Economic Outlook Dimming, Yet Fed Plans Rate Hikes by Gary D. Halbert

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert

July 22, 2014

IN THIS ISSUE:

1.  Did the Economy Disappoint in the 2Q?

2.  There Are Some Problems to Worry About

3.  Chair Yellen: Fed Could Raise Rates Sooner

4.  Illegal Immigration: America’s #1 Problem

5.  D’Souza’s “America” – Another Great Film Documentary

6.  WEBINAR With YCG Investments Tomorrow at 1:00 Eastern.

Overview

The mainstream media was largely successful in convincing the public that the dreadful 1Q GDP number (-2.9%) was the result of the bitter winter in January and February. The media spin was that the economy would snap back strongly in the 2Q with growth of 4%, 5% or even 6%. While there were some encouraging economic reports in April, May and early June, the economy now appears to be losing momentum again.

Predictions of 4-5% GDP growth in the 2Q have faded. A new Wall Street Journal poll last week found that forecasters on average expect 2Q GDP growth of only 3.1%, down from a 3.5% estimate a month ago. The same poll of 48 forecasters now expects the economy to grow by only 1.6% for all of 2014, down from 2.8% forecast earlier this year.

Despite this dimming economic outlook, the media is now concerned that the Fed may begin raising interest rates sooner rather than later, and that the expected series of rate hikes will happen more rapidly than previously expected. But is there any real evidence that Janet Yellen and the Fed have changed their plans? I don’t think so. I’ll tell you why as we go along.

Finally, we’ll round-out today’s discussion by looking at the latest Gallup poll that gauges what most Americans consider to be our biggest problems. For most of this year, Americans cited the economy as our biggest problem. However, in the latest poll a new concern has jumped to the top of the list and for good reason: Immigration/Illegal Aliens. Let’s get started.

Did the Economy Disappoint in the 2Q?

One of the most important economic reports of the year will come out next Wednesday, July 30. It will be the Commerce Department’s first estimate of 2Q GDP. Why is this one so important? It is because there is a broad consensus that the economy rebounded strongly in the 2Q, and another disappointment would raise serious concerns.

As noted above, most people believe that the negative 1Q was largely due to weather, and few fear that we are falling into a recession. But let’s look at some facts. Since 1947 (265 quarters), there have been only 18 times when a quarterly GDP number was -2.9% or worse. Over that long period of time, only once did a reading of -2.9% or worse not lead to a recession. Put differently, in 17 out of 18 times a reading of -2.9% or worse led to a recession thereafter.

Let me be clear – I’m not predicting this will happen. As noted above, the consensus is that the advance estimate of 2Q GDP will come in at 3.1%. My point is that if next week’s GDP report disappoints significantly, as did the 1Q report, the dialogue will quickly shift from a strengthening recovery to fear of a new recession.

Let’s say that next Wednesday’s GDP report comes in at only 2% or less. That would be a big disappointment even though it is still a positive number. Remember, no one expected the 1Q GDP to plunge from -1.0% in the second estimate to -2.9% in the third estimate. If next Wednesday’s 2Q GDP estimate disappoints, it could be quite negative for stocks.

But again, is there any reason to think the first estimate of 2Q GDP will disappoint? Let’s look at some stats. On the bright side, the unemployment rate has plunged to 6.1% in the last year – more than anyone expected. The economy has been producing a monthly average of over 230,000 net new jobs so far this year. Consumer confidence in June rose to the highest level since January 2008. Manufacturing remains firm overall. Those are the positive highlights.

There Are Some Problems to Worry About

There are some concerns, however. Housing starts for the 2Q are below the 1Q based on two months of data. Housing starts fell almost 7% in May to under one million units (985K). Then starts fell again in June to only 893,000 units. Both reports were considerably weaker than expected. Likewise, real fixed business investment has been decelerating over the last few quarters, and there’s no indication that this trend reversed in the 2Q.

Personal Consumption Expenditures (PCE), which measures all goods and services consumed by Americans and is a component of the GDP, is doing poorly.  Considering April and May data (June is not out yet), 2Q PCE is not even with or ahead of the 1Q. This is troubling given that consumer spending makes up nearly 70% of GDP. The media doesn’t mention this.

Durable goods orders reported for the week of June 23 tumbled 1.0%, much worse than expected. In May, durable goods orders also fell 1.0%. On a year-over-year basis, durable goods orders are negative, not great news for 2Q GDP. The durable goods report for June will be out this Friday.

While the official unemployment rate fell to 6.1% last month, the labor force participation rate remains at a 37-year low of 62.8% where it’s been for the last three months. While the White House blames this on Baby Boomers retiring, there are millions of able-bodied Americans who have given up looking for a job or simply do not want to go back to work. There are over 50 million Americans on food stamps, a new record.

Fed labor force

A new Rasmussen poll out this morning found that only 27% of Americans believe that the economy will be better a year from now, while 45% believe it will be worse – this despite the fact that the Consumer Confidence Index hit a new recent high last month.

In conclusion, next Wednesday’s advance report on 2Q GDP may well come in around the consensus of 3.1%, but many forecasters have been revising their estimates lower so far this month. Based on the data I have provided just above, it will not surprise me if the 2Q GDP advance estimate comes in below the consensus.

If that report comes in at 2% or less, well below the consensus, I expect it to be a very negative surprise that will change the dialogue about the economy. Immediately, we will be talking about the possibility of a recession. If so, that would almost certainly weigh heavily on the stock markets, which are long overdue for a correction.

Fed’s Yellen: Fed Could Raise Rates Sooner & Higher…

Ever since Chair Yellen took over the Fed earlier this year, the financial media has been all over her, trying their best to get her to give a date for when the Fed will start raising short-term interest rates. The closest she’s come was back in March when she commented that she wouldn’t expect rates to start to rise “until at least six months” after the QE bond-buying program ends.

It’s now official, QE will end in October as has been expected for some time. The minutes from the Fed’s June 17-18 FOMC meeting were released on July 9 and make it clear that the Committee wants QE to end by the end of October this year, barring any major surprises. So based on Yellen’s comment back in March, most analysts assumed that the first rate hike won’t happen until April or May of next year.

However, with the unemployment rate dropping so much more than expected, analysts want to know if Yellen’s six months after QE comment is still reliable. There has been a lot of speculation that the Fed might move that target up and start raising rates sooner. Likewise, some members of Congress also want to know when rates might start to rise.

In her semi-annual testimony before Congress last Tuesday and Wednesday, Yellen was peppered with questions along this line. Yellen presented a fairly mediocre portrait of current economic conditions. While she pointed to many improvements, her positive statements were almost universally followed by “yet” or “but” or “however.” For example, she said:

“Progress has been made in restoring the economy to health and in strengthening the financial system. Yet too many Americans remain unemployed, inflation remains below our longer-run objective, and not all of the necessary financial reform initiatives have been completed.”

Basically, Yellen said there is no way to know when the Fed will be confident enough in the economy to begin normalizing short-term rates. Several members of Congress were not satisfied with that answer, so they kept after her. One congressman asked her if there is any scenario which could prompt the Fed to raise rates sooner and higher than expected. She finally conceded:

“If the labor market continues to improve more quickly than anticipated by the [Fed],” then increases in the federal-funds rate target likely would occur sooner and be more rapid than currently envisioned.”

While she still refused to put a date on it, at least she admitted that the Fed might move to raise rates sooner (and higher) than currently envisioned, IF the economy heats up more than expected in the second half of this year. Boom! That’s what everyone wanted to know.

And it was as if no one was listening when she reiterated that the Fed would not hesitate to extend QE beyond October if the economy falters. The financial media tried its best to get the markets to focus on Yellen’s sooner/higher comment, but by the end of last week, stocks were at new record highs and long-dated Treasury yields hit new recent lows. What else is new?

The bottom line is that, barring any surprises, the Fed will halt QE by the end of October and likely not start to raise rates until sometime after April of next year. The next FOMC meeting is next Tuesday and Wednesday, July 29-30, and Chair Yellen will not be holding a press conference afterward.

Illegal Immigration: America’s #1 Problem

A new Gallup poll out last week found that Americans now believe that “immigration/illegal aliens” is “the most important problem facing the country today.”  As Gallup noted, that is “up from 5% in June, and the highest seen since 2006.” This is due, of course, to the humanitarian crisis occurring on our southern border.

Gallup found that “dissatisfaction with government”came in second place on the list of the country’s top problems. For most of this year, it was the economy in general or unemployment/jobs that topped the list of America’s most important problems. But those have now dropped to the #3 and #4 spots.

Despite the media’s efforts to cover up the border crisis, most Americans recognize the importance of this grave situation. They also recognize the government’s ineptitude in dealing with this crisis.

Fed problems

Over 57,000 illegal immigrants – most of whom are minors – have flooded across the US border since October of last year, and federal officials expect at least 150,000 more to do so in the next fiscal year. Nearly a third of Americans do not trust either political party to competently deal with what they think are the nation’s “top problems” including illegal immigration.

You should also notice that “poor healthcare” and “high cost of healthcare” comes in at #5 on the list of the nation’s top problems. What you might not notice is that “global warming/climate change” is nowhere to be found on the list of the nation’s 17 top problems.

D’Souza’s “America” – Another Great Film Documentary

In the summer of 2012, I repeatedly urged my readers to go see the film documentary “2016: Obama’s America” which was written and produced by conservative author and commentator Dinesh D’Souza. The documentary focused on Obama’s early life and the influences on him by his father and others. If you saw this film, then you have not been surprised by the president’s rejection of “American exceptionalism” and his seemingly anti-American actions at times while in office.

Now comes D’Souza’s next documentary – “America: Imagine The World Without Her.” For many years, the political left has conducted an orchestrated attempt to rewrite history and bring shame on America. From the taking of the country from Native Americans, from taking the southwestern US from Mexico, to slavery to exploitation of foreign nations for their resources and on and on. President Obama went so far as to apologize to the world for all of America’s ills early in his first term.

D’Souza sets out to correct the left’s version of America’s history and illustrates convincingly that America is still the greatest country on Earth, and that American exceptionalism is still very much alive today. It is a film that will make you even prouder to be an American. I urge everyone to go see America!

Sadly, many young people will likely not see the film and therefore will not know that much of the history they have been taught in public schools is either false or significantly slanted to present a shameful view of America. I plan to give DVDs of the movie to a lot of young people I know for

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