Fed Cuts of a Different Variety

John Mauldin points out this morning that the Fed cut something else recently — their economic projections for 2008:


The Muddle Through Fed    
John Mauldin
Frontline, Feburary 22, 2008

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  1. John Borchers commented on Feb 23

    What I would love to know is why almost everyone believes that this will be such a short economic surpression?

    People in our generation that are trading the market now have totally forgotten that there are times in the market where it may not go up for 10 year periods or even may come down.

    The people that believe the bond insurer and housing bailout will totally solve the problem are completely wrong. The fact is that the average Joe has overleveraged himselve in debt.

    That’s the root cause, it just showed up in housing first.

  2. Will Rahal commented on Feb 23

    Most analysts failed to pick up the risk associated with Inflation and were confounded by soaring earnings and a declining Stock Market.
    I have shown that historically, you can expect a drop in P/E to 1/3 from its high.
    This will take the overall market P/E to the low teens.
    See “Honey, I(nflation) shrunk the P/E”

  3. Ross commented on Feb 23

    They have a Bong in the Fed Governer’s board room? They totally forgot the minus signs in front of some of those percentages. And from now on the use of the term Average Joe has been amended to Leveraged Joe…

  4. Hoppy commented on Feb 23

    Wow. What a bunch of short-sighted idiots, oblivious to the big picture.

    No wonder they keep lowering their lending rates, they couldn’t foresee inflation if it slapped them in the face.

    I wish there was a market for short selling the Fed’s market intelligence.

  5. John commented on Feb 23

    As Mauldin points out it is politically impossible for the Fed to predict a recesssion, 6% unemployment and inflation stuck above 4%. There would be blood in the streets. Hence they are between a rock and hard place. They have to peddle optimism knowing it is likely wrong and in the longer term they look like like lousy forecasters. I also believe there is a political overtone to all this in that they are desperate to prevent a recession happening while Bush is president as it would be the final nail in the coffin of Republican “managerial competence.” We’re almost certain to get a recession and one that is probably going to look much more like the early 1990’s rather than early 2000’s. In other words it’s likely to be both longer and deeper. That said the world is awash in capital and would step in to snap up cheap US assets while the govt in the widest sense clearly has no intention of allowing any major failures of financial institutions. In practical terms this is going to put a prop under most of the US stock market. I’ve long seen the Dow, a very imperfect measure btw but useful shorthand, bottoming around the low 12,000 and for a time I began to wonder if there wasn’t another 1000 points of downside. That risk seems to be fading because of govt interventionism. We’re likely going to have a recession of around a year or so, which has probably started, that will disproportionately affect US consumer spending, housing stays in the tank for another 18 months, credit tightens across the board, the Dow trades in the 12-13000 range all year but doesn’t meltdown, and starts to recover in 2009.

  6. drey commented on Feb 23

    Very intelligent post, John – thanks.

    I disagree with your call of a bottom at 12,000 for the simple reason that there’s still sufficient denial about a recession to suggest that this is not yet baked into the cake. When reality sets in I believe there will be another significant downdraft which takes out the Jan. lows but I like your points about foreign liquidity and govt intervention keeping something of a floor under the market…

    Personally I doubt that I’ll touch stocks until the second half of ’08 and only then if there’s been sufficient carnage to suggest that some of the excess has been wrung from the system.

  7. Emmett commented on Feb 23

    I like John Borchers’ observation “The fact is that the average Joe has overleveraged himselve in debt.”….

    With (institutional) “bailout” becoming the buzzword of 2008… our esteemed leaders should be concerned with a more nefarious threat => that it becomes culturally acceptable to default on your debts… or to even carry exorbitant debt.

    I’m no economist, but if the government tries save the country, why not reward those households that pay down debt instead of saving those who violated first principals of honor and money management? The standard deduction on mortgage interest payment could be modified to reward reduction of principal…

    Trophy houses standing empty does not bother me one bit. Let the army use them for target practice. But Mr. John Q. Hardworker getting a pink slip because his employer can’t raise capital sucks.

    Just trying to think this through.

  8. jim foster commented on Feb 23

    Commentators here seem to believe that the economy is and will be even weaker than the Fed predicts and inflation stronger. On surface seems contradictory. How can inflation rise and continue rising during a protracted, weak economic period? Even more interesting to me is how Real Earnings can even be in the low teens in such a scenario.


    1) for at least 7 years the US has exported inflation, while low interest rates and a dramatically decling dollar have significantly puffed-up profits. Furthermore, significant growth in productivity has largely been captured by Capital rather than Labor — a reversal from previous history.

    2) All of this now changes. Inflation is now rising in major trade partners — especially China and increasingly in Europe. Most important, major trade partners have — up to now — pegged their currencies to the dollar, especially OPEC and China. This will change. It is inevitable that OPEC will leave the dollar peg and then lookout for dramatic oil price changes. In this context, a continuing decline in the dollar will be very inflationary. And decline it will. The US will import rather than export inflation.

    3) Corporate profits are not only bouyed by cheap dollar and cheap money but most importantly by extraordinary global growth. I simply cannot imagine that growth rate continuing long term under the best of circumstances. But it will surely decline significantly with a weak US economy — and then by the inevitable un-pegging of the dollar. By definition, declining US consumption, especially given significantly rising import costs, will hurt the “global growth story.”

    4) The wild card. I assume it is likely that by November the US will be in a nasty recession and the Democrats will win big — with clear control of Congress more important than the Presidency. What might be the consequences, especially given the clear fact that the last 7 years of fiscal and monetary policy have been disastrous?

    — passage of a “universal” health care program will serve to dramatically increase demand for health care, which has already been inflating at 14 to 17% per year. More inflationary juice there BUT at least as important is that much higher health care spending means less fiscal discretion for other programs.

    — what can be done about runaway food, energy and healthcare costs in the context of recession? In the 1970s there were a series of ridiculous efforts at price controls. If not that insanity again, then what? Demcrats have got to serve their constituency just as the Republicans served their constituency with huge tax cuts while runnig massive deficits. How about the alternative of serial minimum wage increases coupled with “infrastructure public works programs?” Who will we borrow from?

  9. dblwyo commented on Feb 23

    I’d say John and Drey have some very good points but then the rest were too. What Barry didn’t mention was that these changes were already drops from the earlier Fall outlook. And while the Fed has to be politically sensitive – there’s already talk of more control, god forbid – that’s a heck of warning shot. Aside from Feldstein’s article & Summers as well one of my other favorite blogs (BeYourOwnEconomist: http://beyourowneconomist.blogspot.com/ ) has a couple of recent posts. I just up my own weekly summary of the news plus some charts trying to explain where we’re at and what kind of cycle this is. Which as y’all point out is likely to be vastly different this time around. Oohrah.

  10. rexl commented on Feb 23

    wage and price controls in the seventies were under Nixon.
    whereas now the growth engines of economy are casinos and healthcare, o yeah, pass the bong.

  11. Winston Munn commented on Feb 23

    To further Jim Foster’s observation:

    From: http://www.treasurydirect.gov/govt/reports/pd/histdebt/histdebt_histo5.htm

    U.S. National Debt

    09/30/2007 9,007,653,372,262.48
    09/30/2000 5,674,178,209,886.86

    Around 50% of this increase has been monetized by FCBs. Had the Fed been required to monetize the debt nationally, it is hard not to call it hyperinflation; however, being distributed among many holders, hyperinflation has been diffused into tradeflation.

    Tradeflation kept pressure on bond yields, creating an artificial borrowing euphoria.

    Meanwhile, the U.S. did all its economy will allow, which is hump and pump new equities to produce mirage wealth. Eric Janzen at Harper’s projected a housing wealth effect 38% above the average. Mean reversion of asset values will wipe out $12 trillion of this mirage capital.

    That loss is enough to cause recession. The depth and length of the recession will be dependent upon the length of time it takes to create a new bubble of mirage wealth.

    With Democrats almost certain to win Congress and the White House, my bet is that the next big bubble will be in the “green” industries. When a wave of geothermal IPOs starts, that should signal the start of the next “great expansion”.

    In the meantime, canned goods isn’t a bad place to store your money.

  12. Ross commented on Feb 23

    Some really really fine posts. You are all to be congratulated. Keep it up.

  13. rexl commented on Feb 23

    but geothermal wells are not as prevalent as single family residences.
    also i have been watching that recent swarm of earthquakes around mexicali, baja california. the area is the location of a very large geothermal site on the mexican side. they do not practice re-injection of the brine water but rather pipe it out onto an old lake bed, laguna salada (where the gulf receded long ago) and let it evaporate. interesting to see how that develops.
    i think this cycle will take a long time in rebuild, especially since housing was not effected much by the slow down of 2000, the housing cycle has been generating since the set back of ’90-’91.

  14. OldVet commented on Feb 23

    I’m still burning about that market manipulation Friday afternoon, especially looking at the time chart of Futures and time chart of S&P before -before !- the AMBAC report. I filed a complaint with the SEC at enforcement@sec.gov.

    If banks want to throw away money to prop up a lousy business like AMBAC, they should do it with their money, not mine.

  15. Dean commented on Feb 23

    After some more futile rate cuts, evaporated bailout schemes, and with more bad news from housing and jobs, the grim reality about the economy will start to sink in, and maybe we will see a honest fed, and true economic projections.

    The point is, the market was marching back to a true level, before the shakedown rummors got started this weekend. The problems aren’t understood by many, not even by the guys running the banks and for sure by the Fed, because they do not understand Syndication or Syndicate attitudes.

    I can guarantee you that it is deeper than AMBC and MBIA and I would venture to say a large part of money is about to suddenly disappear. Every Syndicate is trying to get their cut and this is a lot bigger mess than is being let out, we are starting to see money fleeing and everyone trying to get theirs. I would venture say there are hundreds and maybe even thousands of these Syndicate games going on.

  16. Michael Donnelly commented on Feb 23

    BR: Here’s something that has long stumped me. Does the Fed forecast assume they do nothing from this point forward, or does it assume a certain number of cuts (or hikes) in other words, because they never forecast a recession is that because in their model they keep cutting rates so that we don’t get a recession ?

  17. John Borchers commented on Feb 23


    The Fed never could mention recession. Simple mention from Bernake that there might be flat or no growth would tank the system.

    This is exactly what is wrong with the market’s today. Anyone who mentions something that might pan out gets interpreted as a fact as if it already occured. Since this happens could you imagine what would happen if the Fed were to forecast recession?

  18. Lars commented on Feb 23

    Why do I get the uncomfortable feeling that something’s afoot, is bad but don’t know what. Maybe the next bubble will be survival training.

  19. Nikhil commented on Feb 23

    To be fair to the the fed: They did post this paper/study (which I found as I was searching for their past forecasts)
    on their web site that talks about their forecasting methods and it acknowledges their limitations.

    Gauging the Uncertainty of the Economic Outlook From Historical Forecasting Errors
    David Reifschneider and Peter Tulip
    November 19, 2007

    “Conclusion:…We stress that our approach is not a complete assessment of uncertainty at present. Rather, we intend our estimates to be used in conjunction with the qualitative summary the FOMC will publish of participants’ views concerning the uncertainty of the current outlook. For example, Committee participants may suggest that uncertainty is greater or less than that seen on average in the past or that
    the risks to the outlook are skewed in a particular direction. This information, taken as a whole, is intended to convey a more complete sense of likely outcomes than would be provided by their individual forecasts and the benchmark uncertainty estimates alone.”

    My observation about the market: We are in the middle of strong “bargaining phase”

    There are four pillars that have been producing rallies and supporting this market in the face of bad economic/earnings data over last two months: BBFF – Buffett, Bailouts, Fed and the Fiscal Stimulus!

    Just a strong hunch: Next week is “dress up” week (& quarter-end) for 4 big boys/brokers: No wonder you have these pathetic news induced, psychology shore-up staged rallies that occur at the open or at the close.

    We had the failed “santa/year-end mark-up rally” translating to a sell-off in January after bad employment and ISM report in early Janaury. Then the “hedge funds mark up rally at the end of Janaury failed, from Feb 4th onwards after the employment and ISM services number came out and now we have the brokers closing the quarter and trying to support the markets, which — my guess is — will fail in early March and the media reason for that will be the bad economic numbers that will come out in the first week of march.

  20. Pat G. commented on Feb 24

    Guess that means there will be further analysts downgrades on stocks and further deterioration in their prices.

  21. blam commented on Feb 24

    My humble model tells me that it would be a good time to exit the equity market, if one hasn’t allready done so.

    Never listen to Mauldin. If I want to jab a knife in my thigh, I will do so on my own, thank you.

  22. bonghiteric commented on Feb 24

    They may not be at the “bubble” stage yet but certain components of the agriculture and ag chemical sector are looking a little overvalued. A lot of inflows into commodities and ag-related equities and IMHO its questionable whether the fundamentals support the prices especially given the signs a slowdown is afoot. The two year charts of POT, MON, MOS, and AGU, look awfully similar to the 2003-2005 charts of DHI, CTX, LEN, and BZH.

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