US Perspectives: Not Much Chance for 'QE3'

It is a relief that more Fed intervention is not forthcoming.

Robert Johnson, CFA 14.06.2011
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News last week was sparse, and the market didn't react well to the lack of data. Weaker economic import/export statistics out of China and continuing arguments over the Greek debt situation certainly didn't help markets, either.


On the bright side, the U.S. trade deficit improved dramatically, but almost all of that was due to the effects of the Japanese disaster reducing Japanese imports. If sustained, the shrinkage of the trade deficit could help offset at least a part of the negative effects of poor U.S. auto production when calculating second-quarter GDP.


Initial unemployment claims remained elevated at 427,000 but were virtually unchanged from the prior week. Given the Memorial Day holiday, I would have expected a little more improvement (fewer days to process claims and firms tend to make adjustments prior to holidays to avoid having to pay workers for the days off). Consumer credit managed another month of expansion, indicating a greater willingness for consumers to buy and borrow. However, total consumer debt including mortgages, credit cards, and bank loans decreased about 2% in the first quarter, representing its seventh quarter of decline according to the Fed's Z1 report. Meanwhile consumer net worth (all assets minus debts) managed a 4% (annualized rate) improvement during the quarter, no doubt the source of some of the upward movement in consumer spending.


Fed Chairman Blames Supply and Demand Issues for Commodity Inflation

Fed chairman Bernanke also gave a much-anticipated speech that acknowledged a temporary economic slowing. The fact that the speech failed to mention any prospects for additional quantitative easing seemed to unsettle the market. I, on the other hand, was greatly relieved that more easing was not immediately forthcoming. To me, the program didn't do much more than inflate a lot of asset and commodity prices, which in turn started to kill the recovery.


Bernanke did address the commodity bubble in his speech. He went through great pains and a lot of ink to declare that the commodity price gains were due to supply and demand problems, not QE2. Rising emerging-market demand combined with bad weather and issues in the Middle East were the true causes of ballooning commodity prices, according to Bernanke. He does have a point, but I would note that emerging markets were growing even faster at several points earlier in the last decade without a similar rise in commodity prices. The quick spike down in commodity prices when margin increases were implemented for silver and other commodities seems to suggest that there was at least some speculative element to the 2010-11 surge in commodity prices.


U.S. Short-Term Rates Could Remain Low for Some Time

Bernanke did convince me that he would keep short-term interest rates low for some time. Commodity prices are largely set on a world market where demand is increasing. U.S. commodity demand, especially for gasoline, has decreased over the past two quarters. Therefore, rate increases in emerging markets (which are now well under way) will be necessary to slow worldwide commodity demand. Incremental demand from U.S. consumers hasn't been a big source of commodity price increases; therefore, higher rates in the U.S. probably wouldn't do much to slow world price increases.


Trade Deficit Takes a Temporary Dive

As I anticipated previously, the U.S. trade gap fell meaningfully from $46.8 billion in March to $43.7 billion in April. The March reported deficit was also revised downward, potentially aiding the first-quarter GDP calculation. For some odd reason the market consensus was for a trade deficit of $48 billion despite the well-known problems in Japan (after the March 11 earthquake) and the falling prices of petroleum products. Shrinkage of Japanese imports accounted for over three fourths of the improvement in the trade deficit.


While economists raced to raise their GDP forecasts based on the report, my guess is that the lower imports will mean lower inventories, potentially canceling the positive effects of the trade deficit "surprise." Also those Japanese imports are likely to skyrocket, perhaps as early as June, when the supply chain issues are more fully addressed. While most of the good news was on the import side of the equation, exports inched up 1.3% to a new record as a strong world economy and weak dollar continue to drive U.S. exports.


Consumer Balance Sheets Continue to Improve

The Fed's Z1 report showed that consumer balance sheets continued to improve in the first quarter of 2011 as consumer net worth moved up from $57.1 trillion in the fourth quarter of 2010 to $58.1 trillion, a 1.7% increase (4.1% when annualized).


To put that number in some perspective, the U.S. GDP runs about $15 trillion per year and consumer incomes run about $12 trillion per year. In terms of the last economic cycle, net worth got as high as $66.7 trillion when the economy was going full steam ahead in 2007 before stocks and real estate simultaneously collapsed in 2008 and early 2009, driving the figure as low as $48.7 trillion. Now consumers have recovered just over half of what they lost. Stocks and other financial assets have accounted for the largest portion of this recovery with decreased debt not far behind. However, falling real estate prices have continued to weigh on the data as total real estate held is down for both the quarter and for the full recovery.


Another interesting way to look at the Z1 is to look at debt in the major sectors of the economy.


Debt by Sector

1Q 2011

$ Trillions

Consumer Debt


Non-financial Corporate Debt


Government Debt





Consumer debt continues to fall (for the seventh quarter in a row). Business debt is growing again, though modestly. (And I would guess if I net corporate cash against debt, there would have been no increase in the net corporate debt.) Federal government debt increased at double-digit growth rates for seven quarters in a row before settling down to a 7.8% growth rate in the first quarter.


Overall Debt Growth Fell From Near 10% to Just Over 2% During the Last Six Years

The overall slowdown in total debt growth is truly astounding. In the 2000s, debt growth for the whole economy ran consistently at a 7%-9% rate. Over the last two years, debt growth has run a much more meager 2%-4%. In fact, in the first quarter, debt growth was just 2.3%. And the small increase was a result of the federal government deficit increase swamping declines for consumers and state and local governments. By the way, none of the debt data or growth rates are adjusted for inflation, which would probably just about erase the increased debt levels. Later this month I hope to offer a more detailed analysis of the Z1 report, which is only issued once a quarter.


Headline Retail Sales Likely to Show a Decline in May

The consensus forecast for combined, comprehensive retail sales as calculated by the federal government declined by 0.2%, led by a drop in auto and gasoline sales. Excluding autos (but not gas, which will also decline both in gallons and price per gallon), sales are forecast to rise 0.3%, which is still off from April's 0.6% jump.


The numbers themselves don't worry me. In fact, adjusted for inflation (see below), there is likely to be little change in growth rates between April and May. However, I am sure the media will latch on to a potential decline in retail sales as "proof" that this economic recovery was finished. The fact that the decline is due to Japanese supply chain issues and falling oil prices (and maybe poor apparel sales due to cool weather) will be buried well under the negative headline number.


The news this week won't be new--auto sales were released on June 1, individual chain store sales including the poor apparel numbers were released June 2, and gasoline prices are available daily from many sources, including AAA. About the only new data in the report will come from the volatile restaurant sector that was hard hit in April. The normally stable grocery sector has also had its share of violent ups and downs lately.


Inflation: Is Some Slowing Possible in This Week's CPI and PPI Data?

Consensus estimates for this week point to a sharp deceleration in inflation led by lower energy prices. The CPI is forecast to be flat and the PPI to grow a very modest 0.2%. If these results come to pass, they would represent a dramatic improvement over the 0.4 % and 0.8% levels of just a month ago and even higher numbers the month before that.


Falling gasoline prices are certainly helping, potentially taking 0.2%-0.3% from the overall inflation rate. However, I think the projections for no CPI inflation for May could prove a little optimistic. I believe that higher rents and new and used car prices will push the headline inflation number into positive territory, perhaps to 0.1%-0.2% for the CPI. Still, I will take any improvement I can get in this absolutely fundamental indicator.


Maybe Manufacturing's Declines Will Slow in May

Based on adding up individual Japanese auto companies' production figures, auto production in May should remain relatively flat compared to April, after a hefty decline in April. Honda and Nissan data look a little better, while Toyota's production figures were pretty dismal.


Given that auto production was basically unchanged between April and May, combined with some warm weather on the East Coast (driving utility usage), I expect positive small growth in May's industrial production figures. My May growth estimate of industrial production is 0.2% compared with 0.0% growth in April. I suspect that both the Philly Fed and the Empire regional purchasing manager surveys are likely to improve after April's declines, which were largely due to auto issues. Most of the Japanese transplants are starting to gear up for a return to more normal levels of production in June.


Will Inventory Growth Slow?

Inventories moved up 1.1% in April, slower than overall sales growth. Inventories should grow even less in May as production slowed, as did imports, even as consumers continued to buy. Slow growth in inventories, if not reversed by the end of the quarter, could prove to be an impediment to GDP growth in the second quarter.


Housing Starts: More of the Same

Housing starts look to increase modestly from 523,000 in April to 535,000 for May. High prices (relative to existing homes) and poor employment data continue to weigh on the sector. Recall that at their peak, starts ran over 2 million units on an annualized basis. Current run rates aren't meaningfully above the lows of this cycle.



This is an edited version. The article originated from Robert Johnson’s column at


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Robert Johnson, CFA  Robert Johnson, CFA, is director of economic analysis with Morningstar.

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