Market Update
Dwight Johnston
Vice President, Economic & Market Research
A Big Shift but Not Into High Gear
This quote is from last month’s Words from WesCorp: “We expect that the next few Unemployment Reports will shock the markets out of any concern about the Fed tightening.” As it happened, it didn’t take “the next few” reports. It only took one report. August payrolls declined by 84,000, but revisions to June and July cut another 58,000 off of jobs roster. But the shock wasn’t the Nonfarm Payroll number, it was the jump in the Unemployment Rate from 5.7 percent to 6.1 percent, the highest rate in almost five years.
In early June, the consensus in the economics community and in the fed funds futures trading market was that fed funds would be 3.00-3.50 percent by June 2009. After this latest Unemployment Report, the consensus is the fed funds will still be 2.00 percent by 2009. This change in forecast is not solely based on the last payroll report.
The three major assumptions in June were that the job market would stabilize, the credit crisis would calm, and inflation would continue to rise as commodity prices continue to soar. We now know the job market is not stabilizing, and the outlook for jobs has deteriorated. It’s also very clear that the credit crisis has not run its course. Banks and brokerages have taken more than $500 billion in losses to date and have only been able to raise $360 billion in new capital. At the beginning of the crisis, new speculative capital seemed to be flowing into distressed situations (think Merrill and Citibank), albeit at a high price. But the spigots have been turned off. Conservative estimates are that future losses, mostly concentrated on the balance sheets of banks, will be another $500 billion leaving the banking system short of capital. Some banks will shrink and others will simply fail. IndyMac might prove to have been only an appetizer of what is to come. We don’t like to think of this as an opportunity for credit unions, but the reality is that it might be.
The good news (thank goodness there is some of that) is that commodity prices have continued to tumble. Most commodities are off by 25-40 percent from the peak this year. These declines will take some time to work into the CPI figures, but this gives the Fed breathing room by silencing the inflation hawk crowd.
The Fed is unlikely to ease in September, but we believe the Fed might be back in play on the easing side by late October. Lowering of the fed funds rate from 5.25 percent to 2.00 percent has done little for the economy. The problem is not the level of the funds rate; it’s the credit crunch. We really don’t like being bearish on the economy, but the road back from the credit crunch will be long and bumpy.
You can follow Dwight’s insightful commentary each business day on Member Center or www.wescorp.org. You can e-mail him here.