Eye of the Hurricane

There seems to be sentiment developing that the U.S. has weathered the worst of the current cyclical economic storm and blue skies are ahead. We disagree. Any blue skies you see are likely to be short lived. The economy is in the relative calm of the eye of the business-cycle hurricane. The mortgage credit problems are not over. And credit problems in other sectors are just beginning as the housing recession spreads to the rest of the economy.

The plus-sign in front of the Commerce Department’s preliminary estimate of the change in first-quarter real GDP was deceiving. Real final sales of domestic product, which is real GDP excluding the change in business inventories, contracted at an annual rate of 0.2% in the first quarter.

Real private final domestic sales – i.e., the sum of personal consumption expenditures and private fixed investment expenditures – contracted at an annualized rate of 1.0% in the first quarter, which was the largest contraction since the fourth quarter of 1991 (see Chart 1). So, the housing recession is now spreading to consumer spending, business equipment spending and nonresidential construction spending.

Blackstone Group LP President Tony James said banks are mistaken if they think credit markets have begun a sustained recovery. ``It's not clear to me if it's a permanent upswing as I think many of the banks are saying or the eye of the hurricane,'' James told reporters on a conference call today. Source

Myron Scholes, chairman of Platinum Grove Asset Management LP and 1997 winner of the Nobel Prize in economics, said the worst of the crisis in credit markets may not be over. ``From my perspective, I think that we don't know if the storm has passed or if we are still in the eye of the storm,'' Scholes said in an interview with Bloomberg Radio yesterday. ``Are there other shoes to drop and new events or new shocks that will come to the fore?'' Source