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It Was Bad. The End. (not quite)

Summary:
If that wasn’t the most anticlimactic worst economic quarter in history. The numbers were just as bad as people were expecting – which is the point. It’s not like this economic collapse snuck up on anyone, nor did its scale and depth. We’ve all known from the very beginning what the deal was going to be. Headline real GDP fell by a just about a third, -32.9% (seasonally-adjusted annual rate) and pretty much right on the nose of the most recent analyst estimates. In more appropriately compounded terms, the decline was just shy of 40%. Big whoop. The question on everyone’s mind, the only one that truly matters, is what comes next. That’s been the whole thing from the very beginning. For whatever reasons, right or wrong, they turned the economy off. Can it be turned right back on

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If that wasn’t the most anticlimactic worst economic quarter in history. The numbers were just as bad as people were expecting – which is the point. It’s not like this economic collapse snuck up on anyone, nor did its scale and depth. We’ve all known from the very beginning what the deal was going to be.

Headline real GDP fell by a just about a third, -32.9% (seasonally-adjusted annual rate) and pretty much right on the nose of the most recent analyst estimates. In more appropriately compounded terms, the decline was just shy of 40%.

Big whoop. The question on everyone’s mind, the only one that truly matters, is what comes next. That’s been the whole thing from the very beginning. For whatever reasons, right or wrong, they turned the economy off. Can it be turned right back on again?

There really aren’t a whole lot of clues in this GDP report, including annual revisions that had more to do with Euro$ #3 than anything (and, frustratingly, “residual seasonality”), the bulk just scattered oddities of new plunging records. It’s more of a set of curiosities than relevant pieces for analysis at this point.

It was bad. The end.

It Was Bad. The End. (not quite) It Was Bad. The End. (not quite)

For what it’s worth, the NABE’s estimates put together some time ago proved to be near spot-on for this first leg. I wouldn’t read too much into that, but it doesn’t bode well if these pro forma figures (and my own added on) continue to be. If the economy does work out like them, then that’s really bad news.

And that’s why any chance of this reopening rebound stalling now, in July, maybe even back in June, would be devastating. Petering out near the trough is not what we need; even a double-digit GDP quarter in Q3, as has been figured, would prove to be wholly insufficient.

It Was Bad. The End. (not quite)

The somewhat interesting parts of GDP data begin with PCE, personal consumption expenditures. Q1’s quarterly change was already the worst, so Q2 being nearly seven times as bad just makes this incomprehensible.

What’s somewhat noteworthy is that almost all of this indescribable decline was due to no one being able to go outside and purchase services; the contraction in goods, both durable and non-durable, almost minor by comparison (real PCE was -34.6% Q/Q SAAR, while durables ended up just -5.8% and nondurables -21.6%).

People still bought things on the federal government’s borrowed dime, apparently, using online outlets to do it. What happens in Q2? Services come back, certainly, but at the expense of goods? A zero sum game isn’t going to foster a recovery. And what about with fewer or lower combined unemployment and “helicopter” payments? A labor market still being destroyed this late in the rebound?

It Was Bad. The End. (not quite)

These are questions the production side of the economy (which accounts for much of service sector activity, too; managing, selling, transporting all that stuff) is currently wrestling with. The estimates for GDP inventory were, predictably, the worst on record, the largest drawdown.

As noted yesterday, one reason why was that this destocking perhaps liquidity hoarding process kept up right on and through the last month in the quarter, June.

It Was Bad. The End. (not quite) It Was Bad. The End. (not quite)

A quirk, probably a temporary one, capex, or Real Private Non-residential Fixed Investment, wasn’t worse because IT spending rallied substantially. As anyone who tried to buy a webcam in April or May already knows, various IT components were completely sold out everywhere as companies rushed to convert their operations from office-based to home-based just to remain minimally functionable.

That’s not going to continue going forward, as many company earnings reports indicate plans to lower if not slash all forms of capex if the rebound doesn’t truly ignite soon. Once employees are set up, as most already have, even IT will end up getting chopped in blanket fashion. Something to keep an eye on.

And it may end up being capex which decides how this thing goes; not into a “V”, in my view, but how bad of an “L” we settle in to (and whether that gets settled at all). Productive investment is, after all, the cash-heavy twin to labor costs, and we know what businesses are doing, still, to their marginal employees (jobless claims rose again for the second week, inflecting at more than double the previous record).

It Was Bad. The End. (not quite)

US demand obviously fell sharply, but how soon will it, can it, come back? This is not strictly an American problem, either, both in terms of what the US economy buys from the rest of the world (and pays for it with badly needed “dollars”) as well as the global recession’s impacts elsewhere.

Finally, Q2’s situation provides another admittedly extreme case of how to read the Fed’s balance sheet – specifically bank reserves. You’ll note from the first chart I posted at the beginning showing those against real GDP how they are (mostly) inversely correlated. When the economy’s doing bad, the Fed’s doing a lot.

The right side of that chart demonstrates very well, the Fed doing a lot never accomplishes much in the real economy (or anywhere outside of stocks, if for other reasons). Thus, bank reserves only tell you that the central bank is or has been active, which you should already know from what happened to GDP.

To further emphasize that point, and to put it in more monetary terms, here’s GDP’s implicit price deflator measured against the same bank reserves data:

It Was Bad. The End. (not quite)

When there were little to no bank reserves and “money printing” in the pre-GFC1 era, consumer prices accelerated and broadly increased in more sustained fashion. Too much, in fact, for most policymakers. Rather than the Fed being behind that, Greenspan’s rate hikes tried unsuccessfully to put a lid on it, what was in reality the apex of global eurodollar expansion.

GFC1 and thereafter, less eurodollar expansion or even contraction (general tightness consistent with bond yields, risk-free and risky) with an almost constant presence of QE and Fed balance sheet expansion that behaves inversely to these ups and downs.

Bank reserves prove only the one thing – the Fed’s reactive policy nature, not its efficacy. If anything, the GDP data as whole, real GDP plus its deflators, shows rather damningly how little effect QE, bank reserves, and the central bank actually have on anything in the economy.

In commentary surrounding the economy and markets perceiving whats’ really going on in it, well, that’s a whole other story.

Now that it’s happened, and we have some idea how much happened that we didn’t want, what’s next? Scant clues here, though this does at least confirm the starting point and therefore the concerns about not really rebounding fast enough from it.


It Was Bad. The End. (not quite)

Jeffrey P. Snider
As Head of Global Investment Research for Alhambra Investment Partners, Jeff spearheads the investment research efforts while providing close contact to Alhambra’s client base. His company is a global investment adviser, hence potential Swiss clients should not hesitate to contact AIP

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