Ghost of 2008 Haunts Fed as Companies Take Short View on Risk
United Parcel Service Inc. (UPS) computer systems monitoring the heartbeat of global commerce sent a discouraging message last quarter as package flows began to fall below the company’s forecast.
On July 24 executives announced that they were reducing their Asian air network by 10 percent. Domestic routes were also fine-tuned to lower volumes by systems called Volcano and HFNO that efficiently plan how packages move on planes and trucks to consumers’ doorsteps.
“We don’t wait three months to say, ‘Is there a pattern?’” said Jack Levis, director of process management at UPS, the world’s largest package shipper, in an interview. “We are always looking ahead at what’s the risk.”
The 2008 collapse in U.S. gross domestic product is now “seared into history,” former Fed Chairman Alan Greenspan said in an interview.
That’s changing the way U.S. corporations treat risk: Threats that might portend a slowdown are given greater weight because they could quickly develop into something worse. Hiring, investment and the U.S. economy as a whole now retreat suddenly at the first sign of potential catastrophe, said Joseph Carson, director of global economic research at Alliance Bernstein, an asset management firm headquartered in New York.
This business cycle has “more fits and starts than ever before and global issues affect it as much as local issues because we are so tied into global supply chains,” Carson said. “Risk management strategies seem to have become much more prevalent since the 2008 financial crisis.”
Corporate managers are so adept now at dialing up and dialing back their activity that Carson dubs the post-crash business cycle the “Risk-On/Risk-Off Economy.”
That presents a conundrum for the Federal Reserve, whose Federal Open Market Committee concludes a two-day meeting at about 2:15 p.m. today in Washington. Federal Reserve Chairman Ben S. Bernanke told lawmakers July 17 that the committee is “prepared to take further action as appropriate to promote a stronger economic recovery.”
The three-year expansion has been battered by the flaring of the euro countries’ debt crisis -- the volatility of yields on Spanish 10-year bonds has more than quadrupled since late 2008 -- the March 2011 Japanese earthquake and tsunami, and political battles over the U.S. deficit.
Debt ceiling wrangling in the U.S. Congress caused consumer confidence to fall in August 2011 by the most since the 2008 collapse of Lehman Brothers Holdings Inc. A year later, Bernanke warned lawmakers on July 17 that concerns about automatic spending cuts and tax increases scheduled for 2013, the so- called fiscal cliff, could again depress activity.
Growth slowed to a 2 percent and 1.5 annual pace in the first and second quarters after expanding 4.1 percent in the final three months of last year. Retail sales fell for a third straight month in June, after rising the previous three months. The National Federation of Independent Business’ optimism index fell to 91.4 in June, the lowest reading since October, from 94.4 in May. That was the biggest monthly decline in two years.
“Our customers are increasingly nervous,” Scott Davis, chairman and chief executive officer of Atlanta-based UPS, told investors on a July 24 conference call.
The Fed attempted to insure growth with a $600 billion round of quantitative easing in November 2010 as the economy began to slow. In April 2011, the central tendency forecast by Fed governors and presidents for growth that year was 3.1 percent to 3.3 percent. In June, policy makers published an outline of their so-called exit strategy.
By September 2011, the FOMC declared itself dissatisfied with the economy’s progress and launched what became known as Operation Twist, lengthening maturities of Treasuries on its balance sheet. In November, Fed officials marked down their outlook and forecast growth of just 1.6 percent to 1.7 percent for the year. A second round of Operation Twist was undertaken in June this year as the economy’s pace decelerated again.
“You couldn’t design a better experiment in how policy uncertainty impacts the economy,” said Ethan Harris, co-head of global research at Bank of America Merrill Lynch in New York. “That in turn forces the Fed to act, just as they have in the last two years.”
The Fed has diminished influence over this business cycle because periods of persistent volatility in markets and investor expectations can blunt the impact of monetary policy, said Nicholas Bloom, an associate professor of economics at Stanford University near Palo Alto, California.
“We find you get less of a multiplier out of monetary policy,” Bloom said. “When you are uncertain, you don’t respond to anything.”
An index of U.S. economic policy he constructed rose 67.1 points for the three months ending June, the biggest jump since the U.S. debt ceiling dispute in July and August last year. It’s based on three components: newspaper coverage of policy-related uncertainty, the number of federal tax code provisions set to expire in future years and disagreement among economic forecasters.
After three years of growth, corporate managers are still showing high risk aversion when it comes to investments based on a longer-term outlook.
A Bloomberg News review of the performance of five indicators related to longer-term expenditures or investment shows that their volatility hasn’t declined to pre-recession levels, and in three cases remains much higher than during the pre-recession period.
Wholesale inventory investment volatility remains about twice as high as the pre-recession volatility level. Data on changes in manufacturing inventories, durable orders, imports of goods, and a survey of homebuilder expectations are all more volatile today than before the recession.
With the U.S. expansion’s large swings over the past six quarters, companies are using big data systems inside their own businesses for hints on which way to move. At Norfolk Southern Corp., data-crunching software known as OPD churns through millions of bits of information a week to find out what’s moving across the company’s 20,000 miles of routes.
That capability led the rail company to respond rapidly when Fred Ehlers, vice president of network and service management at the Atlanta control center, noticed in January that coal car loadings were falling. At the same time demand for finished auto shipments out of the Midwest was surging.
Ehlers and the company’s team of network managers shifted locomotives, rail cars, their attention and even people from south to north to serve the booming auto market.
The railroad’s revenue jumped 6 percent to $2.8 billion in the first quarter, a record high for the period.
“We are always adjusting the plan, we are always looking out,” said Ehlers. “Decision making has to be faster.”
Greenspan said in the interview that the memory of 2008, when a shutdown of short-term funding markets sent U.S. gross domestic product down at an 8.9 percent annual rate in the fourth quarter, has shifted attitudes about risk.
Catastrophic events such as wide-scale financial market panic no longer seem remote, and that’s made long-term returns less clear, he said.
Greenspan, who now runs his own consulting firm in Washington, says the ratio of fixed investment to cash flows is a signal of companies’ willingness to turn liquid assets into long-lived investments. This expansion has shown the lowest quarterly ratios since the end of World War II, a sign that corporate managers see a bigger benefit from holding cash than making long-term bets on the economy’s future.
“This was a horrendously different period: short-term credit shut down,” Greenspan said. “The risk premium on long- lived assets is now higher” and a lack of clarity on tax rates and fiscal policy is adding to the reluctance to invest.
Faced with risks like a euro breakup that are hard to quantify, Levis said UPS is constantly running simulations on how it would trim or shift its network of 527 planes and 101,000 ground vehicles.
“It’s about making better decisions under uncertainty,” Levis said. “We have to make decisions quicker than before.”
-- With assistance from Seth Myers in New York. Editors: Anne Swardson, James Tyson
To contact the editor responsible for this story: Christopher Wellisz at email@example.com