By Joseph Y. Calhoun

The Citigroup Economic Surprise index set a record this year for the length of time it stayed in the negative column (data less than expected) of over 200 consecutive days. Even in the depths of the Great Recession we never had more than 100 consecutive days in negative territory. It is odd that economists have remained so optimistic – overly so – even as the data continues to defy their sunny outlook.

The trends that have been in place for over a year continue. The industrial/manufacturing economy is in recession and has been for months in my opinion. The ISM seems to confirm that but don’t take that to mean that a recession for the entire economy is right around the corner. The ISM track record on that is not great. In the past, when the ISM fell below 49 as it did last week, recession has followed in short order about 1/3 of the time. Recessions have started with the ISM above 50 (1969, 1974) but we’ve also had many times when it has dipped below 50 with no recession.

One thing that continues to amaze me is that this manufacturing recession is ongoing even with auto sales above 18 million SAR. Credit is obviously having an impact on auto sales and until that changes the sector will probably continue to boom. We won’t know the consequence of that until much later, probably during recession, but if you can wait, I’d say hold off on buying a car now. I will make the bold prediction that there will be a glut of used/repo cars available sometime in relatively near future. There was some improvement in Durable Goods orders last month but considering inventories I wouldn’t put a lot of faith in it.

One concerning development over the last couple of these reports is the slowdown in housing. It isn’t very deep yet and certainly can’t be called a trend but we’ve had two months now of soft data on new and existing home sales. Construction spending continues to be robust though, one of the few areas we can point to with double digit year over year change. Housing warrants a bit of extra attention in coming months though if the Fed is successful in hiking rates. It may be that they pulled forward some sales by telegraphing the rate hike for so long.

The trade picture didn’t change much from the preliminary report with imports and exports still falling. However, it does seem there is a bit of moderation in the contraction of trade. That may be due to the nascent cyclical recovery in Europe which is looking a bit more durable despite whatever Draghi is doing or not doing.

The employment report was plagued by all the problems of other recent reports and I won’t rehash them here. Suffice it to say that the employment picture is not as bad as the doom and gloom crowd would have you believe and certainly not as rosy as Janet Yellen seems to believe. Like so much about the economy since the Great Recession, it is meh.

Our market based indicators haven’t changed much although the yield curve did flatten a bit since my last report.

10:2 spread

10:5 spread

A flattening curve in this case merely means that short term rates are rising faster than long term rates. I’d also take it as a sign that the market sees a Fed rate hike right now as a mistake that will slow the economy. As I’ve said many times over the last year, I have no idea whether the curve will get to flat before the next recession. I think though that one has to assume that it will. I suspect the difference this time may be one of time in that the curve may flatten a lot quicker than it has in the past.

Credit spreads generally didn’t move much since the last update except in the lowest rated tranches. CCC spreads are blowing out, to levels now that prevailed in the middle of the 2008 crisis. Other, higher rated bond credit spreads are still on a widening trend but haven’t moved much since the last update. One thing I’d like to point out though is that the developing credit crunch is not confined to the US. European high yield and emerging market corporate spreads are also trending wider. In other words, if the US is headed for a credit crunch the rest of the world seems likely to join in.

hy spreads

ccc spreads

em hy spreads

euro hy spreads


The US dollar took a big hit last week as the ECB disappointed markets and the short Euro/long Dollar trade blew up. Short term momentum is now down although intermediate and long term momentum remains positive, pointing to more gains. I guess that might depend on what the Fed does and after the ECB debacle I think it is prudent to start thinking about how the Fed might disappoint as well. Maybe they only hike 1/8 instead of ¼ or maybe the change to IOER isn’t as expected. The point is that like the ECB, the Fed may take action but still disappoint relative to expectations.

dollar index

Overall, the economic outlook hasn’t changed much since the last update. To me the economy looks a lot more fragile than the Fed message is intended to convey. Yellen has as much as said that she believes that hiking rates sends a signal to the market about her and the FOMC’s confidence in the economy. She obviously believes that will make a difference in the real economy, that economic actors will change their behavior based on that Fed optimism. Personally, I think she vastly overstates the public’s confidence in the pronouncements of economists especially those employed by the Fed.

The risks right now, in my mind, are tilted to the downside. The credit markets are still moving in the wrong direction and as I said in my weekly commentary, it isn’t just energy anymore. Furthermore, the junk bond market is almost twice the size it was going into the last recession; growth has been much more dependent on junk financing in this cycle. It seems obvious that it will have a greater impact on the way down too.