Sunday, April 6, 2008

The U.S. Consumer Retrenches

This is from another list by a Goldman Sachs economist. The stimulus package may help a bit as consumers but it will take time to kick in probably. Note that this article predicts housing price declines to bottom out in the middle of next year! The losses in the mortage sector are staggering.

US Views: The Consumer Retrenches

1. The US economy has evolved along the lines of the recession
template we
laid out in early January. First, the most important labor market
indicators -- nonfarm payrolls, the unemployment rate, and the jobless
claims data -- are now all deteriorating at a clearly recessionary
pace.
Second, the news on consumption has worsened substantially in recent
weeks, with a sharp deterioration in auto sales and auto loan
delinquencies (now at the highest level in 30+ years) and poor
anecdotals
about March retail sales. Third, taken together the monthly measures of
economic activity that are used to officially "date" business cycles
-- payrolls, income, business sales, industrial production, and monthly
GDP -- are also looking more consistent with recession, at least if we
allow for the normal tendency of economic data to be revised downward
at
this stage of the cycle.

2. We still think that the pace of decline in real GDP will be
relatively
modest. This is partly because of structural changes in inventory and
payroll management, partly because of the weak dollar and the
improvement
in foreign trade, and partly because fiscal and monetary policy have
already responded aggressively to the downturn. The fiscal boost, in
particular, is likely to lift consumer spending in the second half of
2008, and an add-on package is not out of the question if the jobs
picture
continues to deteriorate (some Democrats are already calling for this).
This is why he have held onto our forecast that the Federal Open Market
Committee will stop easing monetary policy after one more 25bp cut on
April 30. Cuts in subsequent months are unlikely because the committee
will want to assess the effects of the tax rebates before moving
further.
Moreover, Fed officials are hopeful that the financial market
improvement
over the past few weeks will reduce the pressure on them to ease
further.

3. But the economy is likely to look weak until house prices bottom,
which
we don't expect until the second half of 2009. The reason is simple
supply
vs. demand. Although home inventories reported by builders and realtors
have started to decline, broader measures that include foreclosed homes
still seem to be rising. Until the excess supply shrinks substantially,
home prices are likely to keep falling; we are looking for further
declines totaling 10% in 2008 and another 5% in 2009.

4. As we have argued before, these declines are likely to result in
credit
losses totaling $500 billion in residential mortgages alone, and over
$1
trillion including other credits. Of this total, we estimate that
roughly
$460 billion (equivalent to about $300 billion on an after-tax basis)
will
fall on leveraged US financial institutions. So far, they have only
announced about $120 billion of this total. They are likely to
respond to
further losses by continuing to shrink their balance sheets. Using the
model developed in our Leveraged Losses paper (with Greenlaw,
Kashyap, and
Shin), we estimate that these losses imply about a 2-percentage-point
hit
to real GDP growth, before considering multiplier effects. Even after
the
formal recession ends, this retrenchment is likely to weigh on the
economy, and this is one reason why we expect the unemployment rate to
reach 6-1/2% by the end of 2009.

5. As long as the unemployment rate is still rising and house prices
are
still falling, the Fed will not raise rates. So short-term interest
rates
will need to stay low for an extended period of time, and renewed
cuts in
late 2008 or 2009 are much more likely than early interest rate hikes.
This is not necessarily an "investable" view at this point -- if the
data
do get a bit better in the wake of the fiscal stimulus, the markets
continue to relax about systemic risk, and the Fed is stingy with
near-term rate cuts, a further modest selloff in the Eurodollar curve
contracts is quite possible. But Eurodollar curve flatteners could
become
attractive soon.


Jan Hatzius
Chief US Economist
Goldman, Sachs & Co.

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