Over the summer we have held to the view that a double-dip recession is unlikely. While we are still hopeful that will be the case, our estimate of the chances of another, mild recession, are increasing. Consequently, we are sticking to our current conservative strategy of maintaining a higher level of less risky assets than we might otherwise do in a more growth oriented economic climate.
We’ve given more weight to the possibility of a mild recession because of a number of factors, the primary one being the dysfunctional fiscal policy performances in Washington and Europe. The lack of progress in fiscal policy is having a marked effect on consumer and investor sentiment. In fact, various measures of sentiment have declined to new lows for this current economic cycle and these lows are considered to be at recession levels. The irony here is that while consumer sentiment has been headed down, consumer finances have been improving. Consumers have been steadily deleveraging (paying down debt) as continued low interest rates have helped to reduce debt burdens. Delinquency and default rates on consumer credit have dropped dramatically, and access to credit has been slowly improving. Thus we have a contradiction. Typically when someone’s financial situation improves their sentiment goes up, but we are seeing the opposite happen. We believe the grim fiscal policy outlook is what’s driving sentiment down. This decrease in sentiment caused the Personal Consumption Expenditures (PCE) index to begin pulling back in mid-summer. That is, the growth in consumer spending by this measure began to slow down and has since gone into negative territory. If this remains the case then the likelihood of a mild recession increases. Therefore, it is up to the policy makers in Washington and Europe to act quickly and positively, and it seems there is a lack of will to do so in both places.
This week is a data-laden week. On Monday we get the report on New Home Sales. On Tuesday we have the all-important Consumer Confidence report. Wednesday has the Durable Goods Orders report. Thursday is loaded for bear with both the GDP report and the Jobless Claims report. Finally, Friday brings us the Personal Income and Outlays report, as well as the Consumer Sentiment report.