The Economy: One year from now: How strong and why?

[Masshog]

The S&P thread didn't elicit that much comment, hopefully this one will do a bit a more. 

My guess is somewhere around 0 with a modestly negative bent.  I think we are in for a succession of rough quarters as the consumer comes to grips with the new order of things.  John Mauldin has dubbed it the "Muddle Through Economy", and I think the description is an apt one.

1) Energy prices... even should crude fall 45.00 a barrel, gas prices will still be quite high and will still be claiming a big chunk of what was consumer discretionary spending. 2) Consumers are having a much harder time accessing credit.  Home equity lines are being cut like crazy, standards for all kinds of consumer loans are much higher than they were six months ago (I think the decline in credit availability is a big story), their homes can no longer be treated like ATMs, savings yields are terrible, and their stock and property portfolios are both losing value like mad. 3) There are a ton of negative amortizing mortgages due to recast over the next twelve- eighteen  months.  This is a huge problem for both the financial sector, home prices and by extrapolation, consumers. 3) Other than occasional declines as the market moves to quality, market yields are poised to rise (probably more on the long end) as inflation fears worsen.  Remember that 325 basis points of fed cuts has only reduced the 30 year fixed rate mortgages by about 1/4 percent.  4) I personally don't buy the global decoupling story.  I still think that the American consumer is the key to large swaths of the global economy. And lets remember that the global economy is also generating significant inflation.

On the bright side, American companies (outside of financials) have gone into this cycle with much better balance sheets and solid inventory controls, there is a rapidly growing global consumer base, the American economy remains a global powerhouse (otherwise this hit would be already be generating -2% or less GDP) and despite the consumers problems, there is a lot of wealth that has been stored as the result of the last 20 years of secular growth in equities and home values. 

Ok, enough about me, lets debate!!!   

[BlackKnightHogFan]

The S&P thread didn't elicit that much comment, hopefully this one will do a bit a more. 

My guess is somewhere around 0 with a modestly negative bent.  I think we are in for a succession of rough quarters as the consumer comes to grips with the new order of things.  John Mauldin has dubbed it the "Muddle Through Economy", and I think the description is an apt one.

1) Energy prices... even should crude fall 45.00 a barrel, gas prices will still be quite high and will still be claiming a big chunk of what was consumer discretionary spending. 2) Consumers are having a much harder time accessing credit.  Home equity lines are being cut like crazy, standards for all kinds of consumer loans are much higher than they were six months ago (I think the decline in credit availability is a big story), their homes can no longer be treated like ATMs, savings yields are terrible, and their stock and property portfolios are both losing value like mad. 3) There are a ton of negative amortizing mortgages due to recast over the next twelve- eighteen  months.  This is a huge problem for both the financial sector, home prices and by extrapolation, consumers. 3) Other than occasional declines as the market moves to quality, market yields are poised to rise (probably more on the long end) as inflation fears worsen.  Remember that 325 basis points of fed cuts has only reduced the 30 year fixed rate mortgages by about 1/4 percent.  4) I personally don't buy the global decoupling story.  I still think that the American consumer is the key to large swaths of the global economy. And lets remember that the global economy is also generating significant inflation.

On the bright side, American companies (outside of financials) have gone into this cycle with much better balance sheets and solid inventory controls, there is a rapidly growing global consumer base, the American economy remains a global powerhouse (otherwise this hit would be already be generating -2% or less GDP) and despite the consumers problems, there is a lot of wealth that has been stored as the result of the last 20 years of secular growth in equities and home values. 

Ok, enough about me, lets debate!!!  

Just a quick thought on a Sunday.  I don't buy the decoupling theory either.  I believe the credit issues cross the ocean like a global pandemic.  Thus, Trichet will be forced to lower rates at some point.  The mortgage rates, in my opinion, are linked more to LIBOR then Fed Funds.  Thus with the decrease in rates in Europe, LIBOR decreases and the ARMS are self adjusting.  Only question, does it happen in time?

[Masshog]

You are correct in that arms are more linked to libor, but 15 and 30 year fixed are set by the market.  Those are the mortgage rates I was referring to.   

[SultanofSwine]

A saving grace in the later innings of the mortgage mess would be for the resets to hit lower than they have been. That would take some pressure off of folks without the credit score to re-fi to a fixed mort. by allowing them to still make the monthly note even ith the reset.

I went out on the limb with the 4% choice.

[Masshog]

Whoa.... 4%... I hope your right Sultan.... Took the over huh? 

[Masshog]

Remember that with the neg am loans that they recast to a fixed at 30 yr rate +.  The recast isn't a date thing, its when they reach between 115-125% (depending upon the contract) of the original principle balance.  You take a 300k loan, you pay the minimum, the difference accrues in neg am... an pretty soon you have a 345-365k loan balance, and the loan is recast into a fixed.  Payments go up A TON.  The only decent data I have seen suggests that up to 70% of borrowers have been paying the minimum each month.   

[porky_teh_pig]

I'm not a financial geek but I stayed in a Holiday Inn about a month ago.

The thing that worries me is that election years are usually a time of economic growth.  The presiding President sparks the economy so it looks good for his party's predecessor.

The presiding President has tried to spark the economy but it looks like things will be looking down come November.  I'm an independant that leans conservative but I have to wonder what the candidates have planned in speeches to solve an ailing economy.

[Snort and Squeal]

The S&P thread didn't elicit that much comment, hopefully this one will do a bit a more. 

My guess is somewhere around 0 with a modestly negative bent.  I think we are in for a succession of rough quarters as the consumer comes to grips with the new order of things.  John Mauldin has dubbed it the "Muddle Through Economy", and I think the description is an apt one.

1) Energy prices... even should crude fall 45.00 a barrel, gas prices will still be quite high and will still be claiming a big chunk of what was consumer discretionary spending. 2) Consumers are having a much harder time accessing credit.  Home equity lines are being cut like crazy, standards for all kinds of consumer loans are much higher than they were six months ago (I think the decline in credit availability is a big story), their homes can no longer be treated like ATMs, savings yields are terrible, and their stock and property portfolios are both losing value like mad. 3) There are a ton of negative amortizing mortgages due to recast over the next twelve- eighteen  months.  This is a huge problem for both the financial sector, home prices and by extrapolation, consumers. 3) Other than occasional declines as the market moves to quality, market yields are poised to rise (probably more on the long end) as inflation fears worsen.  Remember that 325 basis points of fed cuts has only reduced the 30 year fixed rate mortgages by about 1/4 percent.  4) I personally don't buy the global decoupling story.  I still think that the American consumer is the key to large swaths of the global economy. And lets remember that the global economy is also generating significant inflation.

On the bright side, American companies (outside of financials) have gone into this cycle with much better balance sheets and solid inventory controls, there is a rapidly growing global consumer base, the American economy remains a global powerhouse (otherwise this hit would be already be generating -2% or less GDP) and despite the consumers problems, there is a lot of wealth that has been stored as the result of the last 20 years of secular growth in equities and home values. 

Ok, enough about me, lets debate!!!  

Feel pretty much the same.  I like to say we are in uncharted economic times as we step into the next year.  Don't see much if any growth.

[BlackKnightHogFan]

Remember that with the neg am loans that they recast to a fixed at 30 yr rate +.  The recast isn't a date thing, its when they reach between 115-125% (depending upon the contract) of the original principle balance.  You take a 300k loan, you pay the minimum, the difference accrues in neg am... an pretty soon you have a 345-365k loan balance, and the loan is recast into a fixed.  Payments go up A TON.  The only decent data I have seen suggests that up to 70% of borrowers have been paying the minimum each month.   

I think there are some answers to this issue.  Either by the lending institutions or regulation.  The people who are in the know are aware of this and I think they fix it at the microlevel.  Not unlike the Fed and JPM at the macrolevel.  Call me stupid, but I'm not ready to give up on the US consumer just yet.  Additionally, I do believe oil normalizes, somehow, and by the end of the year consumers have more money in their pockets because of lower gas and food prices.  However, I am not out on the limb with sultan, I am at 1-2%.

[SultanofSwine]

Yeah, took the over. More of a hope than a belief.

[JM Gorilla]

Consumers won't be out of the roughest part until all the commodities markets normalize, not just oil. 

You are correct in that arms are more linked to libor, but 15 and 30 year fixed are set by the market.  Those are the mortgage rates I was referring to.   

Just a note, I know when folks are attempting to forecast the long term rates, they tend to look at the trends on long term bonds more than anything else.  I don't know the exact correlation, but apparently there is one.

[Masshog]

Consumers won't be out of the roughest part until all the commodities markets normalize, not just oil. 
Just a note, I know when folks are attempting to forecast the long term rates, they tend to look at the trends on long term bonds more than anything else.  I don't know the exact correlation, but apparently there is one.

Actually, thats a major part of my job. 

[BlackKnightHogFan]

Actually, thats a major part of my job. 

Okay, then explain to my pea sized brain, with the 30 year bond at 4.5% and the discount window at 2.25%, why all the concern about resets and inflation.  Rates don't seem to indicate inflation on the near term horizon, and the 30 year bond is not significantly higher then 3-4 years ago when all the ARMS were issued.  What is the deal?  Sorry for my stupidity.

[BlackKnightHogFan]

Consumers won't be out of the roughest part until all the commodities markets normalize, not just oil. 
Just a note, I know when folks are attempting to forecast the long term rates, they tend to look at the trends on long term bonds more than anything else.  I don't know the exact correlation, but apparently there is one.

In my opinion, when oil normalizes so will the rest of the commodities. 

[Masshog]

Okay, then explain to my pea sized brain, with the 30 year bond at 4.5% and the discount window at 2.25%, why all the concern about resets and inflation.  Rates don't seem to indicate inflation on the near term horizon, and the 30 year bond is not significantly higher then 3-4 years ago when all the ARMS were issued.  What is the deal?  Sorry for my stupidity.

Awesome question (the one about the 30 year yield).  For several years now rates have been at abnormally low levels. The real rate (the bond yield - the inflation rate) has been extremely thin (very little margin for error if the inflation rate goes higher).  I think most of that abnormal bid was simply the result of money being left so easy for so long.  Excess global capital (much of it Dollars) were struggling to find a low risk home.  The US bond market fit the bill.

More recently the low yields are almost entirely the result of the flight to quality (capital fleeing the badness).  I think bonds are currently one of the worst values of all time (in my opinion).  In other words, bond yields are forecasting nothing about future inflation... and even if they were, the track record of bond market participants as a discounting mechanism for inflation is pretty tenuous. 

As for resets, they are resetting much higher than the teasers... esp. in the case of the neg. am loans.  Remember, its not just the rate of the reset, but also that you are financing between 115 and 125% of the original principle at a rate much higher that a FNMA/FHLMC rate.  I think a lot of these loans recast in the 8-9% range.  Payments triple and quadruple... and more.   Take it one more step, as delinquency and default rates rise, the most immediate impact is on the financials... and as a result, they become less willing to make new loans.... and the badness is transmitted to the real economy. 

Again, just my opinion. 

Also remember, many of the subprime loans reset to Libor, not to treasury yields. 

[Masshog]

Man, two of you are down there in OH-MY-GOD territory.  How about elaborating a bit. For a geek like me it would be interesting to hear your views.

[PhillyHog]

Awesome question (the one about the 30 year yield).  For several years now rates have been at abnormally low levels. The real rate (the bond yield - the inflation rate) has been extremely thin (very little margin for error if the inflation rate goes higher).  I think most of that abnormal bid was simply the result of money being left so easy for so long.  Excess global capital (much of it Dollars) were struggling to find a low risk home.  The US bond market fit the bill.

More recently the low yields are almost entirely the result of the flight to quality (capital fleeing the badness).  I think bonds are currently one of the worst values of all time (in my opinion).  In other words, bond yields are forecasting nothing about future inflation... and even if they were, the track record of bond market participants as a discounting mechanism for inflation is pretty tenuous. 

As for resets, they are resetting much higher than the teasers... esp. in the case of the neg. am loans.  Remember, its not just the rate of the reset, but also that you are financing between 115 and 125% of the original principle at a rate much higher that a FNMA/FHLMC rate.  I think a lot of these loans recast in the 8-9% range.  Payments triple and quadruple... and more.   Take it one more step, as delinquency and default rates rise, the most immediate impact is on the financials... and as a result, they become less willing to make new loans.... and the badness is transmitted to the real economy. 

Again, just my opinion. 

Also remember, many of the subprime loans reset to Libor, not to treasury yields. 

Masshog, you are correct about Libor.  But one thing I would add is that the Option ARMS that are out there are typically based on the MTA, Moving Treasury Average.  I forget the exact calculation but it's a rolling average of the past 12 months 1 year or 1 month rate.  Sorry I can't remember exactly but you should be able to find it with a quick google.  I'm running late for Chinese class or I would look it up and post.  Maybe when I have time later...

[Masshog]

I know they reset at some multiple of a US rate, and that the rate is much higher than the initial rate.... other than that....  Thanks Philly.