In the past consumer confidence was boosted when banks eased their lending standards for consumer loans and especially credit cards. As yet the easier lending standards have failed to lift consumer confidence, though.
Sources: Conference Board; Federal Reserve Board – Senior Loan Officers Survey; Plexus Asset Management.
On the housing front US banks continue to slash their mortgage margins.
Sources: FRED; I-Net Bridge; Plexus Asset Management.
Mortgage rates continue to fall.
Source: FRED.
But the banks are not experiencing stronger demand for mortgage loans.
Sources: Federal Reserve Board – Senior Loan Officers Survey; Plexus Asset Management.
Why? The banks are the culprits. They are making it increasingly difficult for households to obtain mortgages by (again) tightening their lending standards for mortgage loans. But can you blame them, given the environment of massive delinquencies and foreclosures?
Sources: Federal Reserve Board – Senior Loan Officers Survey; Plexus Asset Management.
The banks’ stance on mortgage loans, whether warranted or not, together with the massive oversupply of residential properties, will keep property prices down for longer. With consumer sentiment significantly influenced by consumers’ perception of their wealth situation, consumer confidence is unlikely to recover unless house prices improve.
Sources: Conference Board; Standard & Poors; Plexus Asset Management.
With consumer sentiment expected to remain relatively low, I briefly turn to my outlook for the US economy based on a few simple indicators.
Consumer confidence narrowly tracks the velocity of MZM money supply.
Sources: Conference Board; FRED; Plexus Asset Management.
But why, you may ask. The velocity of MZM (money with zero maturity, i.e. cash) is the ratio of nominal GDP to MZM money supply and indicates the number of times one dollar cash is used to purchase final goods and services included in GDP. The MZM money supply velocity is therefore an indication of the strength of the economy. When sentiment is high, consumers tend to enter into more transactions and money velocity is therefore higher than when sentiment is low. The increase in transactions eventually leads to higher prices. That, in my view, explains the close relationship between the yield on the 10-year Treasuries and consumer sentiment.
Sources: Conference Board; I-Net Bridge; Plexus Asset Management.
It also explains the correlation between MZM velocity and the yield on the 10-year Note.
Sources: FRED; I-Net Bridge; Plexus Asset Management.
These are the very reasons why I recommended a few months ago that you should cut your long positions in US bonds as quantitative easing forced yields lower than the underlying fundamentals. At this stage the 10-year bond is aptly priced, though.
Sources: FRED; I-Net Bridge; Plexus Asset Management.
Going forward, the outlook for the US economy solely rests on consumer sentiment. In my view, consumer sentiment will be influenced by four pillars – the house market, job creation, fixed investment and global demand ex US.
Hold on! What about the current round of quantitative easing (QE2) by the Federal Reserve?
That is where the problem lies. QE2’s focus is on the Federal Reserve injecting cash into the economy by repurchasing US government treasuries. It is expected that banks and other institutions will start lending the funds to consumers and business. Although it is an unlikely scenario in my view, if the banks and others decide against lending and rather hoard the cash or purchase other qualifying assets, the original purpose of the Fed is neutralised as the multiplier effect is 1 versus the current MZM velocity of 1.5
The consumer will therefore not be enticed to spend more as no new jobs will be created, the house market will not improve significantly and, given the current significant overcapacity in the economy, there will be no significant fixed investment. That leaves exports as the only alternative. With demand in the Eurozone expected to be lethargic, especially in the light of the fiscal crisis in the PIIGS, Japan running the risk of returning to a recession, and emerging economies and China, in particular, reigning in their economies by hiking interest rates, the US in my view has only two options left in this scenario. The first is a trade war and the other a significant devaluation of the US dollar.
I subscribe to the view that there is no quick fix to boost consumer sentiment. Even if banks continue to cut their margins on mortgage rates and keep the latter on low levels despite rising long bond yields, improving consumer sentiment is going to be a long, hard and painful process. Banks must be forced to change their attitudes, especially regarding lending criteria for mortgages. They will need to write off substantial amounts in “mortgage debt forgiveness”. Furthermore, the US should pray that something disastrous does not happen elsewhere in the world that may severely curtail exports.
I maintain my view that the yields on US long bonds are heading higher but do not see a major upward spike except in the case of extraordinary happenings such as major wars or extreme terrorism. The volatility of bond yields is likely to be high in the coming months due the economy surprising on both the upside and downside.
