Rudi’s View: Reality Hurts

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By Rudi Filapek-Vandyck

Understanding why global risk assets are in strife this week is understanding how the US estimates, releases and updates its quarterly GDP growth figures.

Two weeks ago (July 30th), the Bureau of Economic Analysis, shortcut BEA, released an initial Q2 GDP growth estimate of 2.4%, which was a little below market expectations at the time, and well below the revised 5% growth figure for Q4 2009 and the 3.7% figure for Q1.

But, as about every optimistic market commentator would point out, it's still 2.4% and that is far from bad.

Side-remark: note how every single one of them refuses to pay attention to the trend in the data; from 5.0% to 3.7% to 2.4% (can we all see the trend?).

The main problem with the 2.4% figure is that it is in essence an extrapolation of what happened in April. What is casually forgotten by all of these commentators, is that economic momentum in May and June weakened noticeably and thus a 2.4% growth figure looks high.

Well, there can be little doubt that the figure will be revised downwards at the next update. How much downwards? A lot.

As new economic input data are being amalgamated and updated, the initial Q2 GDP estimation is being updated as well. As I indicated in my story from 4th August (see “Rudi's View: US Recovery In Worse State”) some economists on Wall Street had already figured out that 2.4% growth figure had probably been inflated by some 0.7% because of too high estimates regarding business inventories.

So 2.4% was at risk of being downgraded to 1.7%. But then most data coming out in the US since then have only further added to the weak(ening) economic picture. Of course, the Federal Reserve admitting things have turned weaker than expected, leading to a downgrade of economic growth projections is a bad omen.

But overnight it was announced the US trade deficit unexpectedly widened from US$42bn to US$49.9bn in June due to a 3% rise in imports outbalancing a 1.3% fall in exports and that really is bad news. Why? Because it suggests the Q2 GDP growth figure needs to be downsized further.

Colleague Greg Peel in this morning's Overnight Report talks about some Wall Street economists now mentioning 1.4% instead. At JP Morgan, economists are talking 1.1%.

The conclusion is thus: that initially reported 2.4% Q2 GDP growth figure is going to come down, and it will come down a lot. Just imagine for a few minutes how steep the “trend” from Q4 last year into Q3 this year is starting to look: 5% followed by 3.7%, followed by 1.1% (?)…

Now we all know why the Federal Reserve has started to signal it has no intention whatsoever to start withdrawing economic stimulus, and why Chairman Bernanke used the phrase “unusually uncertain”, and why the US bond market is painting a much more dire picture than most equity experts are willing to contemplate.

This does raise some questions about why the Reserve Bank in Australia chose to describe the economic recovery in the US as “solid” and “strong” in its latest Statement on Monetary Policy. But I'll come back on the RBA in a second.

Let's zoom in on what has been happening with US consumer spending these past few weeks. The Consumer Metrics Institute in the US, about which I have written repeatedly these past weeks, has updated its surveys into internet-related consumer purchases in the US and across the board, so it appears, year-on-year comparisons reveal weaker trends as US government stimulus is disappearing from last year's reference periods.

But what is more important is that, on the Institute's measurements, the present downturn in consumer spending is starting to shape up as worse than the downturn that started in 2008. This, today, has led to the Institute concluding: “We may ultimately look back on 2008 as a relatively brief economic downturn that was a prelude to a much more prolonged event.”

This “much more prolonged event” is taking place right here, right now.

Time to re-enter the RBA. On 9th August I published a dissertation on why the RBA is now firmly on hold, at least for the next twelve months or so (see “Rudi's View: Hear! Hear! The RBA Has A Message”). This view is not widely shared in Australia. As a matter of fact, I believe only one economist -Clifford Bennett from Herston Economics- is of the same opinion, but he arrives at it via an extremely bullish view.

I, on the other hand, believe the world is firmly in the grip of an economic slow down and there are at present no signals around that would suggest we are about to see an upswing happening. This is why I believe the RBA is on hold, and firmly so.

I also wrote in my story from August 9 that the RBA has been criticised at the end of the two previous tightening cycles of having made one interest rate hike too many on both occasions. Irony has it thus that exactly the same criticism has already shown up in an update by Craig James, Chief Economist, CommSec following the release of weaker than expected labour market data this morning.

(Note: most commentators hold the line that the addition of 23,000 net new jobs in July was in line with market expectations of 20,000 additions, but this ignores the fact that the previous month's number was downgraded by 10,000. Taking both into account today's data should thus be categorised as “slightly disappointing” or “slightly short of expectations”.)

Having said so, most commentators do acknowledge this type of data, including a slight uptick in Australia's unemployment rate to 5.3% from 5.1%, is probably what the RBA wants to see. Thus the current “no further action” stance is simply being confirmed.

Back to Craig James, here's the response to today's labour market update, uncut (my emphasis):

“The economic slowdown has finally caught up with the job market. Consumers aren’t spending, the housing market is slowing, businesses have become more cautious and the services and construction sectors are going backwards, so eventually it had to be reflected in the job market.

“Effectively the Reserve Bank lifted rates too far, too fast, robbing the economy of momentum at a time when the US and Europe continued to meander along. Businesses have become more cautious, cutting work hours and taking on part-time staff in preference to full-time workers. We would expect this mid cycle slowdown to persist until late in 2010.”

James also adds: “ It’s important not to over-react to one month’s set of figures. The economy may have hit an air pocket, but it will be back on the normal flight path once consumers and business have had a few months of stability with interest rate levels. However it does mean that the last remaining rationale for a rate hike in 2010 has been taken away. The risks are now skewed to the Reserve Bank remaining on the interest rate sidelines until 2011.”

I predict more and more economists will fall into line with those last two sentences over the coming weeks and months.

Also, for those readers who have kept up with my stories about consensus price targets this week: note that Coca-Cola Amatil ((CCL)) shares have now risen above the consensus price target.

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