by Calculated Risk on 12/05/2011 09:43:00 PM

I've been wondering how weak the drachma and other currencies would be if there was a break up of the eurozone. The following is just a rough estimate ... but imagine how much more expensive gasoline will be in Greece?

Note: I've added FT Alphaville feeds to the sidebar. It is a must read on the European financial crisis.

From Joseph Cotterill at the Financial Times Alphaville: Post-euro currencies, charted

Along with “redenomination risk” for eurozone financial assets, this is another of those pieces of bank research that’s as interesting for being considered necessary to be written in the first place, as much as for its conclusion.

(Yes, we know it’s a dampener to talk about a euro break-up when the German and French governments are promising European unification, sweetness and light on a scale not seen since Charlemagne. But since it really is about either complete fiscal union, or this – it’s worth noting.)

Click on graph for larger image.

Once again it’s Nomura taking the plunge on covering the break-up issue. In his December 4 note, the bank’s FX analyst Jens Nordvig warned that conclusions about the value of a post-euro currencies would have to be extremely provisional:

... we want to stress up-front that these estimates are unlikely to be particularly precise. They are intended to give a sense of potential magnitudes involved over a 5-year forward time frame, after which we believe temporary transition effects should be smaller.
...
A eurozone break-up will create additional short-term risks and require new risk premia for investors. These extraordinary risk premia will vary by country depending on factors such as market volatility, liquidity conditions, as well as issues relating to capital controls, including possible taxes on capital flows. Since our analysis is focussed on equilibrium considerations over a 5-year period, we will not focus directly on these more temporary effects, although we recognize that they could be crucial in the short-term.

by Calculated Risk on 12/05/2011 06:25:00 PM

Several readers have asked me to comment on this new paper from Fed economists Haughwout, Lee, Tracy, and van der Klaauw: “Flip This House”: Investor Speculation and the Housing Bubble (ht Josh)

[W]e present new findings from our recent New York Fed study that uses unique data to suggest that real estate “investors”—borrowers who use financial leverage in the form of mortgage credit to purchase multiple residential properties—played a previously unrecognized, but very important, role. These investors likely helped push prices up during 2004-06; but when prices turned down in early 2006, they defaulted in large numbers and thereby contributed importantly to the intensity of the housing cycle’s downward leg.

It was pretty obvious that investor buying was pushing up prices in 2004 and 2005. I wrote a post in April 2005 (over six years ago!) on that subject: Housing: Speculation is the Key (Note: in that 2005 post I treated speculation as storage and showed how speculation pushes up prices during the bubble - and pushes down prices after the bubble bursts).

The Fed economists have added some data. Although I think the data suggests a significant role for speculation - especially in certain bubble areas - I think the data is a little confusing. One problem is that many move up buyers tend to buy their new home before selling their old home. So they have two mortgages while the old home is on the market. This was especially common during the bubble because move up buyers didn't want to sell until they were sure they had found something to buy. The Fed data appears to count these people as investors.

Another problem is the Fed didn't try to adjust for 2nd home owners.

But one thing is clear: investor buying did contribute to the bubble, but it wasn't the cause. But - as I noted in 2005:

Speculation tends to chase appreciating assets, and then speculation begets more speculation, until finally, for some reason that will become obvious to all in hindsight, the "bubble" bursts.

It was no surprise that investors piled in after prices really took off. But the real causes of the bubble were rapid changes in the mortgage lending industry combined with a lack of regulatory oversight. The speculators just added to the fire.

by Calculated Risk on 12/05/2011 04:18:00 PM

Another house price index ...

The LPS HPI is a repeat sales index that uses public disclosure by county recorders or loan origination data for purchase loans (if the sales price isn't disclosed).

From LPS: LPS Home Price Index Shows 1.2 Percent Decline in September U.S. Home Prices; Early Data Suggests Further 1.1 Percent Drop in October Likely

“Home prices in September were consistent with the seasonal pattern that has been occurring since 2009,” explained Kyle Lundstedt, managing director for LPS Applied Analytics. “Each year, prices have risen in the spring, but revert in autumn to a downward trend that has not only erased the gains, but has led to an average 3.7 percent annual drop in prices to date. The partial data available for October suggests a further approximate decline of 1.1 percent. Partial data from last month proved to be a good indicator for September's performance: it showed a preliminary 1.1 percent estimated decline, compared to the 1.2 percent as shown by the full month’s data.”

The LPS HPI national average home price for transactions during September was $202,000 – a decline of 1.2 percent for the month. As in previous years, this decline follows a 0.9 percent decline during August (Figure 1).

Click on graph for larger image.

Figure 1: "Prices have fallen since autumn 2008 with brief interruptions each spring. Except for February of this year, prices have not been at the current level since January 2003."

LPS HPI average national home prices continue the downward trend begun after the market peak in June 2006, when the total value of U.S. housing inventory covered by the LPS HPI stood at $10.6 trillion. The value has declined 30.2 percent since that peak to $7.56 trillion.

During the period of most rapid price declines, from June 2007 through December 2008, the LPS HPI national average home price dropped $56,000 from $282,000, which corresponds to an average annual decline of 13.8 percent. Since December 2008, prices have fallen more slowly, interrupted by brief seasonal intervals of rising prices. During this period of more slowly declining prices, the national average price has fallen approximately $24,000 from $226,000. ... Price changes were consistent across the country during September, declining in all ZIP codes in the LPS HPI.

It appears all of the price indexes will show new post-bubble lows later this year - or early in 2012.

by Calculated Risk on 12/05/2011 01:45:00 PM

Over the weekend, the WSJ had an article about a new communication strategy at the Fed: Federal Reserve Prepares to Make Itself Perfectly Clear

Here are some related comments from Chicago Fed president Charles Evans today: A Risk Management Approach to Monetary Policy

The Fed could sharpen its forward guidance in two directions by implementing a state-contingent policy. The first part of such a policy would be to communicate that we will keep the funds rate at exceptionally low levels as long as unemployment is somewhat above its natural rate. The second part of the policy is to have an essential safeguard — that is, a commitment to pull back on accommodation if inflation rises above a particular threshold. This inflation safeguard would insure us against the risks that the supply constraints central to the structural impediments scenario are stronger than I think. Rates would remain low as long as the conditions were unmet.

Furthermore, I believe the inflation-safeguard threshold needs to be above our current 2 percent inflation objective — perhaps something like 3 percent. Now, the “3 percent inflation” number may seem shocking coming from a conservative central banker. However, as Kenneth Rogoff recently wrote in a Financial Times piece, “Any inflation above 2 percent may seem anathema to those who still remember the anti-inflation wars of the 1970s and 1980s, but a once-in-75-year crisis calls for outside-the-box measures.”[5] I agree wholeheartedly with Professor Rogoff.

And actually, this middle ground policy guidance is not as out-of-the box as one might think. Importantly, it is consistent with the most recent liquidity trap research, which shows that improved economic performance during a liquidity trap requires the central bank, if necessary, to allow inflation to run higher than its target for some time over the medium term. Such policies can generate the above-trend growth necessary to reduce unemployment and return overall economic activity to its productive potential. In fact, I have seen model simulation results that suggest to me that core inflation is unlikely to rise as high as 3 percent under such a policy.
...
If, as I fear, the liquidity trap scenario describes the present environment, we risk being mired in recession-like circumstances for an unacceptably long period. Indeed, each passing month of stagnation represents real economic losses that are borne by all. In addition, I worry that even when the economy does regain traction, its new potential growth path will be permanently impaired. The skills of the long-term unemployed may atrophy and incentives for workers to invest in acquiring new skills may be diminished. Similarly, businesses facing uncertain demand are less inclined to invest in new productive capacity and technologies. All of these factors may permanently lower the path of potential output.

As I said in the fall of 2010 and I repeat the message again today: I think state-contingent policies such as those I just described are a productive way to provide such necessary monetary accommodation. There is simply too much at stake for us to be excessively complacent while the economy is in such dire shape. It is imperative to undertake action now.

by Calculated Risk on 12/05/2011 10:00:00 AM

The November ISM Non-manufacturing index was at 52.0%, down from 52.9% in October. The employment index decreased in November to 48.9%, down from 53.3% in October. Note: Above 50 indicates expansion, below 50 contraction.

From the Institute for Supply Management: November 2011 Non-Manufacturing ISM Report On Business®

Economic activity in the non-manufacturing sector grew in November for the 24th consecutive month, say the nation's purchasing and supply executives in the latest Non-Manufacturing ISM Report On Business®.

The report was issued today by Anthony Nieves, C.P.M., CFPM, chair of the Institute for Supply Management™ Non-Manufacturing Business Survey Committee. "The NMI registered 52 percent in November, 0.9 percentage point lower than the 52.9 percent registered in October, and indicating continued growth at a slightly slower rate in the non-manufacturing sector. This is the lowest reading since January 2010, when the index registered 50.7 percent. The Non-Manufacturing Business Activity Index increased 2.4 percentage points to 56.2 percent, reflecting growth for the 28th consecutive month. The New Orders Index increased by 0.6 percentage point to 53 percent. The Employment Index decreased 4.4 percentage points to 48.9 percent, indicating contraction in employment after one month of growth. The Prices Index increased 5.4 percentage points to 62.5 percent, indicating prices increased at a faster rate in November when compared to October. According to the NMI, 12 non-manufacturing industries reported growth in November. Respondents' comments for the most part project continued slow, incremental growth. There still remains a strong concern about lagging employment."
emphasis added

Click on graph for larger image.

This graph shows the ISM non-manufacturing index (started in January 2008) and the ISM non-manufacturing employment diffusion index.

This was below the consensus forecast of 53.8% and indicates slower expansion in November than in October.

by Calculated Risk on 12/05/2011 08:46:00 AM

From the Financial Times Rolling blog: Eurozone crisis lists today's events in Europe:

• Italy’s technocrat-prime minister, Mario Monti, has unveiled tough austerity measures and economic reforms
• Nicolas Sarkozy ... and Angela Merkel ... will meet in Paris ... the structure and rules of a new “fiscal union” in Europe
• Herman Van Rompuy, the European Council president ... meets with foreign ministers to outline the scope of the talks leading up to Friday
• The Irish government presents its austerity budget ...

From the WSJ: Italy Plan Opens Pivotal Week for Euro

Italian Prime Minister Mario Monti, in his first test since taking office two weeks ago, outlined a three-year plan made up of €30 billion ($40.2 billion) in tax increases, spending cuts, pension overhauls and growth-boosting measures.

The package—equivalent to 1.9% of Italy's €1.6 trillion gross domestic product—will likely be followed by Franco-German proposals on Monday to create a new regime for budget policies in the euro zone, which European leaders could adopt at a summit on Dec. 8-9.

From the NY Times: Italy’s Leader Unveils Radical Austerity Measures

Telling Italians that the fate of their country and the euro was at stake, Prime Minister Mario Monti unveiled a radical and ambitious package of spending cuts and tax increases on Sunday, including deeply unpopular moves like raising the country’s retirement age.
...
The standard retirement age, now 60 for many women and 65 for most men, would quickly rise to 62 and 66, with incentives to keep working until age 70; the standard age for women would eventually rise to match that for men. Pensions would be based on the number of years of contributions, not on the worker’s salary at the time of retirement, as is common now.

Weekend:
• Summary for Week ending Dec 2nd
• Schedule for Week of Dec 4th

by Calculated Risk on 12/04/2011 09:08:00 PM

From Jon Hilsenrath and Luca Di Leo at the WSJ: Federal Reserve Prepares to Make Itself Perfectly Clear

The Fed has been working on revamping its communication strategy for months. ... Informally, the Fed already has made clear it wants the annual inflation rate to run at 2% or a bit lower over the long-run. A formal statement would codify the commitment. Such a declaration would likely run alongside a description of the Fed's goals for employment, which Congress requires it to mind along with inflation. Most Fed officials believe the unemployment rate could fall to 5% or 6% without triggering higher inflation.

To articulate its interest-rate strategy, the Fed would expand its quarterly release of the officials' projections for economic growth, inflation and unemployment. It would add details on the Fed's interest rate expectations underlying its economic projections, along with some description of the policy it expects to employ to reach its goals.

I think this would be helpful.

Yesterday:
• Summary for Week ending Dec 2nd
• Schedule for Week of Dec 4th

by Calculated Risk on 12/04/2011 05:35:00 PM

This will be an interesting week ...

From the WSJ: Euro Faces Tests From ECB, EU Summit

This Thursday, policy makers at the ECB will gather for a meeting that is widely expected to lead to a reduction in interest rates by at least 0.25 percentage point, to 1%. On Friday, European Union leaders have scheduled a summit meeting, where euro-zone officials are expected to lay out plans to enforce stricter budget rules across the currency bloc in an effort to keep the Continent's turmoil from worsening.

Market observers say the ECB and the EU summit are intertwined. Investors are eager for the central bank to take a more aggressive role in buying euro-zone government debt, driving down interest rates. But unless euro-zone countries overhaul their fiscal policies, the ECB is reluctant to expand its emergency bond-buying...

From the Financial Times: Monti cabinet agrees Italy austerity plans

Rome’s planned tax increases, pension changes and spending cuts amount to a savings of €30bn over the next three years, of which about €10bn will be put back into the economy through measures to promote growth, including cuts in the cost of labour and incentives to get more women and young people into the workforce.
excerpt with permission

Yesterday:
• Summary for Week ending Dec 2nd
• Schedule for Week of Dec 4th

by Calculated Risk on 12/04/2011 10:45:00 AM

Yesterday someone sent me a column from John Mauldin that had the following graph. The graph shows the BLS Employment-population ratio, 16 years and older, and based on the trend, the author is expecting the employment-population ratio to rise to 65% in 2020.


I think this forecast is incorrect - and this gives me a chance to discuss the participation rate and employment-population ratio.

The employment-population ratio really increased in the '70s and '80s for two reasons: 1) favorable demographics as the baby boom generation moved into their prime working years, and 2) a rising participation rate for women. But that trend was about to change even if there hadn't been a severe recession.

Some definitions:
Participation Rate = Labor force / Civilian noninstitutional population

Employment-population ratio = Employed / Civilian noninstitutional population

Unemployment Rate = Unemployed / Labor Force

If we know the participation rate and the unemployment rate, we can calculate the employment-population ratio as follows:
Employment-population ratio = participation rate * (1 - unemployment rate).

This means that if the unemployment rate stayed steady, the employment-population ratio would follow the participation rate. This is important because the participation rate is impacted by changes in demographics - and we can forecast some of those changes.

The second graph shows the actual annual participation rate and two forecasts based on changes in demographics - both forecasts were made before the recent recession. Now that the baby boom generation is approaching retirement, the participation rate will decline.

Here are the two earlier papers with all of the author's assumptions:
• From BLS economist Mitra Toossi in November 2006: A new look at long-term labor force projections to 2050
• From Austin State University Professor Robert Szafran in September 2002: Age-adjusted labor force participation rates, 1960–2045

Those papers were written when the participation rate was in the mid-66% range. Based on demographics, Szafran had forecast the participation rate to fall to 64.6% in 2015, and Toosi had forecast the rate to fall to 64.5% in 2020. So some of the recent decline was expected - although it happened sooner and faster than either expected because of the severe recession.

And there might be reasons those forecasts were too high. First the participation rate of the 16 to 19 age group has fallen much faster than Toosi forecast (and might not bounce back much after the recession), and second, some people might have permanently given up.

I've made a similar calculation, and based on demographics, it is clear the participation rate would be falling even without a recession. Look back at the first graph - the projected increase in the employment-population ratio would require an increase in the participation rate (or a much lower unemployment rate than we've seen at full employment) - and that isn't going to happen.

The third graph shows the actual employment-population ratio. The two dashed lines are the calculated employment-population ratio using the actual participation rate - and two steady unemployment rates: 5% and 6%. You can see the impact of business cycles on the employment-population ratio (the participation rate is also impacted by business cycles, but much less than the employment-population ratio).

Using the participation projections from Professor Szafran and BLS economist Toossi, this would suggest an employment-population ratio in the 59% to 61% range in 2020 - not 65%.

Professor Krugman also used the employment-population ratio on Friday, but with one very important difference: he only used the 25 to 54 age group. From Krugman: Meh. And I Say That With Feeling

It could have been worse, but the basic story remains the same as it has been for 2 1/2 years: an economy that’s growing, but not enough to feel anything like a real recovery. The measured unemployment rate has trended down for a while, but it’s all basically reduced numbers of people actively searching. My favorite measure these days is the employment-population ratio for prime-age workers, which isn’t affected by changing demography. Here it is for the past decade; see the trend since the recession officially ended? Neither do I.

As Krugman suggests, the participation rate for the 25 to 54 age group has been fairly flat for the last 20 years so we can just look at the employment-population ratio.

This graph shows the participation rate for men, women and all in the 25 to 54 age group.

The participation rate for women had been increasing for decades, and really increased in the '70s and '80s. This is a key reason why the employment-population ratio was increasing (back to the first graph). But the participation rate for women has flattened out.

The participation rate for men has been slowly decreasing for some time. But the overall participation rate has been fairly flat - so for a quick look at the overall employment situation, the 25 to 54 employment population ratio is very useful.

However, when looking at the 16 and over population-employment ratio, we have to also analyze the trends for the participation rate. And the participation rate is expected to decline for the next couple of decades.

by Calculated Risk on 12/04/2011 08:15:00 AM

From HotelNewsNow.com: STR: US results for week ending 26 November

In year-over-year comparisons for the week, occupancy rose 3.4 percent to 45.0 percent, average daily rate increased 3.7 percent to US$90.51 and revenue per available room finished the week with an increase of 7.2 percent to US$40.74.

Note: ADR: Average Daily Rate, RevPAR: Revenue per Available Room.

The following graph shows the seasonal pattern for the hotel occupancy rate using a four week average for the occupancy rate.

Click on graph for larger image.

The fall business travel season is over, and the 4-week average of the occupancy rate will decline into early next year. The occupancy rate is now running pretty close to the median rate for 2000 - 2007. But this is just the occupancy rate, room rates are still lower ...

From HotelNewsNow.com: Data shows full recovery still far away

Jan Freitag, senior VP of global development for STR (the parent company of HotelNewsNow.com), said if the metrics are adjusted for inflation it could be even longer. Specifically, he said the 12-month moving average for U.S. average daily rate was US$107.72 at its peak in September 2008. In October 2011 it was US$101.13.

“You can argue that US$107 versus US$101 is just a US$6 difference,” Freitag said. “But adjusted with inflation you suddenly have to make up US$7 or US$8. It’s at least 24 months away before we do that, and probably longer.”
...
The other metrics are a bit more complicated to calculate. Occupancy in the U.S., for example, was 63.5% at its peak in 2006 and in October 2011 was at 59.8%. But getting back to 63.5% might not be the right goal to shoot for, Freitag said, because the amount of supply added to the landscape has skewed what would be a common denominator.

Instead, Freitag suggested the industry aim to sell more rooms today than it did in 2008—a goal it has already accomplished. The industry sold 40 million more rooms from January to October 2011 than it did from January to October 2008, although there are 100 million more rooms available today than there were at this time three years ago.

“Going back to pre-recession occupancy levels might not be the right goal,” Freitag said. “The right questions might be: ‘Can we sell more rooms?’ And ‘Can we make more revenue?’”

Measuring revenue, the U.S. hotel industry grossed US$109 billion from January to September 2008 and US$106 billion through the same time frame in 2011. “Even though we’re selling more rooms, we’ve made US$3 billion less,” Freitag said. “That’s purely a function of rate.”

Data Source: Smith Travel Research, Courtesy of HotelNewsNow.com

Yesterday:
• Summary for Week ending Dec 2nd
• Schedule for Week of Dec 4th