Fragile Stability

We talk about the signals the economic data are sending out, but this is also a financial crisis that has to be resolved for there to be a broad-based recovery. As with the economy, the major panic of end-2008 has subsided somewhat, giving way to a fragile stability that will need a lot of TLC and a firm hand from the Fed and the government

1) Investors (mind, I say investors, not bank executives - that's another matter) have started to grumble about government and Fed involvement in markets. It's hard to hedge against government action - particularly given Congress' populist bent and limited attention span. Yet the mutterings are a massive shift from last year, when the cry "They (the administration or the Fed) must step in; they must do something" arose any time there was even a mere whisper of trouble. The patient, in other words, is out of intensive care, but still requires major attention. With the worst behind him, the patient is eager to leave the hospital and go home. But the doctors should refuse to discharge him - it will take a while longer to ensure a full recovery - and there is always the danger of relapse.

2) The bond market vigilantes this week stuck their heads over the parapet: punishing the BOE and the U.K. government for sending mixed messages and sending a warning signal to the U.S. and the Fed that there is a need to spell out the exit strategy. The bond market's early warning system is up and running - that's a good sign - but it bears remembering that the safe-haven bid remains an underlying support for government debt. The market's animal spirits remain subdued.
And, by the way, the exit strategy planning is well underway - in a little noticed joint press release issued by the Treasury and the Fed, the last sentence states that at some point, the Treasury will take over the three Maiden Lane vehicles that sit on the Fed's balance sheet - which would indicate that preparations are underway to rid the Fed off any credit exposure. Treasury also committed to helping the Fed achieve the tools it needs to fight inflation - i.e. withdrawing the trillions of dollars it is pumping into the system. One way to do that would be to sell Fed bills to mop up those dollars - which will require legislative action and where the Treasury's support will come in handy.

3) The Obama Administration's plan for regulatory reform. That was the most heartening of actions so far - the administration clearly has a plan and presented it forcefully this week: first on Wednesday, in testimony by Treasury Secretary Timothy Geithner, Fed Chairman Ben Bernanke and New York Fed President Bill Dudley, then again on Thursday in testimony by Geithner alone. It's a year since the downfall of Bear Stearns first made it clear that the regulatory system was woefully inadequate to deal with the turbo-charged financial industry - that we finally have an energetic administration that recognizes the need to address these deep-seated problems and isn't shy in tackling them is in my mind the most encouraging sign one could hope for.

Spring Blandishments

Spring's here and with it comes talk of "green shoots" and "small signs of hopes" when it comes to the economic data - February brought the second month in a row of rising retail sales and personal spending, durable goods orders were up as were existing and new home sales. And bank chiefs talked about a good start to the year for the first two months.

But it pays to remember that the on-month gains came after the economy well and truly tanked in the fourth quarter - it fell so steeply, there had to be some kind of leveling off in the pace of decline. That's no doubt a good sign; a continuation of the fourth quarter's precipitous drop across all sectors of the economy would have been highly alarming. But when things stabilize, there's still a possibility they could resume their decline - it's in no way a given that the only path from here is upward. And in a worrying sign, some bank chiefs, including JPMorgan's Jamie Dimon, are warning that March was a tough month.

The coming week brings the first inklings of this month's data in the form of the ISM's national reports on the manufacturing and non-manufacturing sectors. The headline numbers will show more stability, but it's the components such as inventories, shipments and orders - particularly export orders - that will be the most insightful. Global demand outside the U.S. has collapsed - the major export nations, from Japan to Germany to China, have all reported dire export numbers. Chinese officials believe they have averted crisis with their stimulus package and that the vital signs of their economy - such as bank lending - have improved. Germany says it has done enough to stimulate its economy and that given its high debt levels - left over from the country's reunification in the 1990s - it doesn't have the fiscal flexibility to spend more.

But demand will have to come from somewhere for the U.S. economy to start growing and not just bump along the bottom of the trough for an extended period. The domestic stimulus package is one source - but that won't come into full force until 2010. Foreign demand will take even longer to surface - China's recovery will to some degree depend on a recovery in the U.S. as one of its largest trading partners; Germany needs the rest of the world to recover so it can start exporting again, and Japan's economy remains in a blue funk. A hopefully more immediate source of demand will come from the funds that the Fed is creating and throwing by the armload at financial markets to revive gun-shy capitalist spirits and the broader economy.

Spring crocuses notwithstanding, the economic outlook continues to hang in the balance. It will take longer than one season for the rescue efforts to work their way through the economy.