Economic Data Continues To Weaken
When Bernanke launched QE3 at the September FOMC meeting one of his key worries expressed during the following Q&A session was that the economy was much weaker than the Fed would like. The hope is, through the implementation of a bond buying scheme, that a push higher in asset prices will translate to an increased "wealth effect". This increase in the wealth effect is then expected to morph into stronger economic growth. Well, that is the hope anyway.
As we showed last week in "QE3 - Bernanke's Folly" there really has been very little effect from QE programs as the transmission system remains broken. Banks are still very reticent to lend due the elevated risks of default in the current economic environment. Businesses have no real need for credit as end demand from consumers remains weak.
The problem that the Fed faces today is that the economy is again beginning to show signs of strain as the economic deterioration in Europe continues to infiltrate the domestic economy. (see "Trade Deficit - Exports A Major Concern" for more discussion)
The most recent release of the Chicago Fed National Activity Report (CFNAI) fills out our STA Economic Output Index (EOCI) for August and the picture does not look good. As a reminder the CFNAI is a composite index of 85 subcomponents which is designed to measure the backdrop of the broad domestic economy. The most recent release showed a sharp drop in the overall index with every subcategory showing mild to moderate declines.
The overall index plunged from -.12 in July to -.87 in August which puts the index at the lowest levels since June of 2009. Furthermore, the diffusion index collapsed from -.08 to -.23 while the more important 3-month average sank from from -.26 to -.47. If we dig down into the subcomponents there was little to be opimistic either. Production and Income crashed lower from a positive .08 read in July to a -.58 print in August. Employment, Unemployment and Hours sank from -.02 to -.04 while the all important Personal Consumption and Housing (the two headline drivers for economic growth) slipped further into the red from -.21 to -.23. More importantly that particular subcomponent has printed negative readings for 67 months straight - so much for that housing recovery we keep hearing about. Lastly, Sales, Orders and Inventories, the important components related to employment, fell from a positive .02 read in July to -.01 in August.
As stated above the CFNAI is the last report to be released reflecting activity in the month of August that comprises the EOCI index. This composite index takes a very broad look at the overall economic fabric combining the CFNAI with several Fed Manufacturing Reports, the NFIB small business survey, the ISM composite index (average of manufacturing and services) and the Chicago PMI report. Historically, when the 6-month moving average of this index has been below 35 the economy has either been in, or was about to be in, a recession.
I have noted that during the summer of 2011 the index pointed to a sub-30 reading but the economy was able to avoid a recession by the culmination of events that are more attributable to "mother nature" than to previous Fed intervention. The March 2011 earthquake in Japan shut down manufacturing and limited exports to the U.S. which created pent up demand that was further exacerbated by the "debt ceiling debate" during the summer. With inventories low as manufacturing came back online pent up demand, boosted by falling oil and energy prices and the warmest winter in 65 years, collided to boost economic growth. Furthermore, the exceptionally warm winter positively skewed the seasonal adjustments in the economic data making most reports appear stronger than reality. The question now becomes whether the "mother nature" effect will again come into play?
The chart above shows ONLY the manufacturing components of the EOCI (stripping out ISM Services and NFIB) versus the ISM Purchasing Managers Index. You can clearly see the end of the warm weather effect, and the return to normalcy, in the economic reports as the skew to the seasonal data is removed.
The Problem For Bernanke And Obama
The problem with the deterioration of the data, which is likely to continue as the economies around the rest of the world continue to slip further into recession, is that this impacts the one area that both Bernanke and Obama are hoping to stabilize before the election - employment.
Both Bernanke and Obama are working closely together to ensure that nothing causes an economic, or market, rout prior to the November election. The EU-IMF review of the Greek debt situation, in order for them to get their next bailout, has been pushed from October until mid-November. EU officials have recently stated that "Obama doesn't want anything on a macroeconomic scale that is going to rock the global economy prior to Nov. 6th." What has been promised to the EU by the current Administration in exchange for their cooperation can only be guessed. However, with the ECB and the Fed fully engaged in bond-buying programs to liquefy the banks - the question will be whether it can rapidly be transmitted into economic strength? History says "no".
The one thing that none of these programs ,and actions, can do which is to spur private employment. Private employment is a function of aggregate end demand - when demand exceeds the ability to supply then companies will increase employment. If we take a look at the employment subcomponent of each one of the indexes that comprise the EOCI index above we see that employment, and expectations there of, have fallen to the lowest levels since 2009. The reality is that with new orders falling, backlogs being worked down and pricing pressures rising - there is little need to increase employment at the current time.
However, while this index is not at recessionary levels as of yet - the deterioration of the index is certainly not going to help Obama come November. Individuals tend to vote with their pocketbook, and if unemployment begins to tick up in the weeks ahead, this could sway the vote away from the incumbent.