• Yesterday saw the August consumer confidence report from The Conference Board.  Ouch!  It dropped to the lowest level since April 2009. Unless there’s a massive disconnect, we’re likely to see a very weak ISM (US manufacturing) report on Thursday, and an equally bad August employment report on Friday.  All else being equal, this will put downward pressure on stocks, and upward pressure on high quality bonds (and the other things we own).
  • Arguably the best indicator of US GDP remains the weekly leading economic indicator (WLI) from ECRI. The WLI has steadily fallen since the late April peak. Last week’s reading measured a -2.1. When it drops to the -10 range, the odds are good we’re back in a recession. I suspect we’ll see that in six – eight more weeks. (that’s weeks, not months)
  • As expected, July consumer spending rose considerably to make up for the previous 3 months of declines. All the more reason to expect the BEA’s first read on 3Q GDP to rise to the 2% range (announced at the end of October). But this is going to be a head fake because August and September economic data are going to show a drop to 0% growth. So we have this great set-up coming whereby the BEA’s read will be substantially rosier than ECRI’s view (at the end of October). That could work out to be a big fat melon over the plate. A change-up can be a gift if you’re waiting for it (baseball analogy). You also have to know what to do with it.
  • Monday saw the Dallas Fed data. It followed the trend of the most recent Fed reports from: Chicago, New York, Philadelphia, Richmond — all weakening.
    • the production index cratered from 10.8 in the previous month to 1.1
    • new orders index fell from 16 to 4.8
    • general business activity remained negative for the 4th month in a row and dropped from -1 to -11.4.   These are recessionary numbers.
  • US Housing.  Tuesday saw the latest Case-Shiller housing index. As expected, average house prices rose in 2Q  — the quarter with the largest gains in house prices historically, and peak house listing / selling season. The latest report showed house prices rose 1.1% in June vs May. The initial July & August housing data is suggesting that June was probably as good as it is going to get in 2011. My view on US housing remains the same as it was over a year ago: house prices will decline year over year in 2010, 2011, 2012, and potentially 2013. Each year, the spring and summer will see house prices rise a little and stabilize, then head considerably lower in the fall and winter.  Unless something changes, we’re looking at the prospect of 40% of US home owners with a mortgage being under water this coming winter.
  • Apparently the Fed debated buying more longer term US Tbonds last month. The wisdom / theory being that more buyers would drive the price up and yield (interest rate) down — thus lowering mortgage rates.  How did that work out in QE1 & QE2? The Fed bought Tbonds, but a lot of other Tbond buyers left, causing the total support of buyers for Tbonds to be lower than it was before the Fed tried to “help”. That’s why the price of Tbonds fell while the Fed was “helping” with QE1 & QE2. If the Fed really wants to lower long term interest rates it must know it will have to buy in volume sufficient to drive the price up even if everyone else stops buying.
  • Europe continues to slide into recession.
    • Germany:
      • Mark September 7th on your calendars.  On that day, the German constitutional court rules on the legality of the european bailout mechanism.  Also on that day, the latest bailout agreement heads to the Bundestag for ratification (this is the bailout called EFSF 2.0 that caused so much happiness in mid-late July — the one that is already known to be too small).
      • Angela Merkel (German Chancellor) faces the possibility her government will fall. Her own party (the CDU) released a press brief indicating it is against the latest bailout and will not vote for it. Further, it wants EU treaties re-written to allow nations to go bankrupt and exit the euro.
      • This is painfully obvious, but just so no one misses the point: if Germany does not ratify the latest bailout agreement, things will turn to “hell in a handbasket” in Europe very quickly.
      • Here’s a quote from the German Head of State last week.  ” I regard this huge buy-up of governmental bonds of individual states…. as legally questionable….”  and that the ECB  had gone ” way beyond the bounds ” of its mandate.   He is absolutely right.  EU Treaties forbid the ECB from buying bonds directly from countries. So the ECB gets around this by buying bonds on the open market. This must be infuriating to the Northern European countries.  I don’t see the German Central Bank going along with Eurobonds or any other broad new solution. Any new “solution” at this stage is going to be inflationary. Stopping inflation is hard-wired into all German central bankers — despite what happens in the PIIGS countries. Upshot: look for Europe’s financial crisis to enter a new stage and begin to go asymptotic.
    • As recently as yesterday, the ECB was busy scooping up Italian bonds on the open market. Propping up the Italian bond market is now the most important job for the ECB. But this can’t last. The ECB doesn’t have enough money to continue doing this until the end of the year. Bailout fatigue is hitting several European countries, so having the bailout fund further enlarged is not likely to make it through 17 euro-member parliaments.  Hence my asymptotic statement.
    • Last week I commented that the Greece-Finland agreement on collateral would intensify pressure on Greece to bolt from the euro currency. Within a couple days after my comment the bond market was back to pounding Greek bonds. The price on 2 year Greek bonds dropped so low, it represented a 44% interest rate — if you bought the bond and got your principal back. This might push Greece into a surprise euro exit before the end of the year.
    • European banks are increasingly not making short term loans to each other (in what is otherwise normal banking operations). Instead, they are parking cash with the ECB. Result: the inter-bank lending market is all but frozen. European banks have lost access to US short term lending markets because money market funds have dropped European sovereign debt like a hot potato. Banks don’t lend to each other when they’re skeptical about getting their money back. Gee, what do they know ?  This is the definition of a liquidity crisis, and is the initial stage of a full-blown financial system crisis.