Category: Economic Indicators

What do you think about US Inflation rate in a year?

Posted by admin Jul 13, 2009 No Comments »

Inflation increase for May 2009 on a seasonally adjusted basis was 0.1% and on the annual basis it has fallen by -1.3% over the last 12 months. Core inflation, which excludes food and energy, increased by 0.1% in May whereas energy index increased by 0.2% and food index decreased by -0.2%.

I believe that going forward core inflation numbers would see small increase as housing costs stabilize or increase a little further. Also, energy prices may see continuing increase while coming off their recent lows. As you can see from the graph below, we have seen a roller coaster of a ride in the price of gasoline. From the highs of $3.5/gallon in the middle of 2008 to lows of $1.0/gallon at the end of 2008 to now around $2.0/gallon, gasoline prices are crucial to the inflation numbers. It is apparent that gasoline prices have crept up, and, I believe, that they would continue to increase staying between $2-$2.5/gallon the next year and increasing inflation marginally.

gas prices
Additional factor to consider is the money supply relative to the GDP. M2, which is readily available funds, has been increasing at a faster pace than the US GDP.

m2-gdp

This relative increase would continue to put inflationary pressures on the US economy as more money chases same amount of goods and services. Considering both of these factors, I believe, that by the end of 2009, we may see inflation of around %1.0-%1.5 on a 12 month basis.

Forecast for Home Prices!

Posted by admin Jul 07, 2009 1 Comment »

Before we look ahead, it would be good to start by looking at where we are currently.

People wanted to achieve their “American dream”, which is really one of two things. Either it is a “rags to riches” story, or buying a big home. Congress pushed all kinds of programs to achieve more than 70% home ownership. Some of the programs were specially designed to increase homeownership among low income population. There is nothing wrong in these goals, but nobody paid attention to the means that were employed to achieve those goals. It almost became “by any means necessary”, and lending and underwriting standards went by the wayside. The result – a significant increase in number of foreclosures and defaults among mortgages and all kinds of mortgage related derivatives as people couldn’t afford outsized mortgages they had taken on at “teaser” low rates.

Mounting losses among banks increased counterparty risk to such an extent that banks stopped lending to anybody, not even to the most credit-worthy banks leave alone ordinary citizens. “Toxic Assets”, as they became known, jammed the whole economy which depends heavily on free flow of credit. As credit dried up, it became increasingly difficult for people to re-finance their mortgage and escape increased payments. This contributed further to foreclosure and defaults.

Combination of grinding halt to the economy, drying up of credit, and increase in foreclosures put significant downward pressure on the housing market and home prices. As we can see in the graph below, FHFA housing index was at its highest level in 2^nd quarter of 2007. Since then it has decreased by more than 10%. FHFA Index is seasonally adjusted for purchase-only homes that were “conforming”, i.e. they met guidelines set forth by Fannie Mae and Freddie Mac.

Case-Shiller and FHFA Indices

S&P Case-Shiller Home Price Index is more sensitive to home price changes as it includes all home sales and not just conforming ones. Since its peak in 1^st quarter of 2006, S&P index has declined by more than 31%.

So what about the forecast?

I believe that the factors that caused home prices to go down will again play a significant role in reversing home price decline. Just to summarize again

1) Economy: It needs to show signs of recovery. GDP change needs to move into positive territory to give people confidence to spend on big purchases, such as housing.

2) Credit Availability: Banks are already showing signs of increased risk tolerance after their initial pull back. The pendulum had swing too far the other way. Banks need to make decisions based on credit worthiness of the borrower rather than fear.

3) Foreclosures and Defaults: First, the inventory of foreclosed home that are putting downward pressure on home prices need to be depleted. Second, further foreclosures and defaults need to be reduced so that inventory does not build up again. Government has already initiated a number of programs to modify and refinance loans to prevent foreclosures. I believe these programs are definitely a step in the right direction.

All together, I believe that credit is already becoming available. Foreclosure inventory should continue to go down and may take 6-12 months to clear out. Economy, on the other hand, might take much longer time to recover. It also looks like it maybe a jobless recovery, with economy getting better but taking much longer to reduce unemployment. This delay in economic recovery and delayed reduction in unemployment may push improvement in home prices towards the tail-end of 2010 or early 2011.

Where do you see the US dollar in the near term?

Posted by admin Jun 30, 2009 No Comments »

I am bearish on the US dollar. In my earlier post on the effect of continued issusance of treasuries by the US government on inflation, I had mentioned that China and Japan might get skeptical of the US Government’s deficit and stop buying more treasuries. This will have the effect of devaluing the US dollar.

Apart from looking at demand for dollar denominated assets by foreign investors, I would also like to explore domestic demand for dollar. The US economy is going through a recession. This recession has been accompanied by a considerable slowdown in consumer spending and borrowing.

In my commentary on GDP and Savings Rate, I had shown that personal expenditure has been decreasing at a steady pace. People are spending less and borrowing less. They are de-leveraging their personal balance sheets.

The US consumer is not borrowing to buy houses, either because they no longer qualify due to stricter underwriting guidelines or just waiting on the sidelines for better prices. He is also not borrowing as much to buy cars or white goods or furniture etc.

As you can see below, borrowing by the US consumers has been decreasing since the beginning of 2006 and businesses since the middle of 2007.

d2_17694_image003

I believe that this weakness in consumer and business borrowing will continue in the near term thus continuing to put downward pressure on the US dollar.

Comments on GDP and Savings Rate

Posted by admin Jun 29, 2009 4 Comments »

I had mentioned earlier that GDP should continue to reverse its downward trend. The economy, measured by Gross Domestic Product (GDP), which is the sum of all good and services produced in the country (thats why, “domestic”) had shrunk by 6.3% in the 4th Quarter of 2008.

Latest figures show that GDP contracted by a lesser degree at 5.5% (revised) in the 1st Quarter of 2009. This revised figure was slightly better than the original (or preliminary) estimate of the GDP in 1st Quarter. Looking at the recent trajectory of GDP growth in the graph below

GDP

we can see a small glimmer of hope already and I expect that GDP will continue to shrink by a lesser degree in the 2nd Quarter of 2009.

Why do I think that GDP will continue to improve?

The most important reason is personal spending or in technical terms “Personal Consumption Expenditure or PCE”. Personal spending has been coming down as people have become fearful of losing their jobs and increased emphasize by various financial gurus to build “emergency funds”. This has also resulted in personal savings going up considerably. As you can see below,

pi0509_19705_image001

personal spending as % of personal income (technically Disposable Personal Income, or DPI) has come down from 94% in October, 2008 to 90% in May, 2009. As personal consumption makes a big portion of GDP, it also explains the drop in GDP numbers. I do not foresee this drastic cutback on personal expenses going forward thus improving current quarter and next quarter GDP figures.

You can also see from above graph that personal saving as % of income has shot up to around 7%, some of the highest levels we have seen in recent times. I believe that people will start to splurge a little and these savings rates would come down.

So, I believe that people will start to save less with savings rate coming down from recent high levels as well as increase their expenses. The increased personal expenditure will contribute to improvements in the GDP going forward.

Next 6 month Forecast

Posted by admin Jun 17, 2009 1 Comment »

Let me try to pen my views on how things might turn out in the next 6 months.

As far as equity markets goes, I expect them to remain choppy. The market will swing up and down as positive and negative news get incorporated into equity prices. People are starting to look at how the rate of decline is slowing down, but this is just trying really hard to find something positive. Until there is consistently positive fundamental news, the stocks will continue their sideways movement.

Inflation will continue to inch upwards. The price of oil which impacts most of the components of the CPI has already moved up from its lowest levels. The increase will continue in next six months and we can expect to see moderate increase in inflation numbers.

There is no room to decrease interest rates any further. I expect the Fed to keep them steady for the next 6 months as good news will be combined with bad news and there is not going to be any concerted demand for increasing the interest rates to counter rising inflation.

I expect economy to continue to be weak, especially in business spending and investments. Consumers might get tired of saving and may splurge a little adding some positive news to the GDP numbers. I expect to see continued reversal in the downward GDP trend (even if it is by small measure).