Just as we began to have serious discussions regarding a Fed exit strategy, the economy gets hit with a series of very poor economic reports and we are hearing chatter about a double dip recession.
Today’s employment situation report showed growth in nonfarm payrolls of 54,000, about 120,000 fewer than were expected and that expectation was dropped this week due to other weak economic news. Namely Wednesday’s Institute For Supply Management's (ISM) manufacturing index.
ISM dropped to 53.5 in May from 60.4 in April, the largest month over month drop since 1984. The new orders component slipped to a reading of 51. Readings below 50 indicate a contracting economy. ISM has become one of the most followed economic indicators and if you have any doubt follow the below ISM chart along with a chart of the Dow Jones Industrial Average Index. Dips in ISM have been followed closely by drops in the stock market.
Federal Reserve Board Chairman Ben Bernanke announced in April that the Fed would complete QE2 this month in the Fed’s first ever press conference, though it was not clear whether or not he ruled out a QE3. What was clear was that the Fed would continue reinvesting principal payments from its securities holdings.
That is significant as ending that practice would be the first step in an exit strategy. That exit strategy seems to be further away today than it was last week, but if you were paying close attention to the markets you would have seen that expectations of Fed tightening have been pushed back fairly dramatically since April 1.
Despite what was on the surface a strong employment report for March, which was released on April 1, that is when Fed Funds began rallying sharply. On April 1 the expectation based on fed funds futures was for a 25 basis point tightening by December, now it indicates no change. The June 2012 contract indicated on April 1, rates would have risen to between 0.75%-1% by June 2012, now it is pricing in no change. The October 2012 contract indicated on April 1 that the rate would be between 1%-1.25% by that time, now it is indicating a rate of 0.50% on the eve of the 2012 election.
Given these numbers, talk of a double dip recession doesn't seem so crazy.