Impact of Retail Sales and Trade on Q4 GDP

The two biggest inputs into GDP are consumer spending and trade. Therefore the 2.8 percent decline in retail sales and the surprise widening of the trade deficit in the month of October suggests that GDP growth could take a big dive in the fourth quarter.

Word on the street is that some economists are calling for GDP to decline as much as 4 to 6 percent in Q4, which would be the largest contraction in growth since the 1980s. In the first quarter of 1982, GDP fell -6.4 percent. A 4 to 6 percent drop in GDP would not be out of the ordinary given the current conditions in the US economy. In the fourth quarter of 1990, GDP contracted by 3 percent and in the first quarter of 1991, it contracted by 2 percent.

If you agree that the current recession is worse than the one in the 1990s, then it would be logical to expect a contraction in growth exceeding 3 percent.

Don’t Expect Retail Sales and Producer Prices to Help

Retail sales and producer prices for the month of November are due for release tomorrow. Another large decline in consumer spending will only support our thesis that GDP will see a big contraction in the fourth quarter. All of the leading indicators for retail sales that we follow point to very weak consumer spending last month despite stronger Black Friday sales. SpendingPulse, the retail data service of MasterCard Inc. reported that retail sales excluding autos dropped by the largest amount in 5 years. Chain store sales as measured by the International Council of Shopping Centers also dropped by 2.7 percent last month, the largest decline in at least 8 years. Don’t forget that November was also the month that non-farm payrolls fell 533k. Americans were more worried about keeping their jobs last month than spending liberally.

The Treasury market is already pricing in the possibility of deflation and depression with yields in zero to negative territory for the first time since the Great Depression. Although we don’t think that the US will fall into a depression, the data certainly supports tougher times ahead for the US economy.
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Currencies: Post Thanksgiving Breakout?

On the eve before Thanksgiving, the price action in the currency market has been very erratic. Equities rallied for the fourth straight trading session while the US dollar weakened against the Australian and New Zealand dollars but strengthened against the Euro, British Pound and Japanese Yen.

Currencies appear to be decoupling from equities on this low volume pre holiday trading session. Over the past few weeks, strength in equities has translated into strength in the EUR/USD but that was not the case today. US economic data was very weak, but hope continues to supersede reality as President Elect Barack Obama adds former Federal Reserve Chairman Paul Volcker to his team.

Obama’s Economic Dream Team

Rather than having to pick from Timothy Geithner, Larry Summers and Paul Volcker, Obama has decided to add all 3 of these well respected and talented men to his Economic Dream Team. The equity markets turned around after Obama announced that Volcker will the Chairman of a new White House advisory board that is tasked with stabilizing the financial markets and pulling the US economy out of recession. This new Economic Advisory Board will give their opinions in briefings to the President and include experts outside the government with the goal of “infusing ideas from across the country and from all sectors of the US economy.” Even before taking office, Obama is proving to be a President who wants to hear every possible viewpoint before making his decisions. He is on track to hit the ground running come January 20th and the equity markets have responded very favorably to his appointments and the initial details of his economic recovery plan. Over the next 24 days, Obama will play a critical role in helping to maintain confidence in the financial markets.

Latest String of Economic Data Hits Multi-Year Lows

Confidence will be extremely important as the US economy continues to come face to face with weak economic data. On the eve of Thanksgiving, we have had a harsh reminder of the problems plaguing the US economy. With the shortened holiday trading week, there were a lot of US economic data released today and a number of those indicators hit multi-year lows. As we have previously warned, because third quarter GDP only slipped by 0.5 percent, fourth quarter GDP could be very weak.

Is There a Risk of a Breakout on Friday?

For the currency market, the Thanksgiving Day holiday usually leads to low liquidity and thin volumes. Although this should mean range trading for all of the major currencies, watch out for a post Thanksgiving Day breakout. Low liquidity makes it extremely easy to exacerbate the volatility that we have been seeing in the currency market. In 2007 and 2006, the EUR/USD’s trading range on the Friday after Thanksgiving was more than 3 times its trading range on Thanksgiving Day.

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Currencies Soar as Fed Announces More Stimulus, GDP Not as Bad as Feared

US GDP growth has contracted but that has not stopped the equity and currency market from rallying. The GDP number was not as bad as the market had feared but what really drove the markets higher was the Federal Reserve’s new Term Asset-Backed Securities Loan Facility (TALF).

Both the outgoing and incoming Presidents are stepping on the gas and that is helping to restore investor confidence. President Elect Barack Obama has formed his Economic Team and is outlining his Economic Stimulus plan. The Bush Administration, bailed out Citigroup yesterday and has now made a colossal announcement aimed at putting a bottom in the asset market.

Their 35% increase in the Fed balance sheet represents another $800B worth of stimulus and will cause the Fed’s balance sheet to balloon to $3 trillion. For investors that have been concerned about the funding crisis, this is an even bigger reason to sell dollars.

Here is what the Fed announced minutes before the GDP number:

– New $200B facility to support ABS
– Buy up to $500B in mortgage securities backed by Fannie Mae, Freddie Mac and Ginnie Mae
– Buy up to $100B in direct obligations of housing related Government Sponsored Enterprises
– The Treasury will use $20B of TARP funds to provide credit protection to the Fed

Expect GDP Growth to Worsen

The 0.5% drop in GDP is mild when compared to past recessions and raises the risk of a sharp decline in fourth quarter GDP. Many people believe that the current downturn is the worst since the Great Depression and if that is true, we could easily see GDP fall by 4 or 5 percent in one quarter. In 2001, GDP contracted by 1.4 percent in the third quarter. In 1990, GDP fell by 3 percent in the fourth quarter and in the first quarter of 1982 GDP dropped a whopping 6.5 percent. There is no reason why the worst case scenario this time around is just a 0.5 percent contraction in GDP.

Remember That This is a Crisis of Confidence

However despite the pessimistic outlook for growth, it is important to remember that this was a crisis of confidence. So priority number one for the outgoing and incoming Presidents is to restore confidence. Since Friday they have done a good job with that if Obama outlines more plans at his speech later this morning, we could see the rally in the currency market continue. Don’t forget that the further monetary stimulus is also in the pipeline with the Fed expected to cut interest rates again next month.
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Rising Jobless Claims Makes 8% Unemployment Growing Possibility

Every single day we have more reason to believe that the US unemployment rate will break 8 percent next year. Jobless claims rose to a 16 year high last week of 542k, driving the US dollar lower against the Japanese Yen. Continuing claims rose to 4.012 million, the highest level in close to 26 years.

The most powerful aspect of today’s report is the fact that the Veteran’s Day Holiday usually pushes jobless claims down which suggests that if there wasn’t a holiday, jobless claims could easily surpass 550k.

There is no question that the US labor market is in trouble and non-farm payrolls will continue to drop. However, with major layoffs from companies like Citigroup, there is a decent chance that we may see non-farm payrolls double dip like it has in past recessions. In analyzing non-farm payrolls data during the last 3 recessions, we see that at the beginning of an official recession, as defined by the National Bureau of Economic Research, non-farm payrolls start to decline rapidly. However after falling between 200k and 300k, job cuts stall and then pick up once again. We saw this trend in the 1981 to 1982 recession, the 1990 to 1991 recession and during the 2001 recession.

Therefore don’t expect the labor market to stabilize anytime soon – non-farm payrolls should top -300k, stabilize and then revisit that level once again in the first half of 2009.

2001NFP

1990-1991 and 1981-1982 NFP Charts

ZIRP? Recession Trades
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Dollar Soars as FOMC Minutes Trigger Liquidation

Despite false rallies in the currency market, I have stressed that there is no reason for the liquidation to be over. I warned that the currency and stock market rallies were a mirage rather than a bottom and now, the pessimistic tone of the FOMC minutes has forced another wave of liquidation.

Tuesday’s rebound in risk appetite was short-lived as the FOMC minutes revealed that the contraction in the US economy could last well into the summer of 2009.

In light of the 400 point drop in the Dow, the US dollar and Japanese Yen regained strength as repatriation and risk aversion continues to drive demand for the low yielders. The greenback’s recent strength can be most clearly seen in USD/CHF, which hit a fresh 14 month high today.

As we predicted, the FOMC minutes was the trigger for a major move in the currency market. However the moves that we have seen today need to be sustained before we can see a more meaningful breakout of the recent consolidation that we have seen across the currency market.

Something more powerful such as a decision on bailing out the automakers, next week’s GDP report or another surprising abysmal loss in the corporate or financial sector may be needed before we see new trends develop.

FOMC Minutes Confirms that More Rate Cuts Needed

The tone in the FOMC minutes, like the tone of Bernanke’s testimony yesterday was unmistakably dovish. The members of the monetary policy committee lowered their growth and inflation forecasts, talked about the downside risks to growth and how the contraction in the US economy will not temper until the middle 2009, at the earliest. Some members of the committee even openly discussed the need for further rate cuts, which confirms that rates will be lowered again in December. The Fed feels frustrated that interest rates are closing in on zero and acknowledged that it leaves them with little room to maneuver. Fed fund futures are pricing in a 50bp rate cut with a minor chance of a 75bp cut to 0.25 percent. If the Fed cuts interest rates by 50bp and the US economy fails to recover, their credibility will go out the window as the market questions their ability to tap other tools to stimulate the economy.

Automakers, Philly Fed and Leading Indicators

The Big 3 Automakers (General Motors, Ford and Chrysler) were on Capitol Hill today pleading for a bailout. Although a bailout of the automobile industry is inevitable in our opinion, it remains to be seen whether lawmakers will act quickly. The longer this drags out, the more pain it will cause for US equities.

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