A Wall of Worry for the U.S. Economy

Fears are mounting that the profits recession could become a full blown confidence crisis

By Michael Wallace

Rebalancing of portfolios out of stocks and in favor of fixed assets gathered pace this past week. The steady drumbeat of weak data grew louder and Fed policy expectations adjusted in step. Looking ahead, a couple of appearances by Fed Chairman Greenspan and a banquet of potentially sobering data could solidify the outlook for the economy and policy, amid the building wall of worry that the profits recession could become a full blown confidence crisis.

Over the past week all three major U.S. equity indices crossed back below their 50-day moving average support lines as the pre-announcement season ate away at profit recovery hopes in the second quarter. The slide also followed a battery of weak data, including the Fed's dour Beige Book report on economic activity, headline retail sales, industrial production and capacity use. The capacity use data was particularly noteworthy, falling to levels not seen since Aug. 1983, while industrial production extended its losing streak to eight straight months.


  This came in tandem with the staggering forecast by Canadian telecom giant Nortel Networks of a $19.2 billion second quarter loss, after charges, and the layoff of an additional 10,000 workers. High-tech production in the first quarter has now been revised to a 5.7% annualized rate of decrease, and the figure for second quarter is shaping up to be a jaw-dropping decline of 16%.

To highlight just how sharp the contraction has been, in the second quarter of last year this aggregate posted annualized growth of more than 70%. Capacity utilization in high-tech industries has now fallen for 10 straight months, to 70.3%, which marks the lowest utilization rate in the high-tech sector in 25 years.


  Accordingly, at S&P we have extended our policy call to include an additional quarter point funds cut following a likely snip of 25 basis points at the June 26-27 meeting of Fed policymakers, bringing the Fed funds target rate down a cumulative half percent to 3.5% by September.

Admittedly, it's a very fine line between a full 50 basis point cut in June or a couple more modest moves, but for now we are opting for policy caution to creep in, with a large side-order of risk that the Fed maintains is present front-loading pace. This compares to Fed funds futures that briefly priced in 47% risk of a full 50 basis point cut in June.

A pair of Greenspan speaking engagements on Wednesday will find the Fed Chairman addressing the topics of work skills and the U.S. financial system before the Senate Banking Committee. Of the two, the latter seems a better venue for any new economic or policy cues. Richmond Fed Preisdent Broaddus will speak on June 18 and Governor Meyer will also make an appearance that day.

Data will be highlighted by likely softer housing starts and home completions, with firmer leading indicators, trade, claims, and the Philly Fed index thrown in to boot.

As such, there are no standouts, but in combination with any more earnings confessionals another tier could be built on the wall of worry.

Wallace is a Senior Economist for S&P Global Markets

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