The revised Q2 figures are out and the headline figure – 2.9% growth – is better than the initial advance estimate of 2.5%.  Right after the publication of these revised figures today the spin doctors have been in a frenzy to use this number to prove that the economy is fine. First in the line among these spin doctors is “Eighth Inning” Dallas Fed President Richard Fisher – yes the same Fisher who firmly predicted in June 2005 that we were at the “eighth inning” of the Fed tightening cycle and then went on voting another nine times for a Fed Funds raise. An hour after the release of the new Q2 figures he stated in a speech:

"We are slowing down, but this number may help us keep it in perspective,'' Federal Reserve Bank of Dallas President Richard Fisher said today after a speech in Dallas. ``We could not have kept growing at the rate we were growing in the first quarter.'' He called the figures today ``pretty healthy,'' 

This is also the same Fisher who – in a previous speech – called me and other realists who are worried about housing and the economy an Eeyore.

Beware of these spin doctors. Behind the headline figure, the numbers in the revised Q2 figures are much worse than the initial estimate. Essentially, almost all of the upward revision to the figures comes from a much larger increase in inventories of unsold goods, an ominous signal for future growth as firms saddled with unsold goods will soon start  cutting production (as it is happening, for example in the auto sector). Indeed, if you exclude inventories and look at final sales, the figures are much worse: in Q2 final sales of domestic product grew only 2.3%.

The GDP growth improvement is also due in part to slightly better net exports but beware of this. The fact that now net exports are not anymore a drag on growth is also bad news, not good news: as the economy sharply slows down imports of consumption and investment goods are slowing down. Thus, the news from net exports is also lousy as it signals the coming recession: net exports improve when an economy slows down and worsen when the economy grows fast. Indeed, the figures about a fall in imports - a -0.1% in Q2 – are a clear indication that, as the economy is sharply slowing imports are falling.

The sharp increase in inventories is particularly worrisome since, as in any inventory cycle, an increase in such supply of unsold goods, is a leading indicators that firms will tend to reduce production when faced with slowing demand and rising inventories. So, higher GDP figures for Q2 via higher inventories means that – all equal – Q3 and Q4 figures for GDP growth will be worse than otherwise as a sharp inventory adjustment will occur; indeed, the Ford decision to cut production by over 20% in Q4 is a typical – if extreme - canary in the mine in terms of signaling how corporates will react to a sharp unexpected increase in inventories.

The new data also confirm that the bust in the housing market is even greater than initially estimated: real residential investment fell in Q2 at an annualized rate of -9.8%, much worse than the initial estimate of -6.3%. Given these revised figures I now expect that real residential investment will fall closer to a 20% annualized rate for the next few quarters. As I discussed in a number of recent writings (here and here and here) this housing bust will be a crucial driver – both directly and indirectly of the coming economy-wide recession that I am predicting.

The revised data also confirmed that corporate investment - in software and equipment – was falling already in Q2 at annualized rate of 1.6%, even worse than the 1.0% reported in the first estimate of Q2 GDP; so much for the view that corporates will invest more as housing and consumption falter. Indeed, corporates may be full of profits and cash now but they do not see any good real investment opportunity as other components of demand are slowing sharply and inventories of unsold goods surging; thus, there is an unprecedented share buybacks bonanza, the largest in U.S. history, a signal of no god real investment options out there for corporate America. 

And beware also of the rhetoric on profits and earnings. Based on the revised data, corporate profits in Q3 increase a mediocre 3.2%, down from 12.6% in Q1. Indeed the Q2 figures now show a sharp and worrisome increase in unit labor costs as Q1 employee compensation growth was revised much higher and Q2 was also revised higher. So, you can expect profit growth to become sharply negative once the economy slows down even more in H2 and enters into a recession in 2007. I will separately blog soon on the relation between recessions and the stock market and on what is happening to earnings; the perma-bull spin that earnings growth is still rapid is non-sense once you carefully dissect the data; the reality is that earnings growth is sharply decelerating now with ominous implications for the coming bear market in equities.

So, in summary the details of the new Q2 GDP figures are simply ugly and uglier than the initial estimate: much bigger inventories of unsold goods implying slower production and GDP growth in the second half of 2006; very slow growth of final sales that is down to 2.3%; actual falling investment in software and equipment; a modest trade improvement that is reflecting an economic slowdown; profit growth sharply down, sharp productivity growth slowdown and unit labor costs sharply up; anemic consumption growth and flat consumption of durables (and a worsening of consumer confidence based on current July-August data); negative growth of Federal consumption spending.

So let “Eighth-Inning” Spin-Doctor-In-Chief Fisher eat crow – as he did after he raised rates nine more times after his “eighth inning” speech – again once the actual real economy figures about the coming sharp slowdown and eventual recession will prove him soundly wrong again. Beware of perma-bull spin doctors with rose-tinted glasses who are totally blind to the extent of the current economic slowdown and are still talking about a soft landing of housing and an orderly economic slowdown. Soon enough the only thing orderly about the comatose housing market will be the undertaker carrying the coffin...and the rest of the economy will enter into a coma right after... 

Bob Shiller is Sharply Shrill…Sorry for the poetic alliteration. As I guessed in my previous blog on a severe housing-led recession, Bob Shiller – my former colleague at Yale in the 1990s - is himself a proud member of the Shrill Order of the Reputable Reality-Based Eeyores, as his op-ed  - with Karl Case - on the WSJ today clear shows. He has been predicting a housing bust for quite a while now. Now wonder as the attached figure – showing real home prices for the 116 years – suggests: real home price have been stable – with long cyclical and structural swings but no long run trend – for the last 100 years or so. The major anomaly is the sharp spike in home prices in the last few years - a 83% increase from the start of the current boom in 1997 - that is totally out of line with the long run historical experience. Since fundamentals cannot explain this spike, it is clear that it was a bubble that was bound to burst, as it is happening now (real stock prices – in general and tech stocks in particular - had the same bubbly trend in the late 1990s and, as predicted again by Bob Shiller, they burst into a free fall in 2000-2001).

Today Shiller – like Krugman last Friday – comes only one notch short of predicting a housing-led recession; he believes that there is a severe housing bust coming but he is not certain yet that it will provoke an economy wide recession. But he – like Krugman – is only one step away from that view. He indeed concludes his column by saying:

“Unfortunately, there is significant risk of a very bad period, with slow sales, slim commissions, falling prices, rising default and foreclosures, serious trouble in financial markets, and a possible recession sooner than most of us expected. Deterioration in that intangible housing market psychology is the most uncertain factor in the outlook today. Listen hard and watch out.”

Two points are important here regarding the views in Shiller’s op-ed.

First, like me Shiller is concerned about the broader financial markets implications of the housing bust; I suggested in my previous blog that a housing bust may lead to a systemic banking and financial crisis; his intimations of “rising default and foreclosures, serious trouble in financial markets,” are consistent with my concerns.  The way I put it:

The scariest thing is that the gambling-for-redemption behavior and problems of WaMu are not the exception in the mortgage industry; they are instead the norm. There are good reasons to believe that this is indeed the norm as lending practices have become increasingly reckless in the go-go years of the housing bubble and credit boom.

 If this kind of behavior is – as likely – the norm, the coming housing bust may lead to a more severe financial and banking crisis than the S&L crisis of the 1980s. The recent increased financial problems of H&R Block and other sub-prime lending institutions may thus be the proverbial canary in the mine – or tip of the iceberg - and signal the more severe financial distress that many housing lenders will face when the current housing slump turns into a broader and uglier housing bust that will be associated with a broader economic recession. You can then have millions of households with falling wealth, reduced real incomes and lost jobs being unable to service their mortgages and defaulting on them; mortgage delinquencies and foreclosures sharply rising; the beginning of a credit crunch as lending standards are suddenly and sharply tightened with the increased probability of defaults; and finally mortgage lending institutions - with increased losses and saddled with foreclosed properties whose value is falling and that are worth much less than the initial mortgages –  that increasingly experience financial distress and risk going bust.

One cannot even exclude systemic risk consequences if the housing bust combined with a recession leads to a bust of the mortgage backed securities (MBS) market and triggers severe losses for the two huge GSEs, Fannie Mae and Freddie Mac. Then, the ugly scenario that Greenspan worried about may come true: the implicit moral hazard coming from the activities of GSEs - that are formally private but that act as if they were large too-big-to-fail public institutions given the market perception that the US Treasury would bail them out in case of a systemic housing and financial distress – becomes explicit. Then, the implicit liabilities from implicit GSEs bailout-expectations lead to a financial and fiscal crisis. If this systemic risk scenario were to occur, the $200 billion fiscal cost to the US tax-payer of bailing-out and cleaning-up the S&Ls may look like spare change compared to the trillions of dollars of implicit liabilities that a more severe home lending industry financial crisis and a GSEs crisis would lead to.

The main, still unexplored issue, is where the risk from mortgages is concentrated: among the sub-prime lenders (as i worried about and as the WSJ reports today; see also this Dow Jones story) or among commercial banks or among hedge funds and other financial intermediaries that purchased mortgage backed securities(MBSs) or among the GSEs (Fannie and Freddie)? Commercial banks claims that they have transferred a lot of their mortgage risk to other financial intermediaries – such as asset managers, hedge funds or insurance companies – who purchased large amounts of MBSs. But banks have still lots of mortgages on their books and, on top of it they have tons of consumer debt exposure (credit cards, auto loans, consumer credit) that may go really bad in a recession. If part of the housing risk has been off-loaded to hedge funds, the risk is not just of some of these hedge funds going bust but also their prime brokers (i.e. large investment banks) getting into trouble; counterparty risk will become serious once the hot potato of mortgage risk is pushed from one counterparty to the other. And finally, a large part of the housing risk is also in the hands of Fannie and Freddie. How much are the GSEs at risk is a complex issue that we will cover in a forthcoming RGE brief this week. For now, you can see the RGE coverage of the housing risks for the commercial banks, for the rest of the financial system and for the GSEs in three separate RGE Spotlight issues (here and here and here; these links require a free registration to the RGE Monitor).

Either way, a serious housing bust followed by an economy-wide recession implies serious financial risks for the entire financial system, not just risks for the real side of the economy. A systemic risk episode triggered by a housing bust cannot be ruled out as I discussed in detail in a recent blog of mine.

Second, Shiller confirms – as I discussed in detail before – that futures markets on housing are now predicting a 5% fall in home prices in 2007. But then he makes the argument that, based on the S&P/Shiller-Case home price index, prices have peaked but not fallen yet.

“According to the Standard & Poor's/Case-Shiller Composite Home Price Index, based on 10 major metro areas, housing inflation reached 20.4% in the 12 months ending in July 2004. Now, the latest numbers announced yesterday show only an 8.2% increase in the 12 months ending June 2006, and most of that increase was in 2005. Six of the 10 cities actually fell between May and June. By simple extrapolation, if housing price changes continue to decline as they have, inflation will turn into deflation, and 12-month price changes might be squarely in negative territory by some time in 2007.”

The 8.2% increase in June – on a year-on-year basis – is quite different from the National Association of Realtors data that show – for July 2006 – a year on year increase of only 0.9% for existing homes and 0.3% for new homes. Those NAR data also show that, in three out of four regions- the exception being the South – home prices are actually falling already. Relative to a year ago housing prices have already fallen in the North East (-2.1%), Mid-West (-0.6%) and the West (-0.3%). So, not only housing prices are falling in the bubbly two coasts; they are also starting to fall in the Mid-West, the region where the conventional wisdom was that there was no housing bubble. The fact that home prices are falling in the Mid-West where prices did not skyrocket in the bubble years is a scary signal of how much the housing bust and glut in supply will lead to a sharp fall in housing prices in the quarters ahead with painful effects on the wealth, and thus consumption, of households. 

The current – current not future – fall in home prices is worse than the official data suggest for three additional reasons:

1. Home prices are already sharply falling in many formerly bubbly cities, especially those in bubble regions of the US;
2. as the NYT recently reported, home sellers are now providing a variety of financial benefits (seller paid closing costs, buyer-side realtor bonuses, and seller subsidized mortgages, even $30K swimming pools free) that effectively reduce the price of a sold home, even if the headline price is officially not reduced: “The typical incentive package from a home builder consists of upgrades to the house — granite countertops instead of humdrum tiles, stainless-steel refrigerators and stoves instead of plain white models and wood blinds instead of plastic. At the extremes, some have thrown in $30,000 swimming pools.” Estimates of this effective price cut – via side benefits to buyers – are in the 3% to 8% range. So, while officially median home prices are “only flat” relative to a year ago, the effective median price has already sharply fallen;
3. if you were to control for CPI price inflation – now running above 4% -  home prices are even lower in real terms relative to their nominal value.  More ominously, futures contracts for home prices predict a 5% fall in home prices in 2007, and even a larger percentage fall in a number of key cities.

It is thus now clear that, for the first time since the Great Depression, even actual - i.e. not fudged by side incentives and subsidies - median home prices are already falling - on a year on year basis - and will be falling even more in the next months; the typical lag in the adjustment in home prices to a gap between supply and demand and the massive unprecedented increase in inventories of unsold homes will be the trigger for this home price bust. On a year on year basis, real home price may fall as much as 10% or even more in the next 12 months, even more than currently predicted by the illiquid futures market.

In conclusion, a housing hard landing will lead to a sharp and severe recession: the fall in real residential investment and its effects on aggregate demand will be larger than the 2000-2001 tech bust; the employment effects of the housing bust will be larger than the tech bust as – directly or indirectly – 30% of recent employment growth has been housing-related; the wealth effects of a bust in housing will be large and larger than those of the tech stock bust as homeownership is widespread and housing is a significant fraction of households’ wealth; a housing-related recession can occur if triggered by a housing bubble bursting in the same way in which the bursting of the tech bubble in 2000 led to a recession in 2001; households are now at a tipping point and in a foul mood (as evidenced by the sharply falling consumer confidence level) being buffeted by slumping housing, high and rising oil and energy prices and the delayed effects of rising policy rates while experiencing falling real wages, negative savings and high and rising debt and debt servicing ratios; and Fed attempts to prevent the recessions via a cut in interest rate in the fall or winter will fail to avoid the recession as an unprecedented glut of housing and of consumer durables – starting with cars, home appliances and furniture – will make the demand for housing and durables insensitive to changes in short term and long term interest rates; the housing bust may lead to a banking and financial crisis that may be more acute - and cause a more severe credit crunch – than the S&L crisis of the 1980s and early 1990s that led to the 1990-1991 recession.

Finally, for continued coverage of the developments in housing, check out the RGE Monitor and our page on Housing Bubble and Bust.  We cover three possible scenarios about the housing slump and the US economy in “Scenario 1: U.S. Housing Has Soft Landing, and Growth Continues,” “Scenario 2: U.S. Housing Tanks, But the Rest of the Economy Has a Soft Landing” and “Scenario 3: U.S. Housing Tanks, the Economy Lands Hard in a Recession.”     Also we do a tour of the world’s housing markets. Our neighbor to the north is dealing with a regional housing bubble; see “How Vulnerable is Canada's Western Housing Boom?”  Turkey’s housing sector was booming up until June; see “How Long Will the Real Estate Sector Drive Economic Growth in Turkey?”  India might be seeing a slowdown in its property market; see “Is the Indian Property Sector Boom Deflating?”  Also look in on housing markets and bubbles in Latin America, China, Spain, the UK and Australia.  

My recent detailed analysis of the high risks of a housing-led recession in 2007 has stirred some serious discussions and debates in the blogosphere and the press. Now that the onslaught of bad news about housing (see the table below) has taken the force of a tsunami that will soon trigger an ugly recession, Goldilocks spin-masters and perma-bulls are on the defensive. Since the housing slump is now undeniable – and rather than a slump it looks like a really ugly bust - the new line of defense of perma-bulls is to argue that the problems of the housing market are only a healthy correction from bubbly excesses, that housing is only in a modest slump that will soon bottom out and recover, and that housing problems will not lead to wider macroeconomic troubles such a broad recession.  What a set of Delightfully Delusional Dreams that smash against the ugly reality of recent free falling housing data shown in the table below.

The difference a year makes
Recent data quantify housing cooldown (year-over-year changes).

Builders’ sentiment                              -52.2%

New-home sales                                  -21.6%

Purchase-mortgage applications           -20.9%

Building permits                                  -20.8%

Housing starts                                      -13.3%

Existing-home sales                             -11.2%

Existing-home inventories                       +39.9%

New-home inventories                              +22.4%

Source: MarketWatch

This free falling bust in the housing sector – that I warned about in my last paper -  was indeed colorfully depicted today by David Rosenberg and by Steve Roach, as cited in the FT: "New home sales are now down 22 per cent year-on-year, which is a swing of gargantuan proportion from the plus 26 per cent trend exactly a year ago - this is the weakest trend in a decade," said David Rosenberg, North American economist at Merrill Lynch. "The only thing 'orderly' out there right now is the guy carrying the stretcher." Stephen Roach, chief economist at Morgan Stanley, added: "America's housing bubble finally appears to be bursting." He said a post-housing bubble shakeout could take at least two percentage points off the overall US gross domestic product growth rate.

Indeed, in a matter of months, the gravity-defying housing boom and bubble turned into an alleged “orderly slowdown”; then, the orderly slowdown turned into a euphemistic “soft landing”; and next, the soft landing slipped into a “slump”; most recently, the slump worsened into a hard landing; while the latest data suggest that the hard landing recently turned into a bust. And soon enough this housing bust will turn into a rout and an unprecedented meltdown. To paraphrase the witty Rosenberg, soon enough the only thing “soft” and “orderly” about the collapse of a comatose housing market will be the undertaker carrying the coffin.

As the onslaught of data about the disorderly housing meltdown is piling up, even evergreen perma-bulls such as the WSJ op-ed page are now in defensive and semi-panic mode and are attacking “not-so-cool economists” (what does that is supposed to mean? that you need to be “cool” or hip to be right? what a stupid remark from a WSJ op-ed page that is starting to nervously sweat about the coming recession and is losing its own well-groomed “cool”) that worry about a housing-related bust; but then, the same WSJ op-ed page goes on to warn about the housing slump and blaming only the Fed's past loose monetary policies for the ugly hangover from the housing bubble (more on this below).

I have analyzed in detail in my last blog why we will soon have a housing related recession; these views have been widely picked in the press, most prominently by Paul Krugman in his Friday column in the NYT. While, as Krugman correctly points out, I may be the only “well-known” economist who is arguing that we will have a housing-led recession, many other very prominent economists – including Krugman himself as well as Ed Leamer (who calls a soft landing scenario a “fantasy”), Jim Hamilton (see also here) and Bob Shiller (who predicted the tech bust stock of 2000 and is now predicting a housing bust) – are now of the view that there are serious risk of a housing market bust that could then have macro consequences.

Then, whether this housing bust will lead to a recession or not is the only remaining uncertainty: Krugman himself does not yet share my “certainty” - as he puts it – about a recession but, short of that certainty, he is fully of the view that the housing bust will be “ugly” and has some risks of triggering a broader economy-wide recession. So, the “Shrill Order of the Reality-Based Reputable Eeyores” is growing by the day and I am proud to be in company of such distinguished academic and non-academic colleagues.

For now, since a lot of spin is being furiously spinned around – often from folks close to real estate interests - to minimize the importance of this housing bust, it is worth to point out a number of flawed arguments and misperception that are being peddled around.  You will hear many of these arguments over and over again in the financial pages of the media, in sell-side research reports and in innumerous TV programs. So, be prepared to understand this misinformation, myths and spins.

in the rest of this blog  below I will thus deconstruct and unspin eight commonly heard spin arguments on why we should not worry about the coming housing bust.

Continue reading this blog right below... 

The Biggest Slump in US Housing in the Last 40 Years: These are not my views but those of the Toll Brothers, the famous luxury McMansions homebuilders, as CNN reported last week. Also, as reported by the WSJ today: In his 40 years as a home builder, Mr. Toll says, he has never seen a slump unfold like the current one. "I've never seen a downturn in housing without a downturn in employment or... some macroeconomic nasty condition that took housing down along with other elements of the economy," he says. "This time, you've got low unemployment, you've got job creation, you've got a stable stock market and relatively low interest rates.".  This followed last week’s CNN headline: “Builder: Oversupply slump worst in 40 years. Toll Brothers slashes outlook on new homes as orders plunge and revenue misses forecasts” Indeed, yesterday’s sharply falling profit results from the Toll Brothers confirmed their view that this is the worst housing slump in decades. Similarly, Angelo Mozilo, the CEO of Countrywide – the country’s largest independent home mortgage lender - recently stated: "I've never seen a soft-landing in 53 years, so we have a ways to go before this levels out. I have to prepare the company for the worst that can happen." So, effectively the only debate now is whether housing conditions are the worst in the last 40 years or in the last 53 years. So much for the bullish soft-landing wishful thinking coming out of Wall Street these days….

Of course, the message from the Toll Brothers and Countrywide is like the proverbial canary in the mine that is reflective of an ongoing rout – calling it slowdown or slump is a misnomer by now – in the US housing market. Every possible indicator of the housing sector that has been coming out in the last few weeks – and I will discuss their details below - suggests that the housing market is in free fall.  And today’s figures on existing home sales and unsold homes say it all; as Bloomberg concisely headlined this morning: U.S. Existing-Home Sales Tumble; Unsold Inventory Is Highest in a Decade
 

At this point there no doubt on whether the housing sector is contracting – real residential investment fell at the annualized rate of 6.4% in Q2. The first derivative of the housing market is clear and negative today and looking ahead for the next few quarters. There is not even a debate about the second derivative of the housing market as any estimate out there suggests that the housing sector will contract at a faster rate in Q3 and Q4 than in Q2. Some official estimates that I have seen suggest that real residential housing will contract at 10% - rather than the Q2 6.4% in the next two quarters. My own estimate – based on a reading of the coming data – is that, actually, the contraction is more likely to be of the order of 12-15% annualized rate in the next several quarters. So, the only remaining scary question is about the third derivative of the housing sector and at which point – in terms of quantities and prices – the housing market will bottom out. 
 

I have also argued before that the effects of housing on US economic growth and the role of housing in tipping the US economy into a recession in early 2007 are more significant than the role that the tech sector bust in 2000 played in tipping the economy into a recession in 2001. There are three reasons: 

1. The direct effect of the fall in residential investment in aggregate demand will be as high as the effects of the fall in real investment in the 2000-2001episode. Then, real investment fell by about 2% of GDP. This time around the fall in residential investment alone – let alone the role other components of real investment, such as software and equipment, that are already falling in Q2 – will be as large as residential investment could fall from the peak of about 6.2% of GDP (the highest level since the 1950s) to as low as 4% of GDP at the bottom in 2007.
2. The wealth effect of the tech bust was limited to the elite of folks who had stocks in the NASDAQ. The wealth effect of now falling housing prices – yes median prices are starting to fall at the national level - affects every home-owning household: the value of residential real estate has also increased to 48.5% of household wealth in 2006 from from 38.7% in 1996. Also, the link between housing wealth rising, increased home equity withdrawal (HEW) and consumption of durable and non durables is very significant (see RGE’s Christian Menegatti brief on this), much more than the effect of the tech bubbles of the 1990s. Last year, out of the $800 billion of HEW at least $150 or possibly $200 billion was spent on consumption and another good $100 billion plus went into residential investment (i.e. house capital improvements/expansions). It is enough for house price to flatten – as they already did recently – let alone start falling - as they are doing now since they are beginning to fall in major markets – for the wealth effect to disappear, the HEW dribble to low levels and for consumption to sharply fall. Note that this year there will be large increases in the borrowing costs for $1 trillion of ARM’s while this figure for 2007 will be $1.8 trillion. Thus, debt servicing costs for millions of homeowners will sharply increase this year and next. 
3. The employment effects of housing are serious; up to 30% of the employment growth in the last three years was due directly and indirectly to housing. The direct effects are job lost in construction, building materials, real estate brokers and sales agents, and employees of the mortgage finance industry. The indirect effects imply that the role of housing is even larger than 30%. The housing boom led to a boom in consumer durables spending on home appliances and furniture. Indeed, in Q2 real consumption of such goods was already negative: as you have less new home built and purchased and less old homes refurbished and expanded, you get less purchases of home appliances and furniture. There are also other indirect effects of the housing bust on employment, even on the purchases of motor vehicles. Indeed, the current auto sector slump is not unrelated to the housing slump. As the Financial Times put recently, the sharp fall in the sales of Ford's pick-up trucks is related to the housing slump as such truck are widely purchased by real estate contractors. And indeed in Q2 real consumer durables (that include both cars, home appliances and furniture all related to housing) already fell, consistent with the view that we have now have a glut in the stock of consumer durables (durables consumption has a investment-like nature to it as such goods last for a long time). Thus, as housing sector slumps, the job and income and wage losses in housing will percolate throughout the economy.

How bad are the signals coming from the housing sector? As a recent news headline clearly put it: it is simply UGLY. Indeed, all the indicators from the housing sectors - including the latest housing starts and the homebuilders (NAHB) forward looking business conditions - indicate a housing sector that is literally in free fall. New home sales started to fall since the beginning of 2006 and in some regions they are down over 30% relative to a year ago. As Bloomberg summarized today the new housing data: “Sales of previously owned homes in the U.S. fell more than expected in July, resulting in the biggest supply of unsold homes in more than a decade, as higher mortgage rates discouraged would-be home buyers.. Purchases declined 4.1 percent last month to an annual rate of 6.33 million, the lowest since January 2004, from 6.6 million in June, the National Association of Realtors said today in Washington. Sales fell 11.2 percent compared with a year earlier.”  Indeed, the number of unsold homes and the ratio of unsold homes to new home sales has therefore risen sharply to over 5.5 months of supply. Similarly the ratio of unsold homes to existing home sales has also sharply increased. These are clear indicator of a glut of unsold homes in the market.  Housing starts are also sharply down elative to a year ago and expected to fall further over the next few quarters. Note also that, while overall mortgage applications are still up in the latest figures published today, due to sustained refinancing applications, applications for purchase applications have fallen 1.0% during the last week, this being  fifth  fall in  the  last six  weeks. Moreover, there is a large amount of evidence that suggests increasing cancellation of initial mortgage applications, as the slump in the housing market and in the economy is now scaring households considering buying a home. Thus, the official data on purchase mortgage applications are very likely to exceed actual home sales. 

More generally, note that when demand for housing initially falls relative to a glut of supply, the initial market response is not on price, as it is the case of financial market where prices adjust rapidly, but rather on the quantity of unsold homes and on how long unsold homes stay on the market. Housing prices, unlike financial assets, are sluggish. This market inventory adjustment eventually leads to lower prices once sellers realize that demand is low and that waiting is not going to help.

The housing market has thus followed so far the predicted various stages of adjustment to cycle driven by the initial housing bubble: initially a glut of supply of new homes as high prices (driven in part by speculative demand) led to high and excessive production of new homes; then a fall in demand as speculative high prices and rising rates made the purchases of housing less affordable to many; then, the ensuing inventory adjustment – an increase in unsold homes. Then, the reduction in the production of new homes – lower housing starts – as homebuilders with falling revenues and profits and lower expected demand finally reacted to the growing glut of unsold inventories. Indeed, the value of home builders’ shares on the NYSE has fallen by almost 50% relative to a year ago.  Finally, we have now a price adjustment in two directions: a) an increase in rents as housing affordability fell since more and more households could not afford to pay the speculative prices of existing and new homes; this increase in rents is now correctly jacking up owner equivalent rent and increasing headline CPI inflation; b) the beginning of a fall in actual housing prices as the glut of unsold homes is now putting downward pressure on actual prices.  (for more on recent indicators of the housing bust see the RGE Monitor cluster of readings on housing indicators)

The evidence on falling home prices is now becoming clearer. Since the end of World War II, there has never been a year on year fall in housing prices. There have been instead several quarters in which housing prices declined. Of course in some regions where there were housing busts prices declined for a while: in Texas during the housing bust of the mid 1980s that led to the S&L crisis; in California in the early 1990s following the recession in that state; in Boston in 1990. Those episodes were all associated with the housing bust that was related to the 1990-1991 recession So, you do not need a persistent year-on-year fall in median housing prices to have a housing bust; such bust can occur even if prices are flattening or falling in some regions, but not nationally. Moreover, such regional bust can be associated with national recession, as in the 1990-91 episode. So, the fact that the latest housing bubble was concentrated on the two coasts (North East all the way to Florida; and West Coast, especially California) does not mean that the coming housing bust in these regions will not have national macro effects. For one thing, the value of the housing stock in those two regions is close to 50% of the total housing stock given the bubble of recent years. Thus, a housing bust in the two coasts can and will have macro effects.

Indeed, today the National Association of Realtors reported today that the median price of an existing home rose only 0.9 percent in July from a year ago. So, housing prices are practically flat at the national level. Worse, relative to a year ago housing prices have already fallen in the North East (-2.1%), Mid-West (-0.6%) and the West (-0.3%). So, not only housing prices are falling in the bubbly two coast; they are also starting to fall in the Mid-West, the region where the conventional wisdom was that there was no housing bubble. The fact that home prices are falling in the Mid-West where prices did not skyrocket in the bubble years is a scary signal of how much the housing bust and glut in supply will lead to a sharp fall in housing prices in the quarters ahead with painful effects on the wealth, and thus consumption, of households.  You can expect falling median housing prices, on a year-on-year basis, at the national level starting this month of August: indeed, today's figures on the glut of unsold homes - much larger than in the housing bust of the early 1990s - are only consistent with a highly likely actual fall in home prices in the months ahead and throughout most of 2007. Note  also that, on an inflation adjusted basis, real home prices (relative to the CPI index) are already falling at a 4% plus rate.

Also, as noted by Dean Baker: "current house price indices are failing to pick up the full decline in prices because they miss the various concessions (seller paid closing costs, buyer-side realtor bonuses, and seller subsidized mortgages) that sellers often use to move their houses."

Even more ominously, futures markets now expect that house prices will fall during 2007. Following the lead and prodding of Robert Shiller – the maverick Yale professor who predicted the 2000 stock bust and is now predicting a housing bust - the Chicago Mercantile Exchange opened this spring a new futures market for house prices in ten U.S. cities. While this market is very new and still relatively illiquid, it is now predicting that U.S. house prices will fall in 2007 at the national average level, for the first time in over fifty years. The index of this futures’ market for the entire US is projecting a 5% price fall in 2007. And the futures contracts for individual cities show expected declines in housing prices even larger than 5% for Miami, New York, Boston, San Francisco, Boston, San Diego and Las Vegas.

The likely fall in median home prices in 2007 may actually turn out to be larger than the 5% priced in the futures markets. In fact, one of the peculiar features of the latest housing cycle has been the presence of a large housing bubble: prices were going up well above economic fundamentals because of the speculative demand coming from expectations of increased housing prices that were feeding further speculative demand: "condo flipping" is the popular term for this speculative demand. Now that the bubble is bursting the fall in prices will be sharper than the one implied by medium term fundamantals as the initial price increase was due to a bubble that is bursting and leading to a fall in speculative demand: with prices now falling homeowners and speculators have no incentive to buy new homes as they expect prices to be lower in the future. So, an expected price fall leads to fall in speculative and fundamental demand and triggers actual larger than otherwise fall in actual prices. The speculative excess of a price bubble will now bring the bust of this price bubble. While the effect will be slower than in asset markets where prices adjust instantaneously (due to the sluggish nature of housing prices and their slow adjustment to increased inventories) eventually this price adjustment will occur - as it is now - and it will be very persistent over time. So, you can expect falling housing prices throughout most of 2007.

So, the simple conclusion from the analysis above is that this is indeed the biggest housing slump in the last four or five decades: every housing indictor is in free fall, including now housing prices. By itself this slump is enough to trigger a US recession: its effects on real residential investment, wealth and consumption, and employment will be more severe than the tech bust that triggered the 2001 recession. And on top of the housing bust, US consumers are facing oil above $70, the delayed effects of rising Fed Fund and long term rates, falling real wages, negative savings, high debt ratios and higher and higher debt servicing ratios. This is the tipping point for the US consumer and the effects will be ugly. Expect the great recession of 2007 to be much nastier, deeper and more protracted than the 2001 recession.

And the housing bust is not going to be only a US phenomenon. As I will discuss in another blog, housing bubbles festered in many other economies including many European ones. Thus, the combination of high oil prices, delayed effects of rising interest rates and slump of housing that is now leading to a US recession is a phenomenon that is common to many other economies, including several European ones. So, expect the same deadly combinations of three ugly bears (slumping housing, high oil prices and rising interest rates) to hammer Goldilocks and sharply hurt Europe and other economies in the world.

Update on August 26th:

read my new folllow-up long piece on the housing bust on my blog here (http://www.rgemonitor.com/blog/roubini/143257) 

Thursday August 24th morning update:

This  morning's data on new homes sales, inventories of new homes and prices of new homes fully confirm and reinforce my analysis yesterday that this will be the worst housing bust - calling it slump is too mild - in decades. And since median home prices may actually fall on a year-on-year basis in 2007 - something that has not happened since the Great Depression of the 1930s - this may  end up being the biggest housing bust in the last 75 years, not just 40 years as the Toll Brothers argue or 53 years as Countrywide argues. As reported by Bloomberg this morning:

New Home Sales in U.S. Fell to a 1.072 Million Pace by Bob Willis

Aug. 24 (Bloomberg) -- New home sales in the U.S. fell last month and inventories rose to a record, raising the risk for the economy that the housing market slowdown will become more pronounced.

Purchases of new homes, which account for about 15 percent of the market, dropped 4.3 percent to an annual pace of 1.072 million, the Commerce Department said in Washington. Sales in the Midwest slumped to the lowest level in almost nine years. The median U.S. home price rose 0.3 percent from July 2005, the smallest rise since December 2003.

The weakening housing market is leaving builders with record inventory and little choice but to reduce prices at a time when profits are declining. Some Federal Reserve policy makers have said a slump in housing is one of their biggest concerns because refinancing, which provided homeowners with extra cash to spend, may dry up as home values decline.

``There is no question we have what could be called a housing recession,'' said James O'Sullivan, a senior economist at UBS Securities LLC in Stamford, Connecticut, who forecast a drop to 1.075 million. ``I don't think we've seen the full effect of this yet on the overall economy.''

The decline in new home purchases follows yesterday's report that showed a drop in sales of previously owned houses to the lowest in more than two years. The National Association of Realtors said existing home sales, which make up about 85 percent of all purchases, declined 4.1 percent to an annual pace of 6.33 million in July.

The macroeconomic indicators published in the last week or so have strongly reinforced my out-of-consensus view that the US economy will fall into a recession by early 2007: quite simply most of them are headed sharply south, consistent with a sharp deceleration in growth in H2 that will lead to a recession by 2007.

First, consumer confidence is sharply down as consumers are in a foul mood. No surprise as the three bears of slumping housing, high oil and the delayed effects of rising policy rates are beating down a consumer with falling real wages, negative savings, high debt ratios, rising debt servicing ratios and mediocre job growth.

Second, all indicators of the housing sector show not just a slowdown, not just a slump but an outright rout in the housing sector. As, the Toll Brothers (the homebuilders known for the McMansions of the roaring housing bubble times) put it last week this is the worst housing oversupply slump in the last 40 years. And this is not just the self-serving view of a once high-flying homebuilder whose stock prices is collapsing along that of all Reits and other homebuilders. All the indicators from the housing sectors - including the latest housing starts and homebuilders (NAHB) forward looking business conditions - indicate a housing sector that is literally in free fall. Real residential investment already fell at an annualized rate of 6.4% in Q2; expect it to fall at rates of 12-15% for the next few quarters. And, as I have argued before, the wealth effects and the employment effects of this housing meltdown will be severe, much larger than the effect of the tech sector bust in 2000-2001.

Third, consistent with this housing rout, lending indicators - both for housing and consumer loans - are also headed south. While the supply of credit is not getting tighter, the demand for credit by firms and households is sharply slowing. Of course, the slowdown in the demand for home mortgage related to the housing slump. But now you are also seeing lower demand for C&I loans; this suggests that investment spending may be falling ahead, as already signaled by Q2 data on real investment in equipment and software. Moreover, home equity withdrawal (HEW) will be sharply down soon enough once the housing price flattening turns into an outright fall in average housing prices (such prices already starting to fall in the bubble regions of the US). And with lessened HEW, the ability of households with negative savings to consume more than their incomes - as they have been doing for two years with negative savings - will be severely curtailed.

Fourth, car sales are now falling in real terms. And as Floyd Norris pointed out over the weekend in the New York Times, car sales are one of the strongest leading indicators of US recessions. Consistent with the car dealers' doldrums, Ford now is announcing a sharp cut in production for the rest of the year. While Ford's problems - and the risk that it may eventually end up in Chapter 11 - are partly specific to this firm - as Japanese transplants in the US are doing well and gaining market shares on the Detroit Big Three - the aggregate automotive sales figures signal that the auto slump is not specific to Ford but an aggregate sector wide phenomenon. And the auto sector slump is not unrelated to the housing slump. As the FT put it on Saturday, the sharp fall in the sales of Ford's pick-up trucks is related to the housing slump as such truck are widely purchased by real estate contractors. And indeed in Q2 real consumer durables (that include both cars, home appliances and furniture all related to housing) already fell, consistent with the view that we have now have a glut in the stock of consumer durables (durables consumption has a investment-like nature to it as such goods last for a long time). 

Fifth, other business cycle indicators are also signaling weakness ahead: the Empire State business index, a leading indicator, is sharply softening; inventories are up and figures for May and June have been revised upward. While such revision may boost the revised Q2 figure to 3% from the initial 2.5% this is an ominous signal: with inventories of unsold goods even higher than initially estimated in Q2 and with final sales growing only a 2% rate, the slowdown in demand will force an inventory adjustment in Q3 and Q4 via a reduction in production, thus impart further downward direction to H2 growth.

This wide range of indicators clearly suggests that the economy is headed south with the growth slowdown in H2 likely to be much sharper than in Q2. Of course, cheerleading Goldilocks optimists are systematically biased towards a bullish view of the world. For example, last Friday I was interviewed by CNBC’s Squawk Box: after presenting my bearish views on the economy and on the equity markets, the cheerful anchor concluded with a totally non-consequential: “I guess this is probably a buying opportunity!” (sic!). How could have concluded with such a bullish spin is unfathomable. Of course, once a recession leads to a bearish equity markets with valuations 15-20% below current ones, we may get some buying opportunity at the bottom of the cycle; but certainly not now when P/E ratios are still high on a cyclically adjusted basis. But for perma bulls no fact can shatter their cheerful and deluded view that markets can only go up.

And what are the recent “good” news that perma optimists hold on for their bullish views? Most of them are not that “good” once you scratch the headline figure and look at the details.

First, perma bulls are cheered by the PPI and CPI figures. Indeed, as I suggested weeks ago markets are a few steps behind the curve. I argued that the coming recession will imply a slowdown in inflationary pressure and lead the Fed to cut rates in the fall or winter. But the market consensus, after the FOMC meetings, was still whether the pause will continue or whether inflation would force the Fed to hike again in the fall. The PPI and CPI figures shattered altogether the chances of a hike and made clear that the pause is a stop. But markets have not yet digested that this stop will next lead to a cut once the recession signals are clear. And the softening of the inflation pressures – save for additional energy shocks - is consistent with a softening economy and labor markets. And indeed the equity market rally in recent days is consistent with my view of a suckers’ rally following the Fed pause and future cut. After the FOMC meeting markets were still uncertain on whether the pause was permanent or a pause before another hike; it had not dawned on them that the coming recession implies that the next Fed move would be a cut. Thus, the market rally was tentative; it is only after the PPI and CPI nailed the hike scenario into a clear coffin that equity markets rallied in the typical suckers’ rally based on expectations that the Fed will come to the rescue of the economy and markets. But wait until signals of the incoming recession are stronger for markets to sharply fall when the reality of a recession leading to falling earnings and profits sinks in the mind of investors.

Second, chattering cheerleaders of an ever rising market are cheered by the industrial production data for July. But if you exclude utilities – sharply up on a seasonal basis because of the weather – manufacturing production is up a miser 0.1%, consistent with an economic slowdown.

Third, forever Panglossians are reassured by the low initial claims of unemployment benefits numbers. But low figures for such claims have been consistent for the last four months with a most sluggish labor market where a pathetic 112K jobs have been created per month on average including July when the unemployment rate started to increase. So, there is little to cheer on the labor market front. Also labor market indicators are well known to be lagging rather than leading. When demand first slows down, firm do not cut production or employment; they just let inventories of unsold goods to increase. Only after the fall in sales persists for a while firms will start to cut production to avoid an excessive pile up of unsold goods. And even then firms will tend to hold on their workers – and cut production via reduced capacity use - as losing skilled workers is costly: it is only when the fall in demand and production is significant enough that workers are fired and jobs cut. Thus, employment is a lagging indicator of the business cycle; and the fact that job growth has been dismal for four months now in spite of not being yet in a full fledged recession is an ominous signal for what the labor market will do once the recession is in full swing.

Fourth, optimists sighed a major relief when the July retail sales numbers were sharply up; the spin was that the consumer was entering Q3 with a roar. Of course, observers failed to notice that once you strip sales from gasoline purchases and once you correct nominal figure for the high rate of inflation, the real retail sales are much weaker than the headline. Also, retail sales – especially their non-durables component – are usually the last shoe to drop. In 2000 while the sharp US slowdown – that led to the 2001 recession - was underway real retail sales remained robust until Q3 and they crawled to a stop only in Q4: by September 2000 retail sales were still growing at a rate close to double digits and went into a stop only in December. Also, Q2 figure show that real durable consumption is already falling while non-durable consumption was growing at a modest 2% plus rate. The only component of consumption that was still perky in Q2 – in the double digit real annualized growth rate – was that of services. But the signals from the July services ISM leading indicators suggest that even the service sector is in a slowdown pattern, an ominous signal for the future rate of real consumption of services.

In conclusion, the “bad” news are really bad while the “good” news are only lagging indicators or actually “semi-bad” news under the disguise of “good” news. So, the flow of economic indicators from the last ten days has only confirmed my view that the economy is experiencing a sharp slowdown that will bring a significant reduction in growth – relative to Q2 – in H2 and an outright recession by early 2007. The bulls and apologists for a soft landing are clearly on the defensive as consumer confidence, housing indicators, car/auto sector indicators, credit/lending indicators and other macro measures signal that a strong growth slowdown is underway.  Compared to a few weeks ago when consensus was for a H2 with 3% plus growth and the policy debate was on whether the Fed will keep on hiking in the fall, the current debate is now on how rapid the US slowdown will be, whether the landing will be soft or hard and when will the Fed start cutting rates; chatter on Fed hikes is now mostly forgotten. And indeed my Google News Barometer of Recession signals is still sharply up with over 5,500 mentions in the online press of the term “”Recession”. So, I feel comfortable in arguing that my recession call is as strong as before and I expect the economy to reach soon – by early 2007 - its recessionary tipping point. 

Finally, it is also comforting to note that my out-of-consensus view that the world will not be able to “decouple” from the US recession and that we will not have a “rotation” in global growth from the US to Eurozone and Asia is now becoming a little more mainstream: Munchau in the FT has recently strongly argued that the Eurozone will not decouple from a US recession; he has also argued in his most recent column – as I did in a recent blog – that the Eurozone recovery has very weak legs. So, as I have been arguing for months now, the “decoupling” fairy tale is being peeled away by both reasoning and facts.

This morning we sent to our RGE readers our bi-weekly note on the macro topics we cover. In this note we stressed the importance of South-South trade and financial links, such as the growing role of China in the fortunes of emerging markets, from Asia to Africa and Latin America. As we put it in our note:

Today at the Monitor we look at the increased cooperation and interaction between emerging and developing countries.  

In my recent “recession call” blog I made the observation that current economic and financial conditions in the U.S. eerily resemble those that led to the stock market crash in October 1987. Let me elaborate on the quite worrisome and scary similarities between 2006 and 1987.

In 1987, like in 2006, a new Fed Chairman had been chosen; then Alan Greenspan this year Ben Bernanke.

In 1987, the new Fed Chairman was initially viewed with skepticism by markets and investors; the same for Bernanke today. The lionization of Greenspan as the “Maestro” or his "God-on-Earth" reputation was a much later phenomenon that emerged only in the 1990s; in 1987 investors were extremely skeptical of his skills and ability to be a strong leader of the Fed in difficult times. Ditto for Bernanke today who still needs to establish his credibility and gain the full respect of markets and investors.

In 1987, Greenspan started his term in a period when inflation was rising and there were concerns about inflationary pressure becoming excessive. That is why in 1987 he started his term by raising the Fed Funds rate by 100bps. Ditto for Bernanke who  inherited high and rising inflation and raised rates three times, by 75bps, since he became Fed Chairman earlier this year.

In 1987, the relatively inexperienced Greenspan did not know how to properly communicate his message and he rattled markets. He presented his views in the wrong forum by giving an interview to a Sunday television news show where he expressed his concerns about inflation; the next day stock markets sharply wobbled. He learned his lesson, realized the risks to his reputation, made a mea culpa, never gave again a TV interview for the following 20 years and became altogether Delphic in his public pronunciations. Ditto for Bernanke: after a congressional testimony on April 27^th that was read by investors as dovish, he made the famous flap with CNBC anchor Maria Bartimoro telling her that he had been misunderstood and was more hawkish than market perceived him. The next day – when Bartimoro reported this – equity markets sharply contracted and Bernanke’s reputation was shaken. Bernanke then made his own public mea culpa and you can be sure that - like Greenspan - he will never speak again to any TV reporter, either in private or in public.

In 1987, the biggest external problem of the U.S. was the large current account deficit that had been the result of the twin deficits of the Reagan years. Unsustainable tax cuts and excessive military spending (remember the pie-in-the-sky Star Wars project) in the Reagan I administration led to a strong dollar and a large current account deficit; after 1985 the dollar started to fall driven by the unsustainable external imbalance. In 2006, we bear the consequences of the reckless fiscal policies – unsustainable tax cuts and runaway military spending in reckless foreign adventures like Iraq (pie-in-the-sky dreams of imposing "democracy" in the Middle East) – that led to large twin deficits since 2001. And since 2002 the dollar has started to fall under the pressure of the external imbalance.

In 1987, in spite of the fall of the dollar since the Plaza agreement of 1985, the current account deficit was still large because of the delayed – J-curve – effects of the depreciation and because the still large fiscal deficits and low private savings kept national savings low. Then, the U.S. started to blame its trading partners, Germany and Japan, and their "weak" currencies for being at fault for the continued US trade deficit. The political scare mongering in the US was that a rising export giant like Japan would leading to the hollowing out of the US manufacturing sector; trade frictions with Japan – on cars, semiconductors, etc. – became heated and accusations of “unfair” trade were rampant. Then, the US started to put pressure on Germany and Japan to let their currencies – the mark and the yen – to appreciate significantly more relative to the  US dollar. Today, the scare mongering on “unfair” trade has China as its scapegoat and victim. The US, instead of blaming its own policies that led to low private and public savings for its external deficit, is blaming China and its currency policies for these external imbalances. As in 1987 there is the terror that China will hollow out the US traded sector with its unstoppable export boom. And trade tensions are boiling.

The tensions on trade came to a boil in October 1987 when the markets were already nervous about the economy, inflation, higher interest rates, an inexperienced and initially clumsy Fed Chairman and a soaring trade deficit. The announcement of a large U.S. trade deficit on October 14 was the tipping point. Following this news, Treasury Secretary James Baker strongly suggested the need for a fall in the dollar and made implicit threat that the reluctance of Germany and Japan to let the mark and yen to appreciate could be met with retaliatory trade actions. The following day – the infamous Black Monday of October 19^th 1987, the stock market crashed: the Dow Jones Industrial Average went into a free fall, down 508 points, losing 22.6% of its total value. The S&P 500 collapsed by 20.4%, dropping from 282.7 to 225.06. This was the largest loss that Wall Street had ever experienced in a single day. Technical factors, such as the growth of derivative instruments trading and inappropriate risk management tools (delta hedging that could hedge little in a fat-tail event of systemic turmoil and instead exacerbated the herding reaction of the market) added to the disorderly financial meltdown.

Today, the tensions with China on the trade deficit and the RMB revaluation are reaching a similar tipping point. China is dragging its feet on the currency issue while its trade surplus with the US is rising; Hank Paulson was chosen as Treasury Secretary principally to nudge China into moving; Schumer is bringing his 27.5% China tariff bill to a vote by the end of September and the Treasury has to present another “China Manipulation” report in the fall; the economy is slowing  and mid-term elections are increasing the protectionist mood of Congress both for what concerns trade in goods and asset protectionism (see the CNOOC-Unocal case, the Dubai Ports case; and the pressure to reform the CFIUS process in ways that will be highly restrictive towards inward FDI); markets are hedgy and nervous and investors more risk averse after the May-June financial markets turmoil; the growth of derivative instruments is much more massive than 20 years ago; and wishful and self-serving arguments that such derivative instruments allow to hedge and distribute risk rather than concentrate it more are even more senseless today than they were two decades ago. So, the risks of a systemic crisis are serious and grave.

In these conditions it usually takes little to rattle markets and trigger a meltdown. Hopefully Paulson will be smarter and more discrete than Baker in avoiding bullying China and the countries that are financing the US current account deficit; it is both bad manner to bite the hand that feeds you (or, as Italians say, to spit into the plate from which you are happily eating) and also reckless financial behavior as the US badly needs this cheap foreign financing. Markets are already hedgy on their own and international investors are increasingly risk averse. The US needs to borrow every year almost another trillion US dollars – on top of all the previous stock of past borrowing - to finance its still increasing external deficit. Thus, the risks that things will get out of hand and trigger a financial meltdown of the scale that was experienced in 1987 are serious.  

Today you have trade protectionism and asset protectionism; hedgy and trigger-happy investors and rising geopolitical risks; the risk of a disorderly fall in the US dollar; a slush of financial derivatives that are a black box that no one truly understands (the operational risk in credit derivatives is only the tip of much larger systemic risk iceberg in these instruments, as the pricing of these instruments has not been tested in a real cycle of increasing corporate bankruptcies); increasing VARs and growing levels of leverage; frothy markets where years of too easy money have created bubbles galore - the latest in housing - that are ready to burst; a bubble of thousands of new hedge funds with inexperienced managers that have no supervision or regulation of their activities;  risk management techniques in financial institutions that miserably fail to truly stress test for fat tail events; hedging strategies that – like in 1987 – can hedge nothing once everyone is rushing to the doors and dumping assets at the same time; and a housing markets whose rout may trigger systemic effects through the mortgage backed securities market and the non-transparent hedging activities of the GSEs.

This is a toxic and combustive mix of volatile elements that can lead to a financial explosion and meltdown. And it may take any small match to trigger it: a trade war scare mongering, scorning the foreigners that finance you with restrictions to inward FDI, talking down the dollar to bully China and the US trade partners, a flip-flopping monetary policy, a further spike in oil prices, an event of terrorism or a wider Mid East conflict,  a housing market rout rattling the MBS market, the collapse of a large and systemically- relevant hedge fund or of another highly-leveraged financial institution, a Chapter 11 event for a major US corporation such as Ford or GM leading to systemic  effects in the credit derivatives market.  There is indeed an embarrassment of riches in terms of factors that can trigger a financial meltdown. A single factor among those discussed above may be enough to trigger it; and the risk that a variety of such factors may simultaneously emerge is increasing.

So, to paraphrase Bette Davis in "All About Eve": Fasten your seat belts; it’s gonna be a bumpy ride ahead for financial markets and the global economy…

As I pointed out in my previous blog, markets and investors are behind the curve in terms of their views of what the Fed will do next. The debate and commentary among markets, bloggers and investors – based on yesterday’s FOMC statement – is still on the question of whether the Fed will keep its pause in the fall or whether – given rising inflation – it will tighten again some time in 2006.  The reality is that the next move of the Fed will be an easing - i.e. a cut in the Fed Funds rate - not a tightening, most likely in the fall or winter of this year.

My out-of-consensus call for the next Fed move to be an easing – rather than a hike - is based on a simple point: the U.S. economy is headed towards a sharp recession by early 2007 . Thus, while most commentators are still pondering and stressing the alleged “tightening bias” in yesterday’s FOMC statement, it is because they are still deluding themselves that the economy will face a soft landing; unfortunately the landing will be hard and ugly with a severe recession. Thus, unless core inflation sharply rises (as it could if oil goes sharply higher from here), there is only one choice and direction for the Fed ahead: to cut the Fed Funds rate as soon as there are strong signals that the economy is spinning into a recession. Such recession signals would – with one caveat – certainly lead to a cut in the Fed Funds rate as – unless stagflationary effects of higher oil become much larger – the inflation rate will tend to fall in the coming recession as demand falls, the unemployment rate goes up and wage growth slows down once workers lose jobs.

The only caveat to this easing call is a nightmare scenario where you have true stagflation, rather than stagflation-lite: i.e. a scenario where oil price keep on rising and get into core inflation via second and third round effects while the economy is spinning into a sharp recession. I.e. you need the anti-inflationary forces of lower demand and higher unemployment to be weaker than the inflationary forces of geopolitical shocks bringing oil prices higher (as non-energy commodity prices will start to fall sharply as soon as the U.S. recession trend is evident) for inflation to significantly rise in the coming recession.

Could this true stagflation (inflation sharply up while growth goes to zero and then negative) occur? It is possible only if geopolitics (tensions with Iran, a worsening security situation in Iraq, a wider Middle East conflict, a worsening civil war in Nigeria, a greater confrontation with Chavez) or “nature” (a major Katrina-style hurricane, even worse pipeline problems in Alaska or somewhere else, another workers’ strike in the North Sea) lead to sharply higher oil prices. During recessions, usually prices for energy and non-energy commodities sharply fall (as both demand and supply are price inelastic); but while a US recession and global slowdown will sharply hit non-energy commodity prices, energy prices may remain close to current levels – rather than sharply fall – if geopolitics or “nature” causes another supply shock.

But barring such a major oil supply shock, as the economy spins into a recession, inflationary pressures will dampen over time (with a possible lag given the inflation pressures in the pipeline) and the Fed will get into a panic mode of having realized that it overreacted - with excessive tightening until now - and will thus cut rates. This is the same pattern that we observed in 2000-2001. Then, the Fed expected a soft landing and paused in June 2000 six months before the onset of the recession. But the tech bust led to a growth slump and then recession – like the housing bust will now lead to a recession – and, once the Fed realized too late at Christmas in 2000, that the recession was coming it started to cut the Fed Funds rate – in between FOMC meetings – as early January 2001. This Fed Fund aggressive easing in 2001 did not prevent the mounting recession; and the Fed easing this fall or winter will – similarly - not prevent the coming US recession.

Investors should not read too much into the still “tightening bias “of the Fed in yesterday’s FOMC statement. Effectively, the risks are now balanced – as the Fed sees it – with downside growth surprises being as likely or more as upward inflation surprises. And the Fed has already accepted that core inflation through 2007 will be above the 1-2% range. Again, it worth reading the Fed Minutes of 2000 when the economy went from 5% growth in Q2 to 0% growth by Q4 and outright recession in Q1 of 2001. Then, like now, the Fed was worried about mounting inflation pressures throughout 2000; and even after the June 2000 pause, the FOMC minutes of September and November 2000 show a Fed clueless about the risks of the sharp growth slowdown that was underway and still very worried (in September) and quite worried (in November) about inflation. Even then the Fed expected a soft landing and it got a hard landing.  So, the Fed may be doing the same forecasting mistake now underplaying the recession risks.

So, leading Fed watcher John Berry – citing my recession call and that of DeLong – says today that no one at the Fed is yet worried about a recession. But Fed officials are much more worried about the recession risk than they are claiming or admitting in public.  The simple proof: why would the Fed ever pause, as it did yesterday, when all inflationary  signals and pressures are mounting (headline, every  measure of core, wage growth, falling productivity growth, sharply rising unit labor cost, oil, commodities, you name it)?

Why? The only and simple answer is: they are starting to get scared of the coming recession. Their official argument or excuse for the pause is, of course, that the delayed effects of previous tightening that are in the pipeline and the slowing economy will lead to a slowdown in inflation. But investors should read more carefully the FOMC statement. I have been speaking for the last 8 months of the Three Ugly Bears of slumping housing, high oil prices and the delayed effects of rising interest rates triggering a recession. And yesterday the FOMC endorsed the Three Bears view by stating: “Economic growth has moderated from its quite strong pace earlier this year, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.?”  Three Bears!  Is that plain English clear or what?

Then, the Fed also added: “inflation pressures seem likely to moderate over time, reflecting contained inflation expectations and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.” So, lagged monetary policy will slow down the economy by pushing demand down and unemployment up thus leading to lower inflation; and, on top of the “other factors restraining aggregate demand” will slow down inflation. What are those factors? In Q2 a fall in residential housing, a fall in consumption of durables, a fall in real investment in software and equipment, an increase in inventories as demand slows relative to output. And, as the Fed says, these forces will be stronger ahead: in fact, if these anti-inflationary forces did not prevent a rise in inflation in Q2, the Fed must believe that the fall in durables consumption, in housing, in non-residential investment and in other components of aggregate demand will be larger in H2 than in H1 to trigger the fall in investment. The Fed is telling you that it expects demand to slow further – regardless of the effects of past monetary tightening – and thus lead to lower inflation. Since any basic macro model – say the well respected model of Larry Meyer’s Macroeconomic Advisers that is closely followed by the Fed - tells you that only a significant increase in the unemployment rate will stabilize and then reduce core and headline inflation, if the Fed truly believes that inflation will peak and stabilize or fall in H2 or by early 2007 it must also believe that the growth slowdown will be much more severe than it is admitting it in public. So, there are only two options: either the Fed does not believe that inflation will stabilize in which case it is pausing now because it is already panicky about the recession; or, if it truly believes its own forecast of slowing inflation, it must be expecting a sharp economic slowdown, a much sharper one than the Bernanke forecast or the Fed forecast of a soft landing. 

Indeed, Berry, after citing my views on the risks of a recession said: “Well, Fed officials recognize there are substantial risks ahead, particularly given the pressure of high energy prices on both inflation and consumer spending. None of them is expressing concern that a recession is likely.” So, while Fed officials may not believe that a recession is likely, they are not excluding  - now in public via the mouthpiece of the only Fed watcher who is a true FOMC insider – that there are “substantial risks” to the growth outlook. Is that clear? Substantial risks…Also, as Berry put it: “Nevertheless, Fed officials are generally sticking by their collective forecasts of slower, but still solid, growth in the second half of the year, though they have to be somewhat troubled by the unexpected dip in business investment in new equipment and software in the second quarter.” So, again, Fed officials are troubled that non-residential investment that was supposed to pick up and sustain aggregate demand at the time when housing is falling and consumption growth is slowing, is instead headed south. This fall in non-residential investment is not a surprise, as I have argued before: corporations are flush with cash and profits but they do not see any good real investment opportunities as there is excess capacity and as demand is now slumping. Thus, the unprecedented share buyback bonanza – the biggest in US history - which we are now experiencing proves that firms do not have any good productive investment use for all the profits they have; and they are thus returning these profits to shareholders. Of all bearish signals in the economy, this investment slump and buyback bonanza is one of the strongest leading indicators of the coming recession.

It is true that the Fed has kept a formal tightening bias by suggesting that additional firming of the Fed Funds rate cannot be ruled out given current inflationary pressure; but it clearly stated that “extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.” So, the Fed is fully data dependent. And this means that if the economy slows down more than expected, there will be no firming and a pause that becomes a stop may end up being a cut. The risks are clearly balanced now in the Fed view: there are downward risks to growth and upward risks to inflation that, in the Fed view, will be moderated by the economic slowdown.

In conclusion: investors are still behind the curve debating whether the FOMC statement suggests a further hike sometime in the fall. The reality is different: the next move of the Fed will be easing, most likely in the fall when the signals of a recession become too self-evident for the Fed to ignore them. The only thing that could prevent a Fed Funds rate cut (and lead the Fed to keep a pause or even hike) or postpone the cut into 2007 is a  sharp spike in core and actual inflation driven by a further oil shock or a build-up of domestic inflationary forces. But that would be a true nightmare scenario for the Fed and for the economy: a recession with a sharply rising inflation. Then, if the Fed lost control of the inflationary process, it may well be forced to hike even during an ongoing recession. But this scenario is, still, highly unlikely. The most likely scenarios is a slowdown and recession that cools down inflationary pressures (or, at least, does not stoke them further) and forces the Fed to cut the Fed Funds rate. But, as I have persistently argued, even such Fed ease will not prevent the coming recession. The recession boat has left the harbor and there is very little the Fed can do to prevent it. In 2000 the Fed failed to achieve a soft landing; this year we will get the same pattern as in 2000-2001 but a much harder landing than in the previous recession.

Tomorrow Thursday the Financial Times is publishing an op-ed of mine where I summarize my recession call. Readers with a subscription to the FT can already read it online here.

In a matter of days, my out-of-consensus recession call has become more mainstream and is being picked up and amplified all over the press. Even super-blogger and star academic macroeconomist Brad DeLong has joined my doom & doom club, now predicting - with 30% odds - something worse than a U.S. recession, rather a major financial "meltdown".  So, Daniel Gros: you can now add DeLong to your list of distinguished "gloomy forecasters" that includes folks such as Mike Mussa and the chief U.S. economist at Merrill Lynch. And my now popular Recession Barometer (the Google News mention of terms such as Recession, U.S. Recession and Stagflation) is up to 5,310 mentions for Recession from 4,850 last week. 

The spate of additional bad economic news is piling up: today the crucial forward-looking ISM report for the service sector was a lousy as you can get; and since consumption of services was the only bright spot in the Q2 GDP report, among a gloom of negative growth for most components of aggregate demand, now this shoe is also dropping with lousy implications for Q3 growth. Also, recent revised data on June inventory can only be ready as further downward signals for Q3 growth. And the figures on factory orders - flat ex-transportation - and on initial claims of unemployment benefits are consistent with this further economic slowdown outlook. So, Q3 started on the wrong footing and even revised downward forecasts for this quarter - like the lower but still optimistic 2.5% from JP Morgan - now look like in need of further downward revision. I expect no more than 1.5% growth for Q3, 0% for Q4 and outright recession by Q1 of 2007. 

Much more ominous is the gloomy confidence level of global CEOs and business leaders, as polled by Goldman Sachs, who are now more pessimistic than ever in the last three years about the U.S. and the global economy. This poll and confidence index is very important as, now that the reality of a U.S. slowdown had dawned even in the brains of the most hardened CBPGs (Chattering Baboons of Panglossian Goldilockism), there is a new fairy tale that is being peddled around, i.e. the idea that the rest of the world will happily "decouple" from a U.S. slowdown, i.e. the rest of the world will happily grow fast in spite of a U.S. slowdown.

This now mainstream "decoupling" view (a term most strongly pushed by Goldman Sachs) takes different definitions depending on the source of it: JP Morgan calls it the "rotation in global growth leadership", i.e. the idea that the center of global growth will rotate from the US to Asia and Europe; others refer to it as the switch in the global growth "locomotive", again from the sputtering US locomotive to the now allegedly perky Asian and European locomotives. But, regardless of the labels - "decoupling" or "rotation" or "locomotive" switch - the new conventional wisdom is that the world will somehow keep on growing at a sustained rate even in a US economic slowdown.

I have already conceptually refuted this "decoupling" or "rotation" fairy tale in my long analysis "12 Reasons Why the World Will Not De-Couple From the Coming U.S. Growth Slowdown…Or Why When the U.S. Sneezes the World Gets the Cold". I will leave it to interested folks to read the details of this analysis, but the reasons why a U.S. slowdwon will lead to a global slowdown are clear to any student of 101 economics:
 

1. Trade links are important in transmitting shocks from the US to the rest of the world, especially for countries that export a lot - directly or indirectly - to the US (China, East Asia, Mexico, Canada, etc.)
   
2. The oil and commodity price shock is a shock that is common to the US and many other oil and commodity importing countries; actually EU, Japan, China, India depend on oil imports more than the U.S. does.
   
3. Monetary policy is being tightened in the US and many other economies given global concerns about rising inflation. The era of cheap liquidity is over. See ECB, BoE tigthening decisions today and the end of ZIRP in Japan, as well as the recent spate of policy hikes throughout the EM world.
4. Housing bubbles are bursting - or flattening - not just in the US (where the bust is becoming dramatic lately) but also in many other economies as easy liquidity had led to housing bubbles in many parts of the world.
5. The recent fall in equity prices - during the May-June turmoil and the coming one once the U.S. slowdown dawns on Panglossian investors - will not be just US based; it will rather global and more severe in the rest of the world than in the US as foreign markets are more illiquid than the U.S. one (see what happened to EM equities and to the Nikkei and EU stocks in May-June); it will thus have negative effects on global consumption and investment spending and on business and consumer confidence in many economies.
6. The weakening of the US dollar following the US slowdown will lead - and is already leading - to the appreciation of the Euro, Yen and other floating currencies. Given the tentative recovery of the Eurozone and Japan, this appreciation will hurt net exports and growth.
7. Foreign direct investment (FDI) is another channel of transmission: when the US slows down the sales in the US of US-producing affiliates and subsidiaries of foreign firms fall,  negatively affecting the profits of such firms in their home base in Japan, Europe and around the world.
8. Risk aversion rose globally in May-June and investors are still a nervous wreck given all the macro, financial and geopolitical uncertainties in the world; thus the downturn in markets will negatively affecting "animal spirits", i.e. business and consumer confidence. Already the mood of global CEOs has totally soured based on the Goldman Sachs confidence index.
9. The US and G7 slowdown will have negative growth and financial effects on emerging market economies that, until recently, had widely benefitted from high global growth, high commodity prices and low global interest rates. Lower global growth, lower commodity prices and reduced global liquidity will have negative effects of the real economies of emerging markets, as the May-June sharp market selloff in these markets had been already signaling.
10. The last four global recessions have been characterized by an oil shock and an inflation scare that led to monetary tightening and stagflationary outcomes. The same is happening this time around and global business cycles are highly correlated.
11. There is now a serious risk of a systemic financial crisis - as in the 1987 stock market crash or the 1998 LTCM near collapse. The factors that led to systemic risk in previous episodes of systemic financial distress are present again today.
12. Unlike the 2001 global downturn there is little room for monetary and fiscal policies to be eased to deal with the global slowdown; while exchange rates are now a zero sum game as, in a slowdown, most G7 economies will want to avoid an appreciaton of their currencies. Thus, the risks of trade and asset protectionism are rising in a global economy with large and increasing global imbalances and geostrategic risks.

So, we are now hearing the fairy tale of a decoupling of the world from the US slowdown (that has been most aggressively argued by the same Goldman Sachs that now says that global CEOs are depressed); and we are hearing the even more fairy - or delusional? - tale by former Goldman Sachs head and now Treas Sec. Hank Paulson - in his first public address yesterday - that the global economy is at its strongest in the last 30 years and that the U.S. economy is strong too and that Q2 growth was only an aberration. [In fairness to Goldman Sachs, their outlook for the U.S. economy is less cheerful than the market consensus as they expect a somewhat significant U.S. slowdown; they just still see the world somehow "decoupling" from the U.S.]

So, on top of the 12 reasons above on why the world will not decouple from the US, let me suggest a few separate vulnerabilities in each one of the main world regions outside the U.S.:

• China: its overheating is unsustainable and its dependence on exports to the U.S. make it massively vulnerable to a U.S. slowdwown. China, the world producer of first and last resort needs the world consumer of first and last resort to keep on consuming more than its income to sustain Chinese growth. And now the U.S. consumer is going into a spending strike. So, expect a massive Chinese slowdown.
• Korea and East Asia: these countries depend badly on direct and indirect trade with the U.S, directly via exports to the U.S. and indirectly via their increasing exports of inputs and intermediates to China that - once reprocessed - are then sold to the U.S. And there are already serious signals and concerns that Korea - and other parts of East Asia - are on a slowdown path - with domestic demand and consumption anemic - even leaving aside the coming double whammy of a US cum China slowdown.
• Japan: ditto for Japan as for Korea and East Asia given how much Japan depends on trade with the U.S. and on the returns of its affiliates producing in a slowing U.S. On top of direct/indirect trade link, there is plenty to worry about a Japanese slowdown: paranoia about inflation may lead the BoJ to tigthen too much too fast killing the recovery; the  necessary structrual are taking a back seat; the need for fiscal consolidation may slow down growth; capex spending may be slowing down; consumption and income growth look sluggish; the rise of the yen once the dollar accelerates its fall will hurt net exports while verbal and actual sterilized intervention will be ineffective now that ZIRP is dropped.
• Eurozone: the latest cheer about the Eurozone recovery and resilience is coming mostly from Germany where the signals are more mixed than the cheerful Panglossians are making them: next year's VAT increase may kill the recovery as the increase in the consumption tax did a few years ago in Japan; most economic signals are mixed, including confidence indicators; the unemployment rate is still very high; the retail sector is still soft with consumers still on hold while what is driving growth is mostly net exports and capex spending; high oil prices and rising real rates are hitting the economy; and Merkel's initial reform drive has altogether fizzled away. So, the latest Panglossian optimism about Germany is altogether unwarranted. The rest of the EU looks much more anemic than even Germany, with some countries such as Italy, Portugal, Greece, Spain - as Lachman warned us in the FT yesterday - actually at risk of a more serious financial crisis. Moreover, like in Japan, a ECB too obsessed with price stability and with concerns with inflation may tigthen too much too soon slowing down the recovery. And a rising Euro, given the likely fall in the US dollar once the US slowdown takes its momentum, will only hurt competitiveness and net exports in the EU, as per yesterday's warning by Marty Feldstein in the FT.
• Emerging Markets and Latin America: these regions desperately depend on developments in the U.S. and China. Their high growth in the last few years depended on high global growth, high commodity prices and low interest rates leading to carry trades and capital flows to those emerging regions. But once the U.S. slowdown starts - and the Chinese one ensues - you can expect lower global growth leading to lower EM exports to the G7, lower commodity prices once the G7 and the Chinese slowdown become incipient, and higher interest rates as Fed, ECB and BoJ are all on a tigthening path. And among EMs, those with large current account deficits (almost all of Central and South Europe including especially Hungary and Turkey, South Africa, India and, now, even parts of East Asia returning to current account deficits because of high oil prices) are vulnerable to a sudden stop. The turmoil in EM economies and markets in May-June is only a signal of a bigger turmoil to emerge once the U.S. slowdown gets entrenched.

So, the global picture of a strong global growth is just another fairy tale with little basis. The U.S. slowdown and recession with seriously hurt the rest of the world through the 12 separate channels discussed above. And, regardless of the U.S. slowdown, the recovery in the rest of the world has very weak legs on its own: China, East Asia, Japan, Europe, emerging markets and Latin America are quite vulnerable regardless of a US slowdown. So, it is time to wake up to the reality of a fragile U.S. and global economy: the world is much more vulnerable than the consensus makes it. And the coming U.S. slowdown and recession may also become the tipping point for a global economy that has relied too much and for too long on a battered U.S. consumer that is now dropping the towel and declaring defeat.  It will be a ugly hard landing for the U.S. and the global economy. It is time to wake up from fairy tale dreams and start a sobering assessment of the serious risks ahead. The U.S.slowdown shoe is already dropping; with a modest lag - given the recent upward momentum in EU, Japan, China and the rest of the EMs - the rest of the world will painfully follow the U.S. slowdown. When the U.S. sneezes, the rest of the world gets the cold. No way to avoid that...

Friday Morning Update: The July employment report is out and this is another most dismal and mediocre report consistent with a further sharp growth slowdown in Q3 and for the rest of the year: jobs grew at a lousy 113K rate (well below the Panglossian market consensus of 150K); employment is actually down based on the household survey; the unemployment rate is up, earnings are spurting upward with inflationary consequences. It is as bad as it gets; and news of corporations starting to cut jobs (AOL, Ford, Kodak, Intel, etc.) signals much more serious job losses ahead. Expect employment to crawl to a total halt by August-September and starting to shrink in the fall. Expect now the Fed to pause in August; but, as I have discussed in detail in my previous blog, such Fed pause - or even a now likely easing in the fall - will not prevent the economy from falling into a recession by early 2007. Expect another suckers' rally in the stock market today and on August 8th when the Fed pauses.

Since I have been accused of being an excessively pessimistic bear (even the Dr. Strangelove of Global Macro) - indeed a true member of the tribe of the Nattering Naboos of Negativism (to cite the famous Bill Safire expression) - here is a not-fully random list of "good news" from the US economy in the last week or so: 

U.S. Stocks Fall as Inflation Data Signals Fed May Raise Rates - Bloomberg  (8/1/2006 4:12 PM) 

Oil Prices Jump As Traders Eye Mideast - AP  (8/1/2006 4:14 PM)   

U.S. Personal Spending Rises 0.4%; Inflation Quickens - Bloomberg  (8/1/2006 8:15 AM)

Protectionist policies may add to dollar woes - Reuters  (7/31/2006 2:10 PM)

US heatwave pushes natural gas prices up 14% - FT  (7/31/2006 8:41 PM)   

Running Low on Gas - WSJ  (8/1/2006 5:22 AM)

Wal-Mart, Retailers Stumble Overseas as U.S. Formulas Falter - Bloomberg  (8/1/2006 5:01

Managing price fears at the ECB - IHT  (8/1/2006 5:27 AM)

U.S. East Coast Prepares for Record Heat; Emergencies Declared - Bloomberg  (8/1/2006)

Why options backdating is a big deal - Fortune  (8/1/2006 10:09 AM)

Natural Gas Has Biggest Gain This Year in U.S. on Heat Wave - Bloomberg (7/31/2006)

Markets look to remain jittery - CNN/Money (7/31/2006)

Oil Prices Up As Mideast Fighting Rages - AP (7/31/2006)

Dollar at three-week low ahead of key data - CBS Marketwatch (7/31/2006)

Treasurys dip, dollar slides - CNN/Money (7/31/2006)

U.S. Stocks Slip on Rate Outlook; Avon, Tyson Fall on Earnings - Bloomberg (7/31/2006)

Rising Gas Price: It's Not All About Oil - AP (7/31/2006)

Housing Slows, Taking Big Toll on the Economy NYT (7/29/06)

Dollar Declines as U.S. Economic Growth Slowed Last Quarter - Bloomberg (7/28/2006)

Treasury 10-Year Note Yields Drop Below 5% on Slower Growth - Bloomberg (7/28/2006)

Foundations of US housing market start to look shaky - AFP (7/31/2006)

Men Not Working, and Not Wanting Just Any Job - NY Times (7/31/2006)

Developers nix or delay condo projects - AP (7/30/2006)

U.S. Second-Quarter Gross Domestic Product Grew at 2.5% Rate - Bloomberg (7/28/2006)

U.S. employment costs up 0.9% in quarter - CBS Marketwatch (7/28/2006)

New home sales fall more than expected in June - Reuters (7/27/2006)

Growth Slowing Across the Country, Fed Regional Reports Say - NY Times (7/27/2006)

Manufacturing execs less confident on economy: poll - Reuters (7/27/2006)

U.S. Economy Slows, Inflation Is `Modest,' Fed Says - Bloomberg (7/26/2006)

Sales Slow for Homes New and Old - NY Times (7/26/2006)

U.S. mortgage applications decrease last week-MBA - Reuters (7/26/2006)

Fed Is Showing Concern Over Housing Retrenchment - Berry, Bloomberg (7/26/2006)

Beige Book - FRB (7/26/2006)

Sales of Existing Homes Fall in June - AP (7/25/2006)

College-grad wages stuck in a slump - LA Times (7/25/2006)

Will housing illness infect other sectors? - DiMartino, Dallas MN (7/25/2006)

Gloom or Boom - WSJ ($) (7/25/2006)

Whole Foods' shares slip after sales miss view - CBS Marketwatch  (8/1/2006 10:08 AM)

Aging grids cited in blackouts - USAToday (7/28/2006)

Why Doha's Derailment Matters - BusinessWeek (7/26/2006)

California Declares Power Emergency as Heat Persists - Bloomberg (7/25/2006)

Bubbles caused by cheap cash menace world economy - Reuters (7/24/2006)

G8 document shows splits on nuclear, climate issues - Reuters (7/16/2006)

Is the US Bankrupt? - Kotlikoff, Federal Reserve Bank of St. Louis (7/12/2006)

I could add some other "cheerful" reports on slowing profits, slowing earnings and "great" news from tech firms and stocks, UPS, 3M, Wal-Mart and retail sales....But I will spare you those...

Of course, some will point out to some of the "truly" better news of the last few days (ISM report, consumer confidence, construction spending, etc.) But when you scratch the surface of those "bullish" reports, the details are not as good as their headlines (as I will discuss in a future blog)....So I stick with my bearish call for a sharp US slowdown in H2 2006 and a recession by Q1 of 2007 and to my view that the Fed will not be able to prevent such slowdown even if it were to pause and then ease.  I am willing to listen to contrary arguments and to read some better "news" than those above if anyone is able to provide some.

For more details on my views on the U.S. and global economic growth, inflation, the risks of stagflation and implications for financial markets see my recent blog writings (here and here and here and here and here),  audio conference calls, video webcasts and powerpoint presentations (see here and here...). While the blogs are free and open to all, the latter are restricted to RGE subscribers.