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Look for Low and Away but Watch Out for In Your Ear Economic Update for South Carolina International Trade Conference Gregory Miller Chief Economist May 2007 Soft Landing: Deal or No Deal? 2 • Soft Landing v Recession Watch 2007 – Risk tilting to latter • Consumer “Fundos” OK – Household Resources Holding but “Reserves” Stretched Thin – Oil Impact on the Way – Labor Market Slowing • • • Cap Spending Slowing as Credit Tightens • Stock Follow Profits – But risk sustainability • FOMC Holds at Neutral – No more Preemptive Strikes • Baseline 2007: Soft Landing v Recession 50/50 Housing plummeting – Issue is SubPrime Infection Inflation: Capacity Constraints – The Fed’s playing field – Wages and the Economics of new jobs STI Recession Probability Matrix Reloaded Ver 3 predicted 10 of last 7 recessions Ver5: STI Recession Probability Index “50/50” but lower confidence level half a dozen weak false signals since Oil spike began So, Recession Watch, not Recession Forecast STI RECESSI ON PROBABI LI TY I NDEX 100 50%: Critical 75 55 Value % 50 25 0 -25 89 92 95 98 Recession 3 01 RPM 04 07 US Consumer: Desperate Housewives Income is OK, but “HH reserves” dissipating HH Saving Home-based Wealth HE draw downs And, total spending slows while gasoline share rises 11 11 9 7 9 10 7 5 7 9 5 3 5 8 3 1 3 7 1 -1 1 6 -1 -3 -1 5 92 95 98 2001 Disposable Personal Income (Lft) 4 2004 2007 Saving Rate (Rt) Y/Y% 9 Saving % pYd Y/Y% 11 92 95 98 Retail Sales Y/Y% (Lft) 2001 2004 2007 Gasoline % Retail (Rt) Gasoline % Retail Retail Slows While Gas Takes Share Income Holding but Saving Dissipating Oil: We’re Not in Kansas Anymore, Toto So far, consumers impervious to high energy price, but Impact is cumulative Gas price – just hit new record US still lacks refinery capacity Auto sector lags supply of “cheap/efficient” and, from consumers, the cry is far from overwhelming And, the slowdown doesn’t hit until after oil peaks 75 14 65 55 12 10 45 35 8 6 25 15 4 2 5 -5 0 70 73 76 79 82 Oil (Lft) 5 85 88 91 94 97 00 03 Consumer Spending (Rt) 07 Consumer Spending (%Y/Y) US$ per Barrel (WTI) EVENTUALLY OIL BRAKES SPENDING Labor Market: Imus, Trump, Wolfowitz, Street Sense: Where Will It All End? Full employment but new job increments are successively smaller Layoffs are creeping higher, and Unemployment trough is a “weak economy” signal Last 7recessions began with unemployment rate at (or real near) cycle low Labor Market Slowdown New Payroll Jobs(000) 1Q06 252 1Q07 143 Apr 07 88 New Layoffs: "Household" Challenger Layoffs: Jobs (000) (000) BLS (000) 299 52.7 0.99 109 65.3 1.14 -468 70.7 1.17 Source: BLS, Challenger, Gray & Cristmas, STIEcon 6 US: Cap Spending Catalyst; Excess Inventory; and Credit Tightening • • • Equip Invest = -1.5% last two quarters; 1Q07; durable goods orders = -7.8% – Affects both Goods and Services production Inventory: we can’t measure “unplanned” but we can estimate “excess.” – Excess Inventory = $53 Bill Last 4 quarters = $50 bill – Primarily a “Goods sector” indicator After years of Easy Credit, Banks Tightening Bank Credit Tightening INVENTORY: In Excess, But ... Excess Inventory 100 50 0 -50 -100 0 -5 -10 -15 -20 -25 66 71 76 81 Inventory 7 5 % Responding Positive Real $ Bill 150 86 91 96 Series1 01 06 Recession 2004 2005 2006 Large/Medium Firms 2007 Small Firms US Housing: See You Later, Decorator • Housing Contribution: – 2003 – 2006.2 = 16% of GDP growth – Last four quarters = -23% of GDP growth (most recent qtr = -60%) • • So far, not as bad as early-80s or early-90s = -30%+ Rate of deterioration improving, but “plans” suggest overhang Housing Reverses in Double Digits Collapse: Sales, Production, and Plans 10 Y/Y% 0 -10 -20 Residential Invest Exist Home New Home 30 20 10 0 -10 -20 -30 -40 2000 2003.2 - 2006.1 2006.2 - 2006.4 8 2001 2002 Sales 2003 2004 GDP Resi Invest 2005 Starts 2006 2007 US Inflation: I Totally Don’t Know What That Means, But I Wawnt It! Economics of job creation reverses Wages = 2% and productivity = 4%, job creation makes business sense Wages = 4% and productivity = 1%, new jobs don’t pay for themselves Trade-off: Pass-through (inflation) or profits (decline) Wage Rise Undermines Production Value of New Jobs Average Hourly Earnings Productivity 2003 - 2005 2.1 3.9 1Q06 3.0 1.1 1Q07 4.1 1.2* March 2007 4.1 na Source: BLS; STIEcon 9 Average Education Weekly Prof/Business and Earnings Construction Manufacturing Services Health 2.4 1.6 2.7 2.5 3.2 1.8 2.7 2.8 3.7 2.9 4.2 4.8 1.9 5.9 3.7 4.4 5.2 2.2 5.7 3.4 US Inflation: The Tribe Has Spoken Bernanke: Inflation Bias Remains Fed Inflation Band = 1.0% - 2.0%; Core sticks just above Inflation Moving Target Oil Wages Ag (corn) CORE I NFLATI ON Y/Y % Chg. 3 2 Bernanke Band 1 0 -1 2001 2002 2003 2004 Core PCE 10 2005 2006 Core CPI 2007 Stock Market: Sounds a Little Pitchy to Me, Dawg • Stocks respond to Profits – To which my teenage daughter responds: “Duh!” • But, profits (consistently) report two tricky components – Cost Cutting (each round makes next round more difficult) – Revenue from Foreign Sources • 20% S&P 50% sales from foreign source • 5% 75%! S&P 500 Stocks Rebound w/ Profits 2000 2000 1500 1500 1000 1000 500 500 0 0 82 87 92 S&P 500 11 97 2002 Corp Profits 2007 Monetary Policy: The Procedure Could Kill the Patient, but If We Do Nothing, She Dies Anyway. – Gregory House • Fed “Neutral” = 4.75% - 5.25% • Foreign investors eliminate market rates risk premium • Market rates stuck in a trend-less 50 BP range • Mortgage Rates: Fixed = -60 BP; ARM = -40 BP • Leaves Inverted Yield Curve Risks Credit Crunch • Fed will not ease for Asset Bubbles • Alternative sources: Internal cash, Equity capital Bernanke Fed wants to see data • No more Greenspan Preemptive Strikes • • 12 Waiting for data puts Fed behind the curve By then it may be too late, because … “Round Up the Usual Suspects!” -- Captain Renault The list of traditional recession predictors is falling into alarming territory The Usual Suspects: Common Recession Predictors US Leading New Economic Oil Home Cap Indicators Price ( Sales Spending Inventory (%) *) (Y/Y%) (% 3mma) ($ bill) Going into Last 5 Recessions -0.4 276.3 -10.5 -0.7 26.5 Trend ("past year") -0.1 384.9 -11.4 -1.2 44.0 Current Reading -0.5 313.3 -13.6 -4.4 41.8 * Oil Price measure is "trough-to-peak" %-change during pre-recession period Source: Conference Board, EIA, NAR, BEA, STIEcon 13 Conclusions: Save the Cheerleader – Save the World • Soft Landing and Recession now 50/50 • Expect GDP = 1% to 2% – Risk = negatives • Expect Inflation to moderate, but maybe not fast enough • Oil prices and wages threaten corporate profits • Expect interest rates range bound with downward tilt, but – No relief from inverted yield curve until Fed eases • • • • 14 Inverted yield curve threatens bank profits and credit So, sustainability hostage to Fed Easing The Fed is hostage to price indexes that are slow to improve, so The longer they wait, the greater the risk that RPI is right again SunTrust Economics – Your Resource Gregory Miller Chief Economist 404.588.7918 [email protected] Material we present here is based upon information available on the date of publication. We believe that our data is reliable. However, we do not represent that it is accurate or complete. We solicit no action based upon this material. Opinions we express are our judgment as of this date and may change. (5/07) 15