Interest Rate Roundup

Thursday, August 17, 2006

Let's talk landings ...

"Soft" vs. "Hard" -- that is the question. It's no longer debatable, in my book, that the economy is slowing. The only question is, what kind of landing are we in for?

Wall Street is currently "buying" the soft landing story. That's clear from the big ramp this week in shares. And SO FAR, the evidence would agree. Jobless claims have risen from their lows, but not yet surged. Retail sales have cooled, but not yet tanked. Production has slowed, but not yet plunged.

But here's the problem, as I see it: Every HARD landing starts out looking like a SOFT one. Spending, employment, production don't shut down overnight. Picture a snowball rolling downhill -- it starts out small, then gets bigger and bigger, until ultimately, it steamrolls anything in its path.

I think the chance of a hard landing is much higher than investors appear to believe. The Fed helped inflate, then pop a massive stock market bubble in the late 1990s/2000. To "save" us from a serious recession, it then inflated the biggest housing bubble in U.S. history betwen 2001 and 2005. Now that bubble is clearly bursting.

Just look at the NAHB housing sentiment index I posted a little while back. Or this chart, which shows the seasonally adjusted annual rate of building permit issuance going all the way back to 1991. You'll see a whopping 15-year long trend in which permits were generally rising ... and then an absolute collapse. Is this the stuff soft landings are made of?

The verdict is still out of course. Maybe the rest of the economy will remain just fine and only the housing sector will suffer a recession. But color me skeptical.

Oh, and don't forget the message from the yield curve. Based on the Fed's own research, the current inversion between 3-month T-bill yields and 10-year Treasury Note yields (at about 21-22 basis points) is indicating a greater than 30% chance of recession in the next year. That's up dramatically from virtually nil in the past several months.


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