Another Observation on the Yield Curve

As a follow-up to my recent post about recessions and the yield curve, reader Joan F. points us to a piece by the FT’s James Mackintosh. The money quote:

[T]hose keeping faith in recovery also point to the fact that the yield curve has not inverted – 10-year bonds still yield 2 percentage points more than two-year bonds. Given that the 10-year yield has dropped below the two-year (and the three-month) before every recession since the second world war, perhaps a double dip is not looming.

Unfortunately, a quick glance at Japan suggests that once short-term rates hit the floor, the yield curve may no longer be a valuable indicator. While it warned of the recession that followed the bursting of Japan’s bubble, it missed the three recessions since.

Further Signs of a Slowdown

As expected, BEA’s second stab at GDP growth for the second quarter was even less inspiring than the first. Headline growth was a tepid 1.6%, down from the 2.4% previously reported. Consumer spending and business spending on equipment and software were actually stronger than earlier estimates, but business structures, inventories, and exports all weakened, while imports (which deduct from GDP the way BEA calculates it) grew faster than previously expected.

Last month I pointed out one, small silver lining in the original GDP report: every major category of demand had increased. That is still true in the revised data, although structures just squeaked by with a miniscule 0.01 percentage point contribution to overall growth:

Investment showed particular strength. Business investment in equipment and software (E&S) grew at a 25% pace, thus adding about 1.5 percentage points to overall GDP growth. Boosted by the end (hopefully permanent) of the new homebuyer tax credit, housing investment grew at a bubble-like 27% pace (adding about 0.6 percentage points to GDP).

Despite solid growth in disposable incomes–up 4.4% adjusted for inflation–consumer spending grew at only a 2.0% pace.  As a result, the saving rate increased to 6.1%, compared with 5.5% in the first quarter.

And then there are imports. As I’ve discussed before, BEA calculates GDP by adding up all the components of demand for U.S. products–consumers, businesses, governments, and export markets–and then subtracting the portion of that demand that is supplied by imports. That means that any growth in imports appears as though it subtracts from overall economic growth.

That happened in a big way in the second quarter. Imports grew at a brisk 32% pace, thus subtracting (using BEA’s accounting approach) 4.5 percentage points from overall growth. Which is why all those blue bars in the graph net out to only 1.6% GDP growth.

I should also note that BEA’s calculation of contributions to GDP growth, which I graphed above, is subject to the same criticism that I’ve leveled at the claim that consumer spending is 70% of the economy. In a perfect world, an appropriate share of the imports (the red bar) would be netted against each of the components of demand (the blue bars). The result would be a graph of contributions that would truly illustrate how much each category of demand actually contributed to U.S. GDP growth. I hope to take a crack at that in the future (but I said that last month, too).

The Yield Spread and the Odds of Recession

Worries about a double-dip recession have spawned much economic commentary … and a humorous country and western song. So how likely is a return to recession?

Researchers at the San Francisco Fed took a crack at this question a few weeks ago. Their answer? It depends.

When they used a traditional model based on the leading economic indicators, the probability of a second dip turned out to be about 25% over the next two years (the blue line). When they dropped one indicator from their model, that probability doubled to about 50% (the red line).

That important indicator is the yield spread–the difference between the 10-year Treasury interest rate and federal funds rate. In recent decades, the yield spread has done a terrific job at anticipating recessions. When the federal funds rate has risen above the 10-year rate, the economy has invariably fallen into recession.

As I noted briefly the other day, the relative steepness of today’s yield curve (10-year rate about 2.5 percentage points above the fed funds rate) thus suggests, by itself, that renewed recession is unlikely, despite recent weak economic data. On the other hand, there are reasons to believe that this time things are different (usually a scary phrase). After all, fed funds rate has been pushed down almost to zero and yet the economy no longer appears to be responding. That’s exactly the logic that inspired the SF Fed researchers to try their model without the yield spread.

Investors Should Be Prepared to Face Financial Oppression

That’s the conclusion of a new report by Morgan Stanley analyst Arnaud Mares.

And what, you may ask, is financial oppression? Speaking from the perspective of investors in sovereign debt, Mares defines it as “imposing on creditors real rates of return that are negative or artificially low.” Which doesn’t require outright default. Instead, it

[C]an take other forms: repaying debt in devalued money (e.g., through unanticipated inflation), taxation or regulatory incentives on institutions to purchase government debt at uneconomic prices.

Mares sees sovereign creditors as tempting targets when over-indebted governments decide which of their many fiscal promises they can’t keep.  After all, elderly pensioners cast more votes than coupon-clipping bond holders. And he thinks current low yields provide little protection against that threat.

His piece is definitely worth a read if you want to consider a bearish view on U.S. and European sovereign credit.

A New Price Tag for Stimulus: $814 Billion

Last week the Congressional Budget Office released updated budget projections — a treasure trove of information for budget wonks. For example, CBO released new estimates of the direct budget costs of the 2009 stimulus bill, officially known as the American Recovery and Reinvestment Act (ARRA).

CBO now estimates that ARRA will cost $814 billion from 2009 through 2019. That’s up from the original $787 billion estimate, but down from the revised, $862 billion estimate released in January.

Spending exceeded original expectations because both unemployment and food prices rose more than anticipated, driving up the cost of extended unemployment benefits and expanded food stamp benefits. On the other hand, spending estimates have come down because “recently enacted legislation rescinded some of the funds appropriated in ARRA and limited the period in which higher payments under the Supplemental Nutrition Assistance Program [formerly known as food stamps] will be available.” (CBO did not update estimates for the tax provisions in ARRA.)

For a discussion of why the $814 billion figure (formerly known as the $862 billion figure or the $787 billion figure) is not really the right measure of stimulus, see this post.

On a related note: Earlier today, CBO released an updated analysis of the economic effects of ARRA. It estimates that ARRA reduced unemployment in the current quarter by 0.8 to 2.0 percentage points. In other words, without that stimulus CBO believes that the unemployment rate today would be between 10.3 percent and 11.5 percent, not the 9.5 percent reported in July.

No, the Web Isn’t Dead (Yet)

Wired’s cover story this month, “The Web is Dead,” features the following chart showing the portion of internet traffic in different uses:

Over the past few years, peer-to-peer services and video have gobbled up an increasing share of traffic, while the “traditional” web — you know, surfing from site to site, reading your favorite blog about economics, finance, and life, etc. — has been declining.

Chris Anderson cites this as evidence of the pending death of the web. To which there is only one thing to say: wait a minute buster. Just because the web’s share of total bits and bytes is falling doesn’t mean it’s dying. Maybe it’s just that the other services are growing more rapidly.

One of the benefits of being off the grid for a week-plus is that other commentators have already had the same thought and have tracked down the relevant data. Kudos to Rob Beschizza at BoingBoing for charting the data in absolute terms. Rather than dying, the web is still growing like fresh bacteria in a petri dish:

Double Dippin’

I am more than a week behind on this, but in case you missed it, Merle Hazard has a new ditty out called “Double Dippin’.” This comes with a warning: the opening scene may make you crave ice cream:

Rising concern about a double dip makes sense given the weakness of recent macroeconomic data. On the other hand, it would be highly unusual for the United States to fall into recession with such a steep yield curve.