Business Conditions: Mixed Signals
February 17, 2009
By David Cho & Richard Berner | New York
Indicative of the uncertainty currently surrounding the US economy, the Morgan Stanley Business Conditions Index (MSBCI) yielded mixed signals in early February. On the heels of moderate recovery from three consecutive months of record lows, the headline index reversed course and dropped by six percentage points from 27% to 21% in early February. Before seasonal adjustment, the composite improved by three points, or less than the typical rise in February from what is the weakest month of the year. The question now: Do these data signal a turning point for the economy, or is there still much more pain ahead?
Reasons for optimism. This month’s canvass offered several reasons to hope that US firms were approaching the proverbial corner. Most significantly, the Fed’s efforts to restart the intermediation process, according to our analysts, are bearing fruit. Credit conditions expanded for the first time in over a year-and-a-half – cracking the 50% barrier from a level of 35% in January and 6% at the low, and returning to a level last seen in May 2007. Moreover, the improvement was broadly based: With the exception of utilities, a clear majority of firms in every other sector reported that credit availability had either remained the same or become easier over the past three months. In fact, at least half of all companies in the energy, healthcare and telecommunication services spaces indicated that the current credit environment was relatively less restrictive than in recent periods. And somewhat reassuringly, other external indicators have also begun to provide similar signs of improvement in financing conditions. For instance, according to the most recent Federal Reserve Survey of Bank Lending Practices, the percentage of senior loan officers who reported tighter standards for C&I loans to large and medium firms fell from 83.6% in 4Q08 to 64.2% in 1Q09. While these findings do not yet reflect an official easing of lending standards by any stretch, they may be interpreted as encouraging signposts on the road to eventual recovery. Similarly, our analysts’ overall near-term outlook reached new levels of optimism in February. The business conditions expectations index rose 18 points to 36% this month – the highest reading for this indicator since summer 2008 and the intensification of the credit turmoil last fall. From an industry perspective, analysts in the industrials, materials, and utilities domains expressed the most confidence in their firms’ operations over the next six months. Further, a sizable fraction of respondents from energy, financials, and healthcare expected that, at the very least, business conditions would not deteriorate further for the companies under their coverage. These results were roughly corroborated by the Philadelphia Fed Business Outlook Survey, which reported a nearly 18pp improvement in area manufacturers’ expectations for future business conditions in January. Signs of further distress. Nonetheless, despite these comparatively positive developments, this month’s MSBCI also presented numerous signs that difficulties still loom on the horizon. For instance, in direct contradiction to the marked improvement in our analysts’ overall expectations for the next six months, our survey’s other forward-looking components exhibited either no change or a genuine decline. Against the backdrop of the nearly 600,000 non-farm payrolls that were shed in January and our forecast that unemployment will approach double-digits by year-end (see Recovery Coming but ‘Back-loaded’ Stimulus Means Weaker Near-Term Outlook, February 9, 2009), none of our analysts expected their firms to increase hiring over the next three months – repeating the same miserable outcome from January. Likewise, only 10% of respondents believed that their companies would increase capital expenditures in the near future. In our view, this response makes perfect sense; given the slump in corporate profits, decline in operating rates, and emergence of excess capacity, we believe that firms will cut back on capex for most of 2009. Perhaps most troublingly, the advance bookings index completely erased last month’s gains and fell four points to 11% in this month’s canvass. If this measure is any indication of the pace at which output will fall, then firms may encounter considerable hurdles in the months ahead. Further, this month’s canvass indicated that companies under our analysts’ coverage have continued to lose their grip on pricing conditions. The price index fell five percentage points in February to 43% – still within the mid-40s range in which this gauge has bounced around over the past four months, but reversing the modest gains made in December and January. While some of this decline is clearly attributable to the substantial drop in commodities prices over the past several months, we believe that the global recession and the resultant economic output gap are intensifying this erosion of firms’ pricing power (see Output, Prices and Profits – The Vortex, February 3, 2009). On a micro level, a majority of respondents in every industry outside of consumer staples, healthcare, and utilities reported either reductions in or no changes to prices. This lethal combination of deteriorating consumer demand and steep operating leverage is wreaking havoc on firm profitability. Not surprisingly, our analysts’ outlook on both earnings and margins remained predominantly bearish this month. A paltry 10% of analysts reported that the quality of their companies’ earnings had improved over the past year. And although this measurement was a slight improvement over the single-digit readings that we had witnessed over the previous three months, the primary reason for these gains was a reduction in expenses rather than an increase in top-line growth. Moreover, slightly more than half of all analysts indicated that the recent strengthening of the US dollar had materially eroded their companies’ bottom-line results. In addition, nearly three-quarters of respondents perceived downside risks to their earnings projections, and an even higher percentage of survey participants expected their firms’ margins to either shrink or remain the same in 2009. One final reason for concern. American firms have already undergone a significant amount of restructuring during the current downturn. However, given the staggering array of headwinds confronting the US economy and the increasing likelihood of a deep, prolonged recession, we believe that these trends will ultimately persist through the rest of the year. Unfortunately, this month’s survey results appeared to confirm this view. According to the February MSBCI, approximately 75% of respondents expected their industries to undergo at least some consolidation over the next 12 months. Further, nearly half of our analysts believed that some firms within their industries were at risk of failure – with a majority of survey respondents in the consumer discretionary, financials, healthcare, information technology, and materials sectors expressing such sentiments. Thus, despite some improvement in the MSBCI in recent months, there are still downside risks to our recovery call.
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GDP Downgrade, but Up-Down Risks Are Balanced
February 17, 2009
By Takehiro Sato | Tokyo
The Global Economy in Oct-Dec Deteriorated Beyond Our Assumption as of December Our downward revision this time is a response to a lower launch pad resulting from a sharper-than-expected deterioration in the global economic outlook for Oct-Dec and the first half of 2009. The GDP contraction in Oct-Dec has significantly reduced the baseline for annual growth, particularly in Japan. Japan’s annualized exports virtually halved in Oct-Dec, slashing the net export contribution to -8.7pt annualized. The strangulation of trade finance (export letters of credit, etc.) appears to have directly constrained manufacturing production and exports. There is now some patchy evidence of a thaw, however, with trade finance resuming and improvement on the margins in some domestic and overseas sentiment-related indicators. Also imports have begun to drop sharply since December in response to the export slowdown. While this is clearly a reflection of worsening domestic demand, it should mean that net exports in Jan-Mar make a slightly positive contribution. The outlook for 2009 in fact depends greatly on how the Jan-Mar quarter is viewed. Capex may be further depressed than in Oct-Dec, and personal consumption could also maintain negative growth. However, sentiment-linked data in Japan and abroad (ISM in the US, Ifo in Germany, PMI in China, Economy Watchers Survey in Japan) have in general been showing a marginal improvement in the degree of deterioration. There is some danger in disregarding these glimmers of hope entirely. We now see the risks in our forecast as evenly weighted towards upward and downward revisions. Our bear case this time accounts for a greater downside to net exports in Jan-Mar than we think is likely. Growth Sinks to Post-War Low, -3.3%, Even in Our Bull Case In our base case, the negative base effect puts growth in CY2009 at -4.0%, which is by far the worst in the post-war period. Even in the bull case, the figure of -3.3% will be worse than that in the financial turmoil of 1998. In the bear case, growth is -5.0%. (For F3/10, the bull case is -2.3%, the base case is -3.0% and the bear case is -3.9%.) However, when disregarding the base effect, net GDP growth in 2009 comes to -1.0pt in the base case, a far narrower negative margin than in 2008 at -1.8pt. For 2010, we expect slightly negative growth to continue at -0.3% in the base case, three consecutive years of negative growth. Even in the bull case, we see growth remaining short of its trend growth rate, while the bear case is somewhat lower. For prices, we expect negative average growth in 2009 in all cases. 2H09 in particular is vulnerable to retracement after the surge in commodity prices in the previous year, and we expect core CPI deflation of more than -2.0%Y, which far exceeds the trough (-1.1%) from 2001. With some reaction to the depressed 2009 level, we look for prices to turn up in 2010, depending on commodity price and forex rate levels (note that the Japan core inflation includes energy). Note that we expect weakness during 2008 for the GDP deflator and real GDP to depress domestic demand in 2009 with a time lag. If real GDP and the GDP deflator drop simultaneously, unit labor costs (nominal employee income/real GDP) would be likely to rise, given the downward rigidity of wages and corporate margins (unit profit = nominal OP surplus/real GDP) to fall. The uptick in unit labor costs would heighten pressure for labor market adjustment, and the drop in margins would constrain capex. Corporate Earnings Outlook Is Much Worse than Under Our Former Bear Case As of December, we were forecasting a 20% drop in F3/10 corporate profits in the base case and a 40% drop in the bear case, but current macro conditions force us to lower this further. Now we model for -60% (recurring profits, large firms capitalized at more than JPY1 billion, corporate statistics basis) in the base case, which is lower than under our old bear case. Based on our house macro view, we forecast -5% in the new bull case and -80% in the bear case. It appears that the consensus top-down forecast for F3/10 profits has now come down to about -40-50%, but even this does not look like a big enough drop. The bottom-up consensus forecast, at about -10-20%, is still too optimistic. This creates the potential for negative surprises when companies disclose F3/10 earnings outlooks around April-May. We think that the gap between top-down and bottom-up forecasts could be bridged by a) lower bottom-up forecasts, b) a rise in valuation metrics, or c) share price declines. There is, of course, the possibility of upside to our ultra-bearish outlook; as absolute profit levels sink, rates of change in profits widen easily with changes in underlying conditions. In particular, we look for a pick-up in manufacturing industry production and shipments in Apr-Jun 2009, but the nature of this pick-up would affect the overall top line in F3/10. Even so, we think that profits are likely to decline more sharply than envisaged in the majority of bottom-up forecasts. Catalysts for Healing We identify Jan-Mar 2010 as the likely trough of the business cycle, as envisioned in our previous bear case. With an autonomous recovery in domestic demand unlikely, Japan’s economic recovery will depend heavily on overseas economies. Until domestic policy spurs domestic demand, the fate of the Japanese recovery will depend largely on events abroad. Triggers for a recovery could be 1) fiscal stimulus packages both at home and overseas, 2) improving terms of trade, 3) release of pent-up demand, and 4) increase in excess liquidity. On the first, the market has high hopes for US fiscal policy initiatives. However, the content of the stimulus package which finally obtained congressional approval on February 13 contains very little public spending that would provide a direct stimulus to the economy in F2009 (the year to September). This suggests that the grounds for optimism about a V-shaped recovery in 2H09 are weak. On the other hand, there is anecdotal evidence from China that the 4 trillion yuan stimulus package launched in November is already starting to be disbursed. We would therefore highlight, without much conviction, the possibility that Asia, including China, could be the first of the major economic regions to pull out of the recession. On the second point above, Asia would be a big beneficiary of improved trade terms. The scale of global trade gains/losses in 2009, judging from crude oil and commodity prices, is likely to be roughly half of the 2008 level. It is Asia, including Japan and China, which has been bearing the burden of these trade losses. In Japan’s case, if half of the 2008 terms-of-trade loss (outflow of real income) of about US$0.3 trillion (nearly JPY30 trillion) were to reverse, the impact would be comparable to a tax cut of the same size. The impact of a lower ‘terms-of-trade tax’ might be offset in part by a drop of external demand in the resource-producing countries such as the Middle East, Russia and Latin America, but we would still expect a net tax-reduction effect, as the savings rates of resource-producing nations drop. Pent-up demand (point 3) appeared in the final stages of the 1998 recession when, like now, the negative feedback from financial markets into the real economy strengthened. This is simply a hypothesis, but once roughly a year had passed since the emergence of the event risk, consumption and modest capital expenditure may have revived, as both households and companies became weary of belt-tightening. In the current situation, the global economy has fallen off a cliff since the event risk of last September, but we are hopeful that pent-up demand may come through in similar fashion around Oct-Dec 2009, about one year on from that point. Further Downside Risk: Inadequate Policy Response Domestically, there are event risk concerns similar to the tightening of construction regulation which triggered the housing problem of 2007, and these represent downside risk. One problem is a possible shortage of qualified personnel to perform the peer checks required under the revised architect code that becomes effective in May. Additionally, a revised Installment Sales Law (summer) and law for the execution of warranty against housing defects (October) are coming up. The former could have an impact on consumption of large-ticket items such as cars, depending on how strictly income limits for consumers buying on installment plans are viewed. The latter imposes on homebuilders the obligation to provide a 10-year warranty against defects, which should not have much impact on the majors but could be an extra burden for small- and mid-scale builders. Our chief concern among these is the first one relating to architectural checks. We are on the alert for downside risk from government regulation in 2009. Policy Implications: Further Expansion of Fiscal Policy, Greater Burden on Monetary Policy and Increased Indirect Underwriting of JGBs Given the crumbling economic outlook, we expect the government to start the process of forming a supplementary budget for F3/10 straight after the initial budget for the year has been approved. We estimate the output gap in Jan-Mar as approximately JPY25 trillion. With US fiscal policy showing the way, there is a possibility that the government could aim to expand the size of the new supplementary budget to fill this gap. We assume JPY5 trillion new effective demand (‘real water (mamizu)’), in which we assume JPY2 trillion traditional public works to start taking effect from the Oct-Dec quarter of 2009. On the other hand, the continued slump in tax revenues in F3/10 will inevitably create pressure to view monetary policy, rather than fiscal expansion, as a tool for fixing the economy. Traditional monetary policy options have been almost exhausted, leaving the prospect of a further departure from policy to date in moving towards two new elements, 1) outright purchasing of risky assets, and 2) support for fiscal policy by expanding JGB purchasing. The first element could involve buying straight corporate bonds and then (in order of precedence) securitized products and equities (ETFs), and the second could lead to expanding rinban operations and rolling over BoJ-held JGBs as they reach maturity. Monetary policy would increasingly become a direct financier for fiscal policy. Naturally, at one stage earlier for the policy rate, we would see guidance for term interest rates, as well as abandonment of the complementary deposit facility (payment of interest on excess reserves) and restoration of ZIRP. However, despite a transition ahead to quantitative easing, we do not expect the BoJ to set a target for excess reserves as it did in 2001-07. From here, we think the bank will aim, like the Fed, to expand the scope of its asset purchasing with a focus on the asset side via credit easing (a more relaxed qualitative approach). Governor Masaaki Shirakawa has been stressing the maintenance of market mechanisms in the money markets, and does not appear eager to guide market interest rates still lower. However, we have seen in the past a tendency for the BoJ to pursue incremental policy changes one step behind the pace of events, and then have to adopt a more drastic policy eventually, in reaction to a market backlash with stocks falling and the yen strengthening. We have pushed back our forecast for the timing of full ZIRP by one quarter, from Jan-Mar to Apr-Jun. In our base case, we expect this to end in Oct-Dec 2010, one quarter delay versus our previous forecast. However, if the BoJ’s price outlook (-0.4% in F3/11) materializes, we think it will be difficult to end ZIRP even within 2010. Price and Long-Term Yields to Dip in Mid-Year As discussed earlier, we think that the discrepancy between pessimistic top-down profit forecasts and bottom-up forecasts will have to be bridged by one of three mechanisms. None is particularly bullish for equities. Long-term interest rates, on the other hand, have been staying relatively high. This high level of JGB yields may be due in part to the external environment, where long-term yields in the US have been climbing due to concerns about increased issuance. In addition, we think that high JGB yields reflect 1) the minimal scope for additional rate cuts, 2) the decline in JGB market liquidity as the funding rates of financial institutions remain high, 3) supply/demand balance concerns due to fiscal deterioration and increased issuance globally, and 4) ongoing profit-taking by financial institutions and rebalancing by pension funds as stock prices fall. However, we expect JGB yields to fall to 1.0% in mid-2009, due to several factors. We expect the BoJ to lower the guidance of term rates and increase rinban operations. Supply/demand concerns will continue to brew, but it is the fundamentals of the economy rather than supply/demand which are decisive for trend formation in the bond markets. Macro Implications of Political Risk and Fiscal Expansion With the cabinet’s approval rating below 20%, there is no incentive for the government and ruling parties to call a snap election. The most likely scenario we see now is for the Diet to be dissolved and a general election called sometime after the passage of both the initial budget and a supplementary budget for F3/10. However, election timing remains highly uncertain. Fiscal policy will depend on the political power balance following the election. However, Japan will take its cue from both developed and emerging economies that are massively expanding their fiscal spending. The high level of national debt in Japan is an impediment, but we believe that policy will be forced to switch in that direction, in stages. While Japan’s government debt is way above that of other developed nations, its external balance maintains a current account surplus. Rising oil prices and plunging exports have recently created a trade deficit for five months in a row up to December last year, but the high income surplus has kept the current account in the black. For the investment/savings balance, repayment of corporate and household debt registers has increased savings at a time of global balance sheet compression (deleveraging), and this should help to keep Japan in a current account surplus. Ultimately, we believe that government funding will be sustainable from a macro standpoint. It was deleveraging by the private sector in the first place which made it possible to grow Japan’s fiscal deficit since the 1990s amid asset price deflation. The current return of debt deflation may see this mechanism kick in on a global scale.
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Review and Preview
February 17, 2009
By Ted Wieseman | New York
Treasuries ended the past week mixed, with the 10-year posting strong gains but the long end lagging, as supply pressure from another US$67 billion in coupon supply at the refunding auctions weighed late in the week after the market was previously strongly supported by rising pessimism about the likely efficacy of the government’s response to the economic and financial turmoil. Investors were badly disappointed by the lack of specificity in Treasury Secretary Geithner’s speech about revisions to the TARP program and other efforts to solve the banking crisis – particularly the presentation of only a vague plan for a bad bank-type structure that would somehow use mostly private money with some public backing to buy toxic assets from banks – after the Administration had placed so much focus on the announcement. And as massive as the fiscal stimulus bill rapidly working its way towards passage is, independent analysis by the Congressional Budget Office continued to suggest that it would have little near-term impact on the economy and would likely only begin to be felt in a substantial way next year. Some hopes were restored late in the week, however, by news of a plan being formed to help struggling homeowners reduce their mortgage payments, as clearly slowing the flood of foreclosures remains key to restoring some stability to the housing market. Meanwhile, economic data remained weak and releases over the past week pointed to a more severe contraction over the 4Q08 and 1Q09 period. Certainly the severity of the ongoing recession, with GDP now likely to have declined at a greater than 5% annual rate in both the fourth and first quarters and with a worsening inventory overhang and badly deteriorating global situation giving little hope for any improvement in 2Q, made the delays in both the Treasury’s plans and the expected maximum impact of the fiscal stimulus bill especially disappointing. On the week, benchmark Treasury yields ended mixed, as substantial gains through Thursday were partly reversed in a substantial sell-off Friday as all the week’s supply eventually partly overwhelmed the prior positive impact of rising pessimism about government support plans and resulting weakness in risk markets. The 2-year yield fell 2bp to 0.95%, old 3-year 7bp to 1.33%, 5-year 8bp to 1.86% and old 10-year 13bp to 1.85%, while the old 30-year yield ticked up 1bp to 3.69% after a major sell-off Friday in the wake of the big Thursday auction. The more pessimistic economic outlook helped the refunding auctions go smoothly, though supply indigestion clearly kicked in Friday. Final investor demand was strong across all three auctions, though it took a bit of yield concession to bring in the robust investor interest in the 30-year, which tailed 6bp. The new 3-year closed the week at 1.36% after being auctioned Tuesday at 1.42%, new 10-year at 2.88% after being auctioned Wednesday at 2.82% and new 30-year at 3.67% after being auctioned Thursday at 3.54%. Even with oil and other commodity prices plunging, TIPS performed relatively well, with the 5-year yield down 10bp to 1.07%, 10-year 14bp to 1.64% and 20-year 9bp to 2.31%. Mortgages only managed small net gains on the week after a sizable sell-off Friday, leaving MBS yields near their highest levels since early December, as Fed purchases continued to have little impact beyond mitigating the impact of rising Treasury yields on mortgage rates to some extent. Fed efforts to heal interbank lending markets also continued to lose traction, as forward Libor/OIS spreads moved substantially wider, with the spread to March rising about 16bp to near 98bp, June 19bp to 96bp, September 18bp to 94bp and December 17bp to 97bp. So basically no improvement this year from the current spot spread near 97bp as 3-month Libor held steady near 1.24% on the week. This rising pessimism about future funding conditions drove a substantial widening in shorter-end swap spreads, with the benchmark 2-year spread rising 7bp to 68bp and 5-year 7bp to 71bp. Risk markets showed significant disappointment in the lack of specifics in the Treasury announcement, providing support for Treasuries through most of the week. At the time of the early bond market close, the S&P 500 was down 5% on the week, with financials doing particularly badly as the BKX banks stock index was down 14%. Credit markets were also weaker even as they extended their outperformance versus equities so far this year. Early Friday afternoon, the investment grade CDX index was 5bp wider on the week at 199bp, little changed from its 197bp close on December 31 even as the S&P 500 is now down 8% year to date. The high yield index was 25bp wider at 1,467bp through Thursday’s close and trading down slightly further Friday. Having closed 2008 at 1,143bp, the HY CDX has performed badly compared to the IG index so far this year. The HY CDX index, however, has far outperformed the leveraged loan LCDX index, which appears to be back in freefall after a period of improvement from mid-December to early January. At midday Friday, the index was 396bp wider on the week at 2,004bp, approaching its all-time worst close of 2,327bp hit December 15 after having recovered to as tight as 1,119bp on January 6. Mortgage-related derivatives markets were mixed, showing somewhat more optimism about the vague bad bank plan. Through Thursday, the AAA subprime ABX index was up a point on the week at 34.75 (the lower-rated indices as usual these days showed little additional movement from their rock-bottom levels not far above zero). The commercial mortgage CMBX market was mixed. The AAA index tightened 39bp to 629bp through Thursday, but lower-rated indices, where Moody’s has indicated that big and widespread credit downgrades are likely, struggled badly, with the junior AAA widening 88bp to 1,834bp, AA 198bp to 2,650bp, A 185bp to 3,160bp, BBB 197bp to 4,092bp, BBB- 213bp to 4,380bp and BB 434bp to 5,772bp. These were all-time closing wides for all the lower-rated indices except the junior AAA (which hit an all-time wide of 1,979bp in November). Despite a better-than-expected retail sales report, economic data released over the past week, which filled in most of the missing numbers from the advance 4Q GDP estimate for which BEA had to make assumptions, pointed to worse growth over the 4Q/1Q period. We now expect 4Q GDP growth to be revised down to -5.4% from -3.8% instead of to -4.5%. With much of this downside coming from inventories, pointing to a smaller inventory drag in 1Q, and January retail sales coming in better than expected, the outlook for 1Q doesn’t look quite as bad, but still awful, as we upped our 1Q GDP forecast only slightly to -5.2% from -5.6%. Retail sales surged 1.0% in January overall and 0.9% excluding autos, ending a run of six prior declines. A number of key discretionary categories – notably general merchandise (+1.1%), clothing (+1.6%) and electronics and appliances (+2.6%) – posted gains that were far stronger than implied by the monthly chain store reports. Note, though, that the seasonal swings in January are huge, so it was unclear to what extent this surprising upside might be reversed in coming months, though it did follow extremely weak results in December. A rebound in prices also provided a lift to gas station sales (+2.6%) in January after extraordinarily sharp declines over the prior few months. Food stores (+2.1%) also rebounded after an unusually big drop in December. The key retail control component gained 1.3% in January, much stronger than we expected, though there was a downward revision to December (-3.3% versus -3.0%). Incorporating this result but assuming some payback in February, we boosted our forecast for 1Q consumption to -2.0% from -3.0%. The downward revision to December spending pointed to a downward adjustment to 4Q consumption, however, to -3.7% from -3.5%. Meanwhile, the international trade, wholesale trade and business inventory reports released over the past week filled in most of the remaining missing data from the 4Q GDP report, and the results pointed to a big downward revision from the advance estimate of -3.8%. The trade deficit narrowed much less than expected in December to US$39.9 billion from US$41.6 billion, as a 6.0% plunge in exports exceeded a 5.5% drop in imports. Over the past five months, imports have now collapsed at a 49% annual rate and exports 42%. The December trade gap was much wider than BEA assumed in preparing the advance 4Q GDP estimate, and the real trade numbers in December were substantially worse than the nominal results and much more negative than we assumed, providing a more negative starting point for 1Q net exports. Meanwhile, wholesale inventories fell much more than BEA assumed in December and retail ex-auto inventories were also a bit worse than expected. Combining the international trade and inventory results, we now see 4Q GDP growth being revised down to -5.4% from -3.8%. The modestly stronger outcome we now see for consumption in 1Q combined with a likely smaller reversal in inventories now that 4Q inventories should be revised down substantially were partly offset by the more negative outlook for net exports in 1Q provided by the much worse-than-expected starting point in the December real trade deficit. As a result, we only boosted our 1Q GDP forecast slightly to -5.2% from -5.6%. The economic calendar is fairly busy in the holiday-shortened upcoming week. Initial jobless claims this week will cover the survey period for the February employment report, and the recent trend points to another terrible jobs report, while the Empire State survey on Tuesday and Philly Fed on Thursday will help set initial expectations for the February ISM. The minutes from the January FOMC meeting will be released on Wednesday, and clearly most attention will be paid to the discussion of potential Fed purchases of Treasuries to try to judge how close we might be to such intervention if the market resumes selling off. Fed Chairman Bernanke will also be speaking Wednesday afternoon. There’s only a one-week break before another flood of supply, with the Treasury scheduled to announce a 2-year, 5-year and the first 7-year in quite some time on Thursday for auction the last week of the month. We look for the 2-year and 5-year sizes to both be bumped up another US$2 billion each to US$42 billion and US$32 billion, respectively, and for the 7-year to start at US$20 billion. Notable data releases due out include housing starts and industrial production Wednesday, PPI and leading indicators Thursday and CPI Friday: * We expect January housing starts to decline to a 500,000 unit annual rate. The pace of decline in homebuilding has accelerated over the course of the past few months, and we look for another significant drop in January (-10%). In fact, the labor market report revealed considerable job losses within the residential construction sector. Moreover, winter weather conditions across much of the country during January were somewhat more severe than in recent years, and this may also provide some downside impetus in the Midwest and the Northeast regions. Looking ahead, we expect starts to bottom at about a 460,000 pace within the next several months. * We forecast a further 1.7% plunge in January industrial production. The January employment report pointed to significant further deterioration in activity across a broad range of industries, including machinery, electrical equipment, furniture and printing. In particular, production in the auto sector virtually ground to a halt, with industry data showing that vehicle assemblies tumbled more than 30% on a sequential basis. Indeed, one of the few categories likely to show an uptick in January is utilities, where activity was boosted by unseasonably cold temperatures. * We look for the producer price index to surge 1.2% overall in January and tick up 0.2% excluding food and energy. A sharp jump in gasoline prices should more than offset continued softness in quotes for natural gas, leading to a partial rebound in the headline PPI following some big declines in recent months. Meanwhile, the core is expected to remain close to its recent trend, with a start-of-the-year jump in drug prices helping to offset weakness in other sectors where pricing power has deteriorated. * Based on the components available at this point, we expect the index of leading economic indicators to rise 0.3% in January, as another big jump in the money supply and the steep yield curve should lead to a second straight uptick in the index. A rebound in consumer confidence should also provide a small boost, while jobless claims, the manufacturing workweek and stocks prices will be partly offsetting negatives. * We forecast a 0.6% rise in the headline CPI in January and a 0.2% rise in the core. A reversal in prices at the gas pump should lead to a partial rebound in the headline CPI following some sharp energy-related declines in prior months. The core measure is also expected to show some mild upside relative to the subdued readings posted over the past few months. However, the bulk of the expected elevation is attributable to the fact that seasonal adjustment does not appear to fully account for the typical price hikes that occur in a number of sectors at the start of the calendar year. Indeed, even with the monthly core CPI ticking up 0.2%, the year-on-year change is expected to slip all the way from +1.8% to +1.6% – which would represent the lowest reading since early 2004.
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