by Calculated Risk on 9/07/2011 04:25:00 PM

Today San Francisco Fed President John Williams outlined some of the downside risks and temporary factors for the economic outlook: The Outlook for the U.S. Economy and Role for Monetary Policy. Here are some excerpts:

Temporary factors:

The recent slowdown was due in part to temporary factors. The weather was unusually bad in many parts of the country this past winter, the Japanese earthquake disrupted global supply chains, and, perhaps most importantly for U.S. economic growth, oil and other commodity prices surged. Higher prices at the pump staggered Americans and took a sizable bite out of consumer spending at a particularly sensitive moment for the economy.

The effects of these temporary brakes on growth have largely faded.
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[W]e are vulnerable to negative shocks that could put the recovery at risk. That’s why events in Europe are such a cause for concern. Fears that some nations in the euro zone will not be able to make payments on their debts have spread from smaller countries, such as Greece and Ireland, to larger economies, such as Spain and Italy. This is not something we can dismiss as somebody else’s problem. A full-blown financial meltdown in Europe would hit U.S. exports, which have been one of the economy’s few bright spots. Perhaps more importantly, it could slam U.S. financial markets and deal a further blow to already fragile confidence. In other words, a downturn in Europe could knock the props out from under the U.S. recovery.

We’ve had our own shock right here at home in the form of the contentious debate over a long-term fix for the federal budget deficit. It’s essential that we bring the budget under control. But, how this is accomplished is extremely important, both for our country’s short- and long-run economic health. ... In the near term, efforts at deficit reduction may reduce demand and further slow the already precarious recovery. In addition, the deficit controversy has added one more ingredient to the currents of economic anxiety that are roiling households and businesses.

And on downside risks:

[S]everal more persistent trends are also impeding recovery. The news from the housing market has been particularly dismal. Past recoveries typically got a kick start from a rebound in home construction and spending on furniture, appliances, and other big-ticket items people needed for their new houses and apartments. This time, though, construction is stuck at post-World War II low levels. A huge supply of homes is available for sale, which keeps prices down. Add to that what might be called a shadow inventory of some 4 million homes whose owners are seriously delinquent on their mortgages or in foreclosure. Despite great loan terms and low prices, buyers who qualify for credit are understandably nervous about jumping back into the housing market. And, of course, millions of other potential buyers are underwater on their current mortgages, making it hard for them to sell or refinance.

Meanwhile, the bounce in consumer spending often seen in the wake of recessions has been unusually tepid this time around. The combination of huge amounts of household debt, losses in the housing and stock markets, and high unemployment has clearly taken a toll on both the ability and willingness of households to spend. People are on edge waiting for the other shoe to drop. Consumer sentiment plunged last month, which was partly a reaction to the unnerving news about the federal debt ceiling debate in Washington, D.C., and the European debt crisis. In fact, the latest consumer sentiment readings are near the all-time lows recorded in late 2008 during the most terrifying moments of the financial crisis. Here is a telling statistic: Sixty-two percent of households expect their income to stay the same or decline over the next year, the worst reading in the over 30 years that this question has been asked. With consumer spending making up 70 percent of the economy, it’s hard to have a robust recovery when Americans are so dispirited.

Right now I'd put the European crisis and premature austerity as the two biggest downside risks. High gasoline prices are still a drag, as is the ongoing housing crisis.

John Williams concludes:

Right now, though, the real threat is an economy that is at risk of stalling and the prospect of many years of very high unemployment, with potentially long-run negative consequences for our economy.

by Calculated Risk on 9/07/2011 02:00:00 PM

Fed's Beige Book:

Reports from the twelve Federal Reserve Districts indicated that economic activity continued to expand at a modest pace, though some Districts noted mixed or weakening activity. The St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco Districts all reported either modest or slight expansion. Atlanta said activity continued to expand at a very subdued pace, while Cleveland reported slow growth and New York indicated growth remained sluggish. Economic activity expanded more slowly in the Chicago District and slowed in the Richmond District. Business activity in the Boston and Philadelphia Districts was characterized as mixed, with Philadelphia adding that activity was somewhat weaker overall. Several Districts also indicated that recent stock market volatility and increased economic uncertainty had led many contacts to downgrade or become more cautious about their near-term outlooks.
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Consumer spending increased slightly in most Districts since the last survey, but non-auto retail sales were flat or down in several Districts.
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Manufacturing conditions were mixed across the country, but the pace of activity slowed in many Districts. The New York, Philadelphia, and Richmond Districts reported declining activity overall, and contacts in the Boston and Dallas Districts noted slowing demand from European customers. Cleveland said factory production was stable, and manufacturing activity in the Atlanta and Chicago Districts grew at a slower pace. Minneapolis, Kansas City, and San Francisco reported slight expansions, and St. Louis said activity continued to increase and that several manufacturers planned to open plants and expand operations in the near future. Most manufacturing contacts were less optimistic than in the previous survey; however, future capital spending plans were solid in a few Districts.
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Labor markets were generally steady, although some Districts reported modest employment growth.

And on real estate:

Residential real estate activity remained weak overall, although a few Districts noted some slight improvements. Contacts in the Boston, Atlanta, Minneapolis, and Dallas Districts reported an increase in home sales over the previous year's weak levels; however, the uptick in the Atlanta District was concentrated mainly in Florida. The remaining Districts all reported stable or slower sales from the previous survey period ...

Commercial real estate conditions remained weak or little changed in most Districts, although some improvements were noted by New York, Minneapolis, and Dallas. Commercial real estate activity was sluggish in the Boston, Cleveland, Richmond, Atlanta, Kansas City, and San Francisco Districts.

This was based on data gathered on or before August 26th. More sluggish growth ...

by Calculated Risk on 9/07/2011 12:20:00 PM

From Chicago Fed President Charles Evans: The Fed's Dual Mandate Responsibilities and Challenges Facing U.S. Monetary Policy

Suppose we faced a very different economic environment: Imagine that inflation was running at 5% against our inflation objective of 2%. Is there a doubt that any central banker worth their salt would be reacting strongly to fight this high inflation rate? No, there isn’t any doubt. They would be acting as if their hair was on fire. We should be similarly energized about improving conditions in the labor market.

In the United States, the Federal Reserve Act charges us with maintaining monetary and financial conditions that support maximum employment and price stability. This is referred to as the Fed’s dual mandate and it has the force of law behind it.

The most reasonable interpretation of our maximum employment objective is an unemployment rate near its natural rate, and a fairly conservative estimate of that natural rate is 6%. So, when unemployment stands at 9%, we’re missing on our employment mandate by 3 full percentage points. That’s just as bad as 5% inflation versus a 2% target. So, if 5% inflation would have our hair on fire, so should 9% unemployment.

The current unemployment rate of 9.1% (16.2% U-6) is a tragedy. Even though the high unemployment rate was a direct result of the bursting of the housing bubble and the financial crisis - Evans argues that we shouldn't just accept a sluggish recovery:

In their book This Time is Different, Carmen Reinhart and Ken Rogoff documented the substantially more detrimental effects that financial crises typically impose on economic recoveries. Recoveries following severe financial crises take many years longer than usual, and the risk of a second recession before the ultimate economic recovery returns to the previous business cycle peak is substantially higher. In a related study of the current U.S. experience, Reinhart and Rogoff show that the current anemic recovery is following the typical post-financial crisis path quite closely, given the size of the financial contraction. It would be nice to point to some features of the recovery that suggest greater progress relative to the Reinhart-Rogoff benchmark. But those are hard to come by.

It bears keeping in mind that the Reinhart-Rogoff predictions of a slow recovery are based on historical averages of macroeconomic performances across many different countries at many different times. They highlight a challenge we face today, but from the standpoint of the underlying economic analysis, there is nothing pre-ordained about these outcomes. They are not theoretical predictions—rather, they are reduced form correlations. The economy can perform better than it did in these past episodes if policy responds better than it did in those situations. In my opinion, maintaining the Fed’s focus on both of our dual-mandate responsibilities is a necessary and critical element of an appropriate response to the financial crisis that can produce better economic outcomes.

by Calculated Risk on 9/07/2011 10:00:00 AM

From the BLS: Job Openings and Labor Turnover Summary

The number of job openings in July was 3.2 million, little changed from June. Although the number of job openings remained below the 4.4 million openings when the recession began in December 2007, the level in July was 1.1 million openings higher than in July 2009 (the most recent trough).

The following graph shows job openings (yellow line), hires (purple), Layoff, Discharges and other (red column), and Quits (light blue column) from the JOLTS.

Unfortunately this is a new series and only started in December 2000.

Note: The difference between JOLTS hires and separations is similar to the CES (payroll survey) net jobs headline numbers. This report is for July, the most recent employment report was for August.

Click on graph for larger image in graph gallery.

Notice that hires (purple) and total separations (red and blue columns stacked) are pretty close each month. When the purple line is above the two stacked columns, the economy is adding net jobs - when it is below the columns, the economy is losing jobs.

In general job openings (yellow) has been trending up - and job openings increased slightly again in July - and are up about 13% year-over-year compared to July 2010.

Overall turnover is increasing too, but remains low. Quits increased slightly in July, and have been trending up - and quits are now up about 9% year-over-year.

by Calculated Risk on 9/07/2011 07:26:00 AM

The MBA reports: Mortgage Applications Decrease in Latest MBA Weekly Survey

The Refinance Index decreased 6.3 percent from the previous week. The seasonally adjusted Purchase Index increased 0.2 percent from one week earlier.
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"Heading into the Labor Day weekend, the 30-year rate was at its second lowest level in the history of our survey (the low point was reached last October), and the 15-year rate marked a new low in our survey," said Mike Fratantoni, MBA's Vice President of Research and Economics. "Despite these rates however, refinance application volume fell for the third straight week, and is more than 35 percent below levels at this time last year. Purchase application volume remains relatively flat at extremely low levels, close to lows last seen in 1996."
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The average contract interest rate for 30-year fixed-rate mortgages decreased to 4.23 percent from 4.32 percent, with points decreasing to 1.04 from 1.29 (including the origination fee) for 80 percent loan-to-value (LTV) ratio loans. This is the second lowest 30-year rate recorded in the survey.

The following graph shows the MBA Purchase Index and four week moving average since 1990.

Click on graph for larger image in graph gallery.

The four week average of the purchase index is now at the lowest levels since August 1995.

This doesn't include the large number of cash buyers ... but purchase application activity was especially weak over the previous month, and this suggests weak home sales in September and October.

Also - with the 10 year treasury yield below 2% this week - mortgage rates will probably be at record lows in the survey next week.