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Fed Forecasts No Recession in 2008

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
November 27, 2007

IN THIS ISSUE:

1.   The Economy – Good News Before The Bad

2.   Retail Sales Strong Over Thanksgiving Weekend

3.   New Fed Forecast Predicts No Recession In 2008

4.   Will The Fed Cut Rates Again On December 11?

5.   US Dollar Continues To Fall To New Lows

6.   Hillary Falters In Iowa, But Bush To The Rescue

Introduction

For the last year (several years, actually), I have been telling you that a recession was not the most likely scenario, contrary to what you hear from the perma-bears and the gloom-and-doom crowd.  I have told you repeatedly that the US economy would continue to surprise on the upside, and that the equity markets would continue to go higher.

But in light of recent economic data and the swoon in the stock market over the last month or so, fears of a recession in 2008 have heightened.  There is a broad consensus that the US economy is slowing down in this final quarter of the year, and that 2008 will see even slower growth in GDP.  As a result, even some respected economists and market analysts are increasing the odds for a recession in 2008.   

Yet in a newly expanded economic forecast released last week, the Federal Reserve itself forecasted that a recession in the US next year is not likely.  Yes, the Fed dialed back its growth forecasts for next year in the report last week, but as you will read below, the Fed does not expect a recession next year.

As I will discuss below, despite forecasts that economic growth will slow significantly from recent quarters in 2008, we have a long way to fall before we remotely approach recession levels.  A recession is defined as two back-to-back quarters of negative growth in GDP.  At the very least, that would take some time, barring another 9/11-type negative shock.

The US economy is led by consumer spending, as long-time readers undoubtedly know.  Consumer spending now accounts for over 70% of GDP.  And consumer spending has surprised on the upside for over two decades.  Despite warnings from the negative crowd, consumer spending just continues to surprise, even now.

For example, most analysts have been predicting a disappointing holiday season for US retailers, since consumer confidence has plunged over the last three months. Yet sales at the nation’s largest retailers spiked over 8% above last year’s levels last Friday after Thanksgiving.   

The above is just a taste of what we will get into this week.  Plus, at the end, I’ll briefly comment on Hillary’s fall in the polls in Iowa, and – believe it or not – why President Bush seems to be coming to her rescue.  This is very bizarre!  Let’s dive in and see what we will learn as we go along.

The Economy – Good News Before The Bad

As noted above, it is widely agreed that the economy has slowed down in the 4Q.  I will give you the latest economic reports below, but first, brace yourself for some good news.  On Thursday of this week, the Commerce Department will release its second estimate on 3Q GDP.  In its preliminary report, the government estimated that 3Q GDP rose 3.9%, which was well above expectations.  But it now appears that 3Q growth was even higher than 3.9%.  The consensus expectation is for the Commerce Dept. to increase 3Q GDP to 4.8% (annual rate) on Thursday.  Several forecasters are expecting a number of 5% or above this week.

Now for the bad news.   Many forecasters believe that if the 3Q GDP report on Thursday comes in at 4.5% or above, the Fed will be hesitant to lower interest rates at the next FOMC meeting on December 11.  That remains to be seen, however.  The housing and subprime numbers continue to deteriorate overall, and there is little disagreement that this sector is what is slowing down the economy.  So the Fed still has plenty of motivation to lower rates as I will discuss below.

The Index of Leading Economic Indicators (LEI) fell –0.5% for October.  That is a fairly big monthly drop, although not unprecedented.  The LEI has been in a sideways pattern all year, despite the big gains in GDP in the 2Q and 3Q.  Now it appears to be rolling over to the downside, which is consistent with the slowdown in the economy in the current quarter.  The question is, how much on the downside?

Consumer ConfidenceMeanwhile, consumer confidence has declined for the last four months.  Take a look at the chart at left.  The Consumer Confidence Index is an important indicator since it is a proxy for consumer spending which makes up apprx. 70% of GDP.  Based on the decline in the index recently, we would normally expect a marked drop-off in consumer spending; however, retail sales rose 0.2% in October.

As I will discuss below, sales at major retailers were strong over the Thanksgiving weekend.  Perhaps that’s because consumer confidence, as measured by the University of Michigan’s Consumer Sentiment Index, rebounded somewhat by mid-month. 

On the manufacturing front, the ISM Index fell to 50.9 in October, down from 52.0 in September.  Industrial production fell 0.5% in October.  The latest report on durable goods orders will be released tomorrow (Wednesday) and is expected to show another monthly decline for October, following a 1.7% decline in September.

In balance, the recent economic reports were indicative of an economy that is slowing down.  But it is important to keep in mind that the economy is slowing down from very strong levels in the 2Q and 3Q.  Consumers continue to spend, so there is no reason to believe that a recession is just around the corner as the gloom-and-doomers would have us believe.

Retail Sales Strong Over Thanksgiving Weekend

As we headed into the Thanksgiving holidays, US retailers were prepared for a disappointment.  With investors and consumers getting more nervous about the rise in oil prices, the meltdown in the mortgage market and the housing market and the latest decline in the stock markets, the outlook for the holiday shopping season had turned quite cautious.  Sales at major retailers softened in September and October.

Moody’s Investor Services made the following forecast for this holiday season last Wednesday just before Thanksgiving: “We expect (retailers') operating performance to soften over the next few months as the prolonged downturn in the housing market, a cooler labor market, high gas prices and tighter consumer credit result in a slowdown in consumer spending.”

Surprise, surprise!  U.S. consumers spent $10.3 billion on holiday purchases the day after Thanksgiving, 8.3% more than a year earlier.  The 8.3% jump in spending more than doubled forecasts by retail trade groups.  ShopperTrak, the Chicago-based retail research firm stated over the weekend: “Consumers remained resilient and proved they were willing to spend even with oil prices rising and other economic pressures.”

ShopperTrak noted, however, that while there were more shoppers than expected, the average spending per customer was down 3.5% from yearago levels on the Friday after Thanksgiving.  Overall, ShopperTrak predicts that holiday shopping sales through Christmas will increase 3.6% this year, down slightly from the 4.8% gain last year.  That is certainly not suggestive of an economy that is going into a recession.

New Fed Forecast Predicts No Recession In 2008

In an expanded report released last week, the Federal Reserve revealed its economic outlook for 2008 and beyond.  While the Fed lowered its previous growth forecast for 2008, it does not believe we will see a recession next year.  The Fed expects the US economy to grow by 1.8%-2.5% in 2008.  That is down from its earlier forecast of 2.5%-2.75% growth in GDP next year. 

The Fed cited the ongoing problems in the housing market, the credit crunch and high oil and gasoline prices as the main reasons for the downgrade in their forecasts for growth in 2008.

As for the final quarter of this year, the Fed predicted growth to slow to around 1.5%.  We won’t see the advance GDP estimate from the Commerce Department until late January, but a number in the 1.5%-2.0% range should not come as a big surprise.   

The latest expanded report from the Fed also included forecasts for growth in 2009 and 2010, along with inflation and employment projections for those years, as shown below:


2008 2009 2010
GDP Growth 1.8-2.5% 2.3-2.5% 2.5-2.6%
Unemployment Rate 4.8-4.9% 4.8-4.9% 4.7-4.9%
PCE Inflation Rate* 1.8-2.1% 1.7-2.0% 1.6-1.9%
PCE Core Inflation* 1.7-1.9% 1.7-1.9% 1.6-1.9%

* On November 14, Fed Chairman Ben Bernanke announced that the Federal Reserve Open Market Committee (FOMC) will primarily use the Personal Consumption Expenditures Index (PCE) as its main gauge of US inflation, rather than relying primarily on the Consumer Price Index as in the past.  According to Bernanke, the Fed considers the PCE Index as a better indicator of trends in inflation.

These new long-range forecasts from the Fed are very interesting on several levels.  First, they tell us that the Fed does not expect a recession for the next three years.  I would be the first to say that such a forecast could well be too optimistic.  Let us not forget that these are only projections, and as such, they are subject to revision.

Second, the Fed continually warns us that there are inflation risks in the economy.  Yet the inflation forecasts above suggest that the Fed believes both “headline” inflation and “core” inflation (minus food and energy) are going to go down in the next few years. 

Some analysts worry that if inflation fails to fall to the levels projected above, the Fed will not lower interest rates going forward.  However, I would argue that if the Fed is remotely correct in its inflation forecast, that should mean the FOMC has room to lower short-term interest rates several more times if needed, as I have suggested recently.

Finally, the Fed expects the unemployment rate to remain below 5% for the next three years.  That, too, is indicative of a growing economy and no recession.  Again, these forecasts may be too optimistic. 

Will The Fed Cut Rates Again On December 11?

The interest rate futures markets are priced for another quarter-point cut in the Fed Funds rate on December 11 when the FOMC meets next.  The new forecasts above suggest that the Fed is open to cutting rates again.  However, certain Fed officials have said that the decision to cut rates on October 31 was a “close call.”  Upon reading those minutes, however, it is clear to me that the Halloween rate cut was not a close call; in fact, there was only one of the 10 FOMC members who voted against it.

In reading the minutes, it seems clear to me that the Fed is most worried about the economy for 2008.  In particular, the FOMC members appear convinced that the biggest risk to their economic forecasts is the possibility that the housing slump and related credit crunch will get even worse next year.  They noted concerns about consumer spending if home prices fall significantly further next year.  Here are some of the Fed’s “Risks to the Outlook”:

“Most [FOMC] participants viewed the risks to their GDP projections as weighted to the downside and the associated risks to their projections of unemployment as tilted to the upside. Financial market conditions had deteriorated sharply in August, and although there had been some signs of improvement since then, [credit] markets remained strained. The possibilities that markets could relapse or that current tighter credit conditions could exert unexpectedly large restraint on household and business spending were viewed as downside risks to economic activity… The potential for a more severe contraction in the housing sector and a substantial decline in house prices was also perceived as a risk to the central outlook for economic growth. But participants also noted that in recent decades, the U.S. economy had proved quite resilient to episodes of financial distress, suggesting that the adverse effects of financial developments on economic activity outside of the housing sector could prove to be more modest than anticipated.

Participants were more persuaded than they had been in June that the decline in core inflation readings this year represented a sustained albeit modest step-down rather than the effect of transitory influences. Nonetheless, participants saw some upside risks to their inflation projections. Recent increases in energy and commodity prices and the pass-through of dollar depreciation into import prices would raise inflation over the medium term. That increase could lead to an upward drift in inflation expectations that would add to price pressures and could be costly to reverse.

The possibility that financial market turbulence could have larger-than-anticipated adverse effects on household and business spending heightened participants’ uncertainty about the outlook for economic activity. Most participants judged that the uncertainty attending their October projections for real GDP growth was above typical levels seen in the past. In contrast, the uncertainty attached to participants’ inflation projections was generally viewed as being broadly in line with past experience, although several participants judged that the degree of uncertainty about total inflation was higher than usual, reflecting the possibility that the recent volatility in food and energy prices might persist.”

What the above tells me is that the Fed is less confident in its long-range projections than it has been in the past, particularly because of the housing slump and the credit crunch.  I think they are quite correct to have such concerns.

If I read correctly between the lines, I would say the FOMC feels that if it can get through 2008 without a recession developing, then 2009 and 2010 should be just fine.  If that is their primary mindset, then I think they will be willing to cut rates several more times if needed in 2008.

Now, whether they cut another quarter-point in December remains to be seen.  Several Fed officials have made public statements suggesting that another cut on December 11 is unlikely.  Certainly, a failure to cut again on December 11 will spell bad news for the equity markets, at least for a day or two.  Some would argue that these public comments about no rate cut in December have already contributed to the downward correction in stock prices in recent weeks.

The good news, I think, is that the Fed does appear to be willing to lower short-term rates more if need be.  My guess is that if Chairman Bernanke wants another cut in December, he’ll get it.

US Dollar Continues To Fall To New Lows

The US dollar continues its downward slide against most major currencies.  As of yesterday (Monday), the dollar fell to an all-time low against the euro which is trading near $1.49.  The dollar fell to a two-year low of 108 against the Japanese yen.  The dollar is at a 26-year low against the British pound which now costs almost $2.07. 

The falling dollar has advantages and disadvantages. The weaker dollar attracts more visitors from foreign countries since goods in US stores are much cheaper for them.  On the other hand, if you wish to, or have to, travel to foreign countries – especially Europe, Japan or even Canada – you’ll be paying a lot more for your purchases.

A lower dollar also means that our exports are cheaper for foreign purchasers, which explains why US exports are soaring.  On the other hand, a weaker dollar means that our imports are more expensive generally speaking. 

Thus, the weaker US dollar has the benefit of reducing our trade deficit, the difference between the amount the US imports from the rest of the world and the amount it can sell to the rest of the world.  On the other hand, a weaker dollar can lead to an increase in inflation.  Arguably, the weaker dollar is contributing to higher oil prices.

The dollar last peaked in October of 2000 when $1 would buy you 1.21 euros, whereas today $1 only buys you about 0.66 euro.  Despite its seven-year slide, the US dollar remains the world’s “reserve currency,” and oil is still priced in dollars.  While some oil exporting nations are making noise about pricing oil in euros or some other currency than the US dollar, that is not likely to happen anytime soon.

There is also speculation that some countries that have huge currency reserves in US dollars will decide to convert those dollars to euros or some other major currency.  China, it is said, is considering converting some of its massive dollar reserves to euros, and there are fears that the greenback could go into freefall, which would create all sorts of major problems.

Quite frankly, that is not likely to happen.  The US is the largest economy and the largest importer in the world.  If the dollar goes into freefall, the US economy goes down with it.  If the US economy goes in the tank, so will the rest of the world.  This is why international monetary authorities will step in to support the dollar if necessary.

The Fed obviously doesn’t see a dollar freefall happening either.  No such currency crisis is factored into the Fed’s rather benign long-term economic and inflation targets.    

We frequently get calls from clients and readers that want to know how they can profit from the dollar’s decline.  There are very liquid futures markets in all of the major currencies, but I don’t recommend that individual investors trade in the highly leveraged, highly volatile futures markets.

One way I have discussed in the past to take advantage of a falling dollar is EverBank World Markets in St. Louis.  EverBank offers Certificates of Deposit denominated in any one of 15 major foreign currencies.  They also offer multi-currency CDs for additional diversification.  EverBank has been offering these foreign currency CDs for many years, and I have never had a complaint about their service – quite the opposite actually.  You can reach EverBank at 800-926-4922.

While I do not recommend specific mutual funds in this E-Letter, there are several funds and ETFs available that are direct currency plays, including several that are designed specifically to take advantage of a drop in the US dollar.  In the Rydex Euro Currency Trust (FXE:NYSE), each share of the fund represents ownership of 100 euros. The fund benefits if the dollar falls relative the euro.

The ProFunds Falling U.S. Dollar Fund (FDPIX) and the Rydex Weakening Dollar Fund (RYWBX) are indexed to the NYBOT U.S. Dollar Index (USDX). The Dollar Index also has a heavy weighting in euros (57%) as well as exposure to the yen, British pound and Canadian dollar, among others.  ProFunds Falling U.S. Dollar fund is designed to deliver a 1:1 inverse of the dollar index’s performance, whereas the Rydex Weakening Dollar fund is leveraged to deliver a 2:1 inverse of the dollar’s performance.  Both funds represent a way to “short” the US dollar.

The Merk Hard Currency Fund (MERKX) is an actively-managed fund with exposure to the Swiss franc and Australian dollar.  In addition to currencies, the fund also owns foreign bonds and streetTRACKS gold (GLD:NYSE) shares.  The Franklin Templeton Hard Currency Fund (ICHHX) is also actively managed.  It holds mostly foreign treasury bills and currency swaps, with primary concentrations in Europe, Canada and the Far East.

Another popular fund offering a currency play is the PIMCO Developing Local Markets Fund (PLMIX). This open-ended mutual fund has exposure to more than 30 foreign countries, including many emerging market currencies.

There are several other currency-oriented mutual funds on the market and more are being trotted out as the US dollar continues to fall.  But are these newer offerings coming to the party too late, as is often the case with trendy mutual funds?   Obviously, I don’t know the answer. 

One caution, however: I would not recommend “shorting” the US dollar at this point.  The market is extremely oversold, and just about everyone is bearish.  Many currency traders and speculators around the world believe the US is headed for a recession, but as I have discussed earlier, a recession is not the most likely scenario.  

The point is, I think it’s too risky to hop on the short-the-dollar bandwagon at this point.  Again, I am not recommending that you invest in any of the mutual funds discussed above.  Should you wish to check them out, be sure to read the prospectus carefully and determine if the fund(s) is suitable for your financial situation.

Yes, the US dollar may fall further before finding support; on the other hand, as more people learn about the Fed’s long-term economic forecasts discussed above, the dollar could reverse higher.  Even if the major trend is still down, a mere correction on the upside could be quite nasty at these very depressed levels.

Hillary Falls Behind Obama In Iowa

For the first time since the presidential campaign began, Hillary has fallen behind Obama in a major national poll.  The Washington Post/ABC News Iowa voter poll released last week was a shocker: Obama 30%, Hillary 26% and Edwards 22%.   

The “internals” of the poll were even worse for Hillary.  Among others, the poll found that Obama is running even with Hillary among Iowa women voters – he’s pulled way up with women.  Of the 55% of Iowa Democrats who prefer change (versus the 33% who want experience), Obama leads with 43% to Edwards’s 25% and Hillary’s 17%.

It’s too early to conclude that Hillary will lose in Iowa, but her numbers have been falling for the last month, while Obama has been gaining on her over the same period.  Even if she loses in Iowa, that doesn’t mean she won’t win the nomination.  Be sure to read Dick Morris’ excellent analysis of this latest poll in the Special Articles below.

Bush Comes To Hillary’s Rescue… Say What?

In what was a shock to Democrats and Republicans alike, President Bush seemed to come to Hillary’s rescue last week as she continued to slide in the polls.  What, you didn’t hear about this?  In an interview last Tuesday with ABC Nightly News Anchor Charlie Gibson, President Bush said something very surprising about Hillary.

When asked by Gibson if Bush thought Hillary has the experience to be president, Bush responded: “No question, there is no question that [Hillary] Clinton understands pressure better than any of the candidates, you know, in the race because she lived in the White House and sees it first — could see it first-hand.”

Bush also said that Hillary “understands the klieg lights,” a reference to being under the pressure of the presidential spotlight.  By doing so, Bush lent credence to Hillary’s campaign assertion that she could “hit the ground running” if she were elected president.

Now why in the world would George W. Bush be coming to Hillary’s rescue at a time when her lock on the Democratic presidential nomination is diminishing?  Frankly, I am stunned and have no idea.  But political guru Dick Morris, who worked for the Clintons for years, has some very interesting thoughts on the subject – be sure to read his latest article on this in the Special Articles below.

I’ll stop here and let you go on to read the very interesting Morris columns below.

Best regards,

 

Gary D. Halbert

SPECIAL ARTICLES

Fed Cuts US 2008 Growth Forecast (From the BBC)
http://news.bbc.co.uk/1/hi/business/7104575.stm

Poll: Obama Leads Hillary in Iowa
http://www.newsmax.com/morris/obama_hillary/2007/11/21/51258.html

Bush Rescues Hillary
http://www.newsmax.com/morris/morris_bush_hillary/2007/11/23/51743.html

 

 


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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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