The US economy has now lost six million jobs since the recession started in December 2007, with most of those losses occurring in the last six months. The record of 17 successive monthly job losses matches that reached during the 1981-1982 recession. Clearly, the latest employment data support the view that we are bottoming out, but while the rate of decline in unemployment (as in many economic statistics from trade to industrial production) is abating, current elevated levels will underpin the new culture of thrift apparent among US consumers. The GM/Chrysler bankruptcy will hit jobs this Summer; although manufacturing only employs tens of thousands, auto dealerships employ about 1m people in the US. The savings rate, already at 5.7% as of April, is likely to hit 7-8% by year end. In fact, when marginally attached and involuntary part-time workers are included, the rate of unemployed or underemployed workers hit 16.4% last month, up from 15.8% in April and almost twice the level of a year ago.
On that basis, it's unsurprising, but also unsustainable, that government transfers have now reached over 16% of personal income, up over a third in a decade. While the terrifying freefall sensation engendered by last Autumn's Lehman collapse and TARP fiasco is now over for the US and global economies, we are going to level out at a much lower altitude. There can be no return to the leverage fuelled boom conditions of 2003-7, given the scale of the aggregate debt burden faced by the US at about 400% of GDP. A US recovery will be grindingly slow and capped at maybe 2%, suggesting unemployment will almost certainly remain near double digits through 2010 as projected by the CBO . One slight positive is the declining demographic trend in new labour force entrants, although medium-term this will likely add fuel to the inflationary barbeque being cooked up by central banks from China to the UK.
As the Fed surveys the financial markets, it can certainly take some comfort from declining measures of market stress such as 2 year swap spreads, but must be getting concerned at the implications of soaring energy prices and long bond yields. In combination, higher mortgage rates and gas prices threaten to choke off an incipient recovery, and yet both result indirectly from the Fed's own crisis strategy. A rebound in hugely oversold equity markets was inevitable after the 57% decline from the October 2007 highs, and in early March there were many bargains among blue chip stocks and corporate bonds, particularly in the resources and materials area I favored. However, in this latter stage of what still looks like a bear rally, momentum chasing liquidity has become the driving force.
Quantitative easing and other unconventional Fed strategies have led to a surge in money supply which has ended deflation fears but also effectively devalued the dollar, and by implication the value of financial dollar assets, creating demand for monetary alternatives or “real assets.” Although the scale of output gaps or 'slack' is high right now, and generally assumed to mean that CPI inflation won't be an issue, asset market inflation, coupled with currency debasement is the immediate effect of extremely loose monetary policy, and will remain the case until financial markets anticipate a clear exit strategy from this policy. That was why I favored an inflation hedging strategy back in February. Effectively, markets will demand a 'show us the money' tightening of monetary policy via higher rates and/or a withdrawal of direct liquidity support for the banking system, or else clear evidence that the recovery is faltering. It is possible that a failed bond auction in a major economy this Summer, in what will be a remarkably busy schedule for issuance (with $12trn to raise in 2009), may force the issue prematurely. Either way, the current complacency may be shaken. Speculative investors, surfing a wave of excess liquidity, may by driving commodity prices and bond yields to levels unjustified by fundamentals at this point, undermining the very economic recovery on which their optimism depends.
