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CNB Economic Commentary: Sept 3

September 3, 2013

To: Everyone
From: Gregory S. MacKay, Senior Vice President & Chief Economist
Date: 08/30/13

Along with the regular economic news, we can look to Washington this fall for three events that will help shape the ongoing expansion: the Fed Chairmanship, the U.S. budget process, and the debt ceiling.

Right or wrong, Chairman Bernanke is to be replaced. With President Obama seemingly narrowing his choices to either Larry Summers or Janet Yellen, let’s look at both of them and a possible dark horse no one has seemed to mention. The process is for the President of the United States to offer a nominee to the Senate Committee on Banking, Housing, and Urban Affairs. The nominee is interviewed by the Committee, and then is voted on by the entire Senate. Only very early in the history of the Fed has a nominee been rejected. Hence, whoever the President selects should be close to a shoo-in. Politically, Larry Summers might be the candidate of choice. He was President Clinton’s Treasury Secretary and President Obama’s Director of National Economic Council for a couple of years. He believes that a little inflation can help employment, and sees unemployment as the primary problem today. The dark cloud overhanging him is his support to deregulate banking during Clinton’s tenure, which was partially responsible for the “Great Recession”. He now suggests more financial reform is in order. Janet Yellen is currently Vice Chairman of the Federal Reserve Board and the favorite of most bankers, economists, and investors. She has been at the Fed throughout its unusual expansion, and served as President Clinton’s Council of Economic Advisors Chair (a position previously held by both Alan Greenspan and Ben Bernanke). She also sees a little inflation as not detrimental to the economy, and also looks at unemployment as the primary problem. She also believes more regulation (like Glass-Steagall) is necessary to address “too-big-to-fail”. The only possible cloud over her is that she has no experience in the private sector, having worked up through academia to the Council of Economic Advisors and the Fed. The only other difference might be that Mr. Summers may be more of a “take charge” Chairman, while Ms. Yellen has worked with Mr. Bernanke’s “team approach”. If the choice gets dicey, I’ll offer up Bill Dudley, NY Fed President, as a compromise candidate. He has worked in both the private sector (Goldman Sachs and Morgan Guaranty) and the public sector (two separate stints at the Fed). He has recognition in international economics (member of G30 and the Bank of International Settlements. He is a strong believer in current Fed policy and has spoken at length of the need to match the coming “tapering” of bond purchases with actual economic data.

Let’s not forget the other possible effects on the economy our Washington legislators can produce. While Congress is currently on break, the two houses are going to have to produce a budget in very short order. With the new fiscal year beginning in October, it’s a virtual lock that we’ll begin fiscal 2014 without a real budget in place. The latest impediment to compromise is the debt ceiling – yes it’s back to haunt us again. After last winter’s contentious ramblings, it was hoped that the debt ceiling wouldn’t be reached until late in 2013, after sequestration and an improving economy had narrowed our budget deficit. While tax revenues are up and government spending is down, the debt ceiling is about to be reached again and has become a bargaining chip in the budget process. This time, there is about a $100 billion difference in spending plans between the two political parties. Republicans are happy to let sequestration continue with no cuts to defense spending, but Democrats want to replace sequestration with a variety of tax increases and spending cuts, including defense spending. Neither side appears to be moving, so we’ll see those wonderful “continuing resolutions” to pay our bills until some compromise is finally reached. The probable solution is some type of extension of the current budget. Without it, many Federal Agencies begin to shut down, stock and bond markets get nervous, and consumers pull back. The sound bites from Congress are about to get really silly again. That’s not what we need while we’re still in a modestly expanding economy.

Let’s not forget the other recent economic and geo-political events. Whatever is happening in Syria is not good for our economy, but no one else has applied for our position as global cop. Second quarter GDP was revised upward to an almost healthy 2.5% increase, mainly due to revisions in business spending and exports. Yet durable goods orders had a large drop in July as businesses sensed a consumer pullback. Consumer income and spending had a poor showing in July, each barely rising .1%. Pending home sales and prices nationwide continued to increase, but at a much slower pace than earlier in the year. So the Fed is faced with a leadership issue compounded by a mixed economy, and Washington is gearing up of another two-step budget dance. Stay tuned.

Mixed economic data, Syria, looming Congressional follies, and a holiday weekend added up to a bad week for stocks. It’s still a good year, but be careful out there. At 3:32 p.m., for the week and year:

Dow Industrials 14811 -1.3% +13.0%
NASDAQ 3592 -1.8% +18.9%
S&P 500 1633 -1.9% +14.5%

 Some foreign money funneled into the 10 year Treasury, but rates were generally stable otherwise.

  US Treasuries
Municipal Bonds
  8/30/13 8/23/13 8/30/13 8/23/13
2 Year .39% .38% .43% .40%
5 Year 1.62% 1.63% 1.53% 1.48%
10 Year 2.77% 2.82% 2.99% 3.01%