Mish's Global Economic Trend Analysis

Fed Study Shows "Persistent Fed Overoptimism about Economic Growth"; What Will They Do About It?
Diving Into the ISM: What's It All Mean?
Total Construction Spending Weaker Than Expected; Residential Construction Spending in Contraction
Debt of Six Eurozone Countries Exceeds 100% of GDP, Two More Coming in 2015 (France and Spain)
Four Trade War Questions; PMI Reports; Currency Manipulation Charges

Fed Study Shows "Persistent Fed Overoptimism about Economic Growth"; What Will They Do About It?

Posted: 02 Feb 2015 06:06 PM PST

Since 2007 nearly every Fed economic forecast has been on the optimistic side.

In an attempt to explain, a new Federal Reserve Bank of San Francisco dives into the Persistent Overoptimism about Economic Growth.

My friend "BC" commented "It has taken 7-8 years for Fed economists to get around to this brilliant insight."

I provide the real reasons following this excerpt from the report ...

Since 2007, Federal Open Market Committee participants have been persistently too optimistic about future U.S. economic growth. Real GDP growth forecasts have typically started high, but then are revised down over time as the incoming data continue to disappoint. Possible explanations for this pattern include missed warning signals about the buildup of imbalances before the crisis, overestimation of the efficacy of monetary policy following a balance-sheet recession, and the natural tendency of forecasters to extrapolate from recent data.

Explaining the persistent overoptimism

Economic forecasting can be a humbling endeavor. In a cross-country study of private-sector forecasts from 1989 to 1998, Loungani (2001) finds that "the record of failure to predict recessions is virtually unblemished." He also finds that forecast revisions in one direction tend to be followed by further revisions in the same direction and that one-year-ahead growth forecasts are typically too optimistic.

Implications for economic models

Research has identified numerous instances of persistent bias in the track records of professional forecasters. These findings apply not only to forecasts of growth, but also of inflation and unemployment (Coibion and Gorodnichencko 2012). Overall, the evidence raises doubts about the theory of "rational expectations." This theory, which is the dominant paradigm in macroeconomics, assumes that peoples' forecasts exhibit no systematic bias towards optimism or pessimism. Allowing for departures from rational expectations in economic models would be a way to more accurately capture features of real-world behavior

An updated study by Ahir and Loungani (2014) finds that the private-sector's record of failure to predict recessions remained intact through 2008 and 2009. A study by Alessi, et al. (2014) finds that one-year-ahead growth forecasts from the Federal Reserve Bank of New York and the European Central Bank from 2008 to 2012 exhibited substantial overoptimism, averaging 1.6 to 2.4 percentage points above actual growth. The SEP growth forecasts fit the pattern of these various studies.

What Will They Do About It?

That question is easy to answer: absolutely nothing. There is a systemic bias towards optimism from economists in general, not just central banks.

I have mentioned that numerous times in recent years, even after it was long understood the recession of 2007-2009 was a balance-sheet recession.

For example, on January 6, I noted Economists Upbeat Despite 4th Consecutive Decline in Factory Orders; Auto Orders vs. Expectations.

Economists are among the most optimistic groups on the planet. Year in, year out they project improvements in growth.

So today, despite 4th Consecutive Decline in Factory Orders, it's no surprise that economists remain optimistic.

Private Pep Rally

On January 29, Fed Chair Janet Yellen met with Senate Democrats at a private luncheon. She told the Democrats that the U.S. Economy is Strong.

"She went through the issues of unemployment and inflation. Very positive. And economic growth numbers were good, have been good. There's work to be done," Sen. Richard Durbin (D-Ill.) said after the luncheon.

Could the Fed be rear-view mirror forecasting once again? I think so. Third quarter GDP rebounded strongly, so Yellen did what economists do, project strength into the future. Somehow this tendency is one-sided. Economists seldom project weakness the same way.

Diving Into the Details

On January 31, I went Diving Into the 4th Quarter GDP Report and noticed some ominous trends.

On February 1, I made a pretty bold statement Canada in Recession, US Will Follow in 2015.

Today, I noted Total Construction Spending Weaker Than Expected; Residential Construction Spending in Contraction.

Also today, but something I did not comment on, U.S. Consumer Spending in December Weakest Since 2009.

U.S. consumer spending recorded its biggest decline since late 2009 in December with households saving the extra cash from cheaper gasoline.

Other data on Monday showed factory activity cooled in January, suggesting the economy may have entered the new year on a slightly softer footing than had been expected.

Nevertheless, upbeat and cash-flush consumers are expected to step-up spending and buoy the economy this year.

"The consumer is poised to do well in early 2015. Lower gasoline prices are going to provide a big lift to consumption," said Ryan Sweet, a senior economist at Moody's Analytics in West Chester, Pennsylvania.

Reasons for Optimism

Missed warning signals about the buildup of imbalances before the crisis
Overestimation of the efficacy of monetary policy following a balance-sheet recession
Natural tendency of forecasters to extrapolate from recent data.

Comment on Reason #1

Bernanke like Greenspan could not see the obvious. This is a general statement. Buildup of imbalances has nothing to do with it. Neither Greenspan nor Bernanke could spot bubbles.

Janet Yellen right now is virtually blind as a bat. She cannot see the bubbles in bonds and equities the Fed created. When those bubbles burst, the slowdown should smack some sense into the Fed, but it won't. Moreover, the bigger this equity bubble gets, the bigger the crash. The Fed cannot see that either.

Comment on Reason #2

These arrogant fools actually believe they are economic wizards who can steer the economy like a truck on a highway. The idea that central banks can set interest rates is as faulty as Russian central planners can correctly set the price of oranges. But that's what they believe.

Comment on Reason #3

They are extrapolating 3rd quarter GDP into the future again right now. They miss the bond and equity bubbles, factory orders, and countless other things. All strong reports are thought to be representative. All weak reports are deemed to be a "soft patch".

Judging from the "strong economy" statement of Yellen, the Fed seems to believe the US will "decouple" from the clearly slowing global economy. It has for a while, but it cannot last.

Too Much Fail in Models

Here is the first of two bonus reasons to help explain overoptimism:

The Fed (economists in general) have far too much faith in economic models and far too little common sense. The economy cannot be driven like a truck. Fat tails appear far more than theory suggests. Why? Because many widely-held theories are complete nonsense.

Anyone recall the widespread belief people would not walk away from their homes? And what about the idiotic Keynesian theory that recessions and inflation could not happen at the same time.

Economists widely believed that bit of nonsense. Yet, instead of abandoning Keynesian theories, they went further down the rabbit hole to explain things.

System Runs on Lies

Here's a final bonus explanation the San Francisco Fed failed to mention: Good news sells. People do not like the truth. They would rather hear lies. And the Fed is willing to provide lies, especially in difficult times.

The entire system runs on lies such as

Pro-forma data
Beat-the-street nonsense where corporations provide analysts with numbers the corporations know they can beat by a penny
Analysts are more than willing to downgrade expectations to help corporations beat-the-street

When it Becomes Serious

The Fed does not want an audit? What pray tell does it have to hide?

European politician Jean Claude Juncker summed it up nicely: "When it becomes serious, you have to lie".

And so the Fed does. Sometimes, as a matter of arrogant belief in their own wizardry, they even start to believe the lies they tell.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Diving Into the ISM: What's It All Mean?

Posted: 02 Feb 2015 02:09 PM PST

This morning the Institute for Supply Management released its much followed Manufacturing ISM® Report On Business®.

Index	Jan	Dec	PP Change	Direction	Rate of Change	Trend in Months
PMI®	53.5	55.5	-1.6	Growing	Slower	20
New Orders	52.9	57.8	-4.9	Growing	Slower	20
Production	56.5	57.7	-1.2	growing	Slower	11
Employment	54.1	56.0	-1.9	Growing	Slower	19
Supplier Deliveries	52.9	58.6	-5.7	Slowing	Slower	20
Inventories	51.0	45.5	5.5	Growing	From Contracting	1
Customers' Inventories	42.5	44.5	-2.0	Too Low	Faster	2
Prices	35.0	38.5	-3.5	Decreasing	Faster	3
Backlog of Orders	46.0	52.5	-6.5	Contracting	From Growing	1
Exports	49.5	52.0	-2.5	Contracting	From Growing	1
Imports	55.5	55.0	0.5	Growing	Faster	24

What's It Mean?

The PMI is a diffusion index. Numbers above 50 indicate expansion, numbers below 50 indicate contraction.

A key problem with diffusion indices is the size of the company does not matter. For example, a chemical company with 300 employees carries the same weight as an auto manufacturer with 200,000 employees.

Moreover, there are some peculiarities with the break-even number of 50.

The ISM says A PMI® in excess of 43.1 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the January PMI® indicates growth for the 68th consecutive month in the overall economy, and indicates expansion in the manufacturing sector for the 20th consecutive month. Holcomb stated, "The past relationship between the PMI® and the overall economy indicates that the PMI® for January (53.5 percent) corresponds to a 3.3 percent increase in real gross domestic product (GDP) on an annualized basis."

Thus, a manufacturing PMI above or below 50, does not imply similar overall economic activity as one might expect. Also, month-to-month changes show a lot a variances so it's important to look at trends over a longer period of time.

Manufacturing ISM Historical

The NBER (the historical arbiter of when recessions start and end) says a US recession began in November of 1973. The Manufacturing ISM was 68.1 at the time.

The above chart also shows some recessions began with the manufacturing PMI in negative territory. In isolation, the PMI itself does not say a lot. One needs to incorporate other data.

Manufacturing ISM Percent Change From Year Ago

Upturns from deeply negative tend to end recessions (purple circles), but spikes below the zero-growth tend line don't necessarily mean anything.

There were 10 occasions since 1950 in which the year-over-year growth of manufacturing PMI sunk to -20% that were not associated with a recession.

On the other hand, the chart shows that recessions generally start with the PMI near the zero-growth line. In those occasions where recessions started with PMIs well above 50, the PMI quickly crashed into negative territory.

Manufacturing ISM Percent Change From Year Ago Detail

Far too much reliance is given to these indicators, even though flirting around the zero-line is generally not associated with high growth.

The Manufacturing ISM is now at a spot where recessions frequently begin. Yet, far more often than not, recessions do not begin at this spot.

Nonetheless, please note the weakening trends in the table at the top.

Exports are slowing
Imports are up
Prices falling rapidly
Backlog of orders in contraction
Growth slowing nearly everywhere
Customer inventories rising

None of those imply strong growth.

The ISM says today's report "corresponds to a 3.3 percent increase in real gross domestic product (GDP) on an annualized basis". I will take the under for numerous reasons stated previously.

For more GDP look-ahead analysis, please see ...

January 31: Diving Into the GDP Report - Some Ominous Trends - Yellen Yap - Decoupling or Not?
February 02: Total Construction Spending Weaker Than Expected; Residential Construction Spending in Contraction
February 02: Four Trade War Questions; PMI Reports; Currency Manipulation Charges

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Total Construction Spending Weaker Than Expected; Residential Construction Spending in Contraction

Posted: 02 Feb 2015 11:22 AM PST

Construction spending for December was weaker than expected. Lots of reports recently have been "weaker than expected". From Bloomberg.

Highlights

Construction outlays rebounded 0.4 percent in December after dipping 0.2 percent the month before. December was below market expectations which were for a 0.6 percent gain.

December's increase was led by public outlays which rebounded 1.1 percent after dropping 1.8 percent jump in November. Private residential spending rose 0.3 percent after edging up 0.1 percent in November. Private nonresidential construction spending eased 0.2 percent in December after a 0.8 percent rise the month before.

On a year-ago basis, total outlays were up 2.2 percent in December compared to 2.7 percent in November.

Recent History Of This Indicator

Construction spending slipped 0.3 percent in November after a sharp 1.2 percent rebound in October. Market expectations were for a 0.5 percent gain. November's decrease was led by public outlays which fell 1.7 percent after a 2.8 percent jump in October. Private residential spending rose 0.9 percent, matching the pace the month before. Private nonresidential construction spending dipped 0.3 percent in November after edging up 0.1 percent in October.

Total Construction Spending Percent Change From Year Ago

click on any chart for sharper image

This is another trend that looks ominous. Year-over-year growth in total construction spending has fallen from 8% in February of 2014 to 2% in December.

Commercial Construction Spending Percent Change From Year Ago

Residential Construction Spending Percent Change From Year Ago

Residential construction spending will be a net contraction from 1st quarter GDP unless the trend reverses soon. But why should it? And if residential drops deep enough, total construction spending will subtract from 1st quarter GDP.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Debt of Six Eurozone Countries Exceeds 100% of GDP, Two More Coming in 2015 (France and Spain)

Posted: 02 Feb 2015 10:48 AM PST

In 2014 there were six eurozone countries whose debt-to-GDP ratio went over the 100% threshold. Two additional countries will pass that barrier in 2015.

The Maastricht Treaty on which the euro was founded was designed to keep "sound fiscal policies", with debt limited to 60% of GDP (not 100%), and annual deficits no greater than 3% of GDP."

Every country in the eurozone, including Germany, has been in violation of those rules. Let's take a look at the biggest violators as reported by El Economista. Data is from second quarter of 2014 (undoubtedly worse now).

100% Debt-to-GDP List

Italy 133%
Portugal 129.4%
Ireland 116.7%
Cyprus 112.2%
Belgium 105.1%
Greece 174.9%
Spain 100.3% (2015 estimate)
France 100% (2015 estimate)

In regards to France, Laurent Bigorgne, director of the Institut Montaigne, predict that French liabilities will not stabilize, but will continue to progress."

That certainly seems like a very safe prediction.

Wild Blue Yonder

And as debts soar off into the wild blue yonder, the need to keep interest rates at 0% to perpetually mask the problem increases.

I offer this musical tribute to celebrate the Keynesian policies that perpetuate wild blue yonder government spending and absurd central bank policies.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Four Trade War Questions; PMI Reports; Currency Manipulation Charges

Posted: 01 Feb 2015 11:47 PM PST

With the declining yen, Japan's manufacturing PMI has risen eight months. In contrast, China has been wavering near the stagnation line since early 2011.

Trade war questions relate to the just-released PMI reports and also the 4th quarter US GDP report. Let's start with today's PMI releases on China and Japan.

HSBC China Manufacturing PMI

The HSBC China Manufacturing PMI shows Chinese Operating Conditions Deteriorate Fractionally in January.

Chinese manufacturers saw a fractional deterioration in operating conditions at the start of 2015. Although output rose slightly and new orders broadly stabilised, staffing levels were cut for the fifteenth successive month. Meanwhile, relatively subdued client demand led companies to reduce their stock holdings of both post and pre-production goods in January. On the costs front, lower raw material prices led to the steepest reduction in average input costs since March 2009, which contributed to a sharp decline in prices charged.

After adjusting for seasonal factors, the HSBC Purchasing Managers' Index™ (PMI™) posted at 49.7 in January, down slightly from the earlier flash reading (49.8), but up fractionally from 49.6 in December. This signalled a second successive monthly deterioration in the health of the sector, albeit only slight.

Latest data indicated a renewed expansion of Chinese manufacturing output in January, though the rate of increase was only fractional. This was the first time that production has risen in three months.

Manufacturing companies reduced their headcounts again in January. That said, the rate of job shedding was the weakest recorded in 15 months and only slight.

China Manufacturing PMI Index

China's manufacturing PMI has been flirting just above and just below the stagnation line since early 2011. More time has been spent in contraction than expansion in that period.

Japan Posts "Solid" Growth

In contrast to China, the Markit/JMMA Japan Manufacturing PMI shows solid production growth at start of 2015.

Key Points

Headline PMI posts above 50.0 for eighth month running
Further increases in output and new orders
Inflationary pressures remain amid reports of yen depreciation

Summary

Data at the start of 2015 signalled a solid improvement in operating conditions in the Japanese manufacturing sector. Production growth continued for the sixth month running, supported by a further rise in new orders. Subsequently, payroll numbers remained in growth territory, with the latest expansion broadly in-line with the previous month. Meanwhile, upward pressures on both input and output prices remained.

The headline PMI posted at 52.2 in January, little changed from 52.0 in December and above the 50.0 no-change mark for the eight month running, thereby signalling sustained growth in the Japanese manufacturing sector at the start of 2015.

Panellists attributed the latest increase to a combination of improved advertising, stronger demand conditions and the launching of new products. Similarly, new orders from abroad rose in January.

Japan Manufacturing PMI

Four Trade War Questions

How long will China let Japan debase the Yen without a response?
How long before US manufacturers whine about loss of exports?
Will exports add to or subtract from US GDP next quarter?
Will the US economy decouple from the global economy?

1A. China will not let Japan (and increasingly Europe) get the upper hand forever. China will soon take strong action to reduce the value of the yuan.

2A. Manufacturers will start whining loudly if they are not already. Expect to see currency manipulation charges in the news again soon. Those charges will escalate as soon as China responds to Bank of Japan and ECB moves to reduce the value of the yen and euro.

3A. Subtract. Not only are US exports getting more expensive relative to Europe and Japan, the entire rest of the global economy is slowing rapidly.

Our biggest trading partner is Canada, and Canada is in recession, with a rapidly sinking Canadian dollar on top of it. (See Canada in Recession, US Will Follow in 2015)

4A. No. The US will not decouple as economists assume.

Diving Into the GDP Report - Some Ominous Trends

I addressed questions three and four in more detail in my Saturday, January 31 post: Diving Into the GDP Report - Some Ominous Trends - Yellen Yap - Decoupling or Not?

There's much more analysis of autos, imports, inventories, and other US GDP factors in the above link, including a discussion of US recession possibilities. Please give it a look if you missed it.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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Mish's Global Economic Trend Analysis

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