds of pounds at each end. If the risks are balanced, the concerns about inflation must be significant.

Consider these two stories from FedEx and UPS. From the WSJ: FedEx Cuts Earnings Outlook
FedEx Corp. lowered its earnings outlook Friday, citing high fuel costs and weakness in its less-than-truckload freight business.

The Memphis, Tenn., company had already cut its earnings forecast in September and said it would reduce capital spending ...
And from Reuters: UPS to hike delivery charges by 4.9 percent
Package delivery company United Parcel Service Inc said on Friday it was raising its prices for 2008 by about 4.9 percent, matching a planned hike by rival FedEx Corp ...
Economic weakness and rising prices. A teeter totter balanced with significant weight on both ends.