Letter from New York

Stefan and I have just got back from a trip to visit our counterparties in New York. The mood is almost universally gloomy with – predictably – housing and gas prices the dominant themes. The TV news channels run an almost constant stream of features on the cost of motoring (a gallon went through the $4 mark for the first time at the weekend, up from $3.10 a year ago, a 30% rise), with interviews with disgruntled car owners explaining why they are staying at home during the driving season. One news channel has a permanent banner at the bottom of the screen saying “America’s Oil Crisis” – it’s as big a deal as “America’s War on Terror” post 9/11.

It’s difficult to see that this (and higher food prices) in an environment of plummeting house prices (down over 14% year-on-year) won’t lead to a collapse in consumption. As consumption is over two-thirds of US growth, a recession still looks likely. But there are a couple of things that do mitigate the doom and gloom for the US consumer. Firstly is the fiscal stimulus from the tax rebate cheques which have given most families anything from around $600 to $1500. About 30-40% of this money is likely to be spent rather than saved or used to repay debt. So retail sales numbers for May, June and July could look surprisingly strong and keep GDP growth in positive territory. There are rumours of a further tax stimulus package later this year too.

Secondly, employment is much stronger than it was at the time of the 2001 downturn. Then, the economy was regularly shedding from 150,000 to over 300,000 jobs monthly. Last month’s reading was a loss of 49,000 jobs and the biggest monthly fall so far was March’s 88,000. We’ve talked before about the possibility of big negative revisions to these recent data, but nevertheless the employment background is less of a headwind to growth than it has been historically. Why? Well the 2001 recession was a corporate recession – companies had spent too much on capex (during the tech bubble) and had got their balance sheets in a mess, taking on too much debt. Corporate recovery was about sorting out balance sheets (hence the rally in corporate bonds incidentally) and about downsizing the workforce. As a result they are going into this downturn with a much leaner labour force and won’t need to cull like they did last time.

So what we are seeing is that firms are not laying off employees like they did in the early 1990s. But they are cutting back on hours worked, and more importantly, for those people who don’t have a job, finding one is becoming extremely difficult. The persistency of unemployment is increasing. The unemployment rate is rising (to 5.5%) and the jobs slowdown is spreading to all sectors of the economy – but for the time being it is the cost of living increase that is hurting, not (yet) the loss of income.

A couple of final thoughts. The strains in the financial system persist despite the Fed’s bailout of Bear Stearns. Banks still won’t lend to each other, even at rates significantly above official market rates. There remains a stigma about using the Fed’s new discount window (open to brokers as well as banks) – nobody wants to be the next Bear Stearns, and rumours can still bring down weaker players. Inflation (and stagflation) worriers can, however, take heart that the Fed has not yet been using the most powerful piece of technology known to man (to paraphrase Ben Bernanke) – the printing press – to create US dollars. The size of its balance sheet remains almost unchanged since July 2007, and it has plenty of ammunition left to respond to further liquidity needs by the market before it has to start cranking up the handle and printing dollar bills.

On the credit front, the days of easy money are over for companies, and not only because of wider credit spreads. A feature of the corporate markets over the past few years has been the ease by which companies have been able to waive covenants on their debt when they got into difficulties. With the wall of capital having disappeared, bankers are playing hardball. Not only is the number of requests for covenant amendments increasing, but the costs are too. Permission might have been granted for free a year or so ago – now, for covenant renegotiations relating to financial performance a typical waiver “fee” might be 2.25% of the loan value, or an increase in the lending spread by 150 basis points per year. The Fed’s Senior Loan Officer Survey shows that lending standards more generally are tightening: 70% of the 100 odd banks surveyed in April had increased loan pricing to their corporate customers. Default rates remain super low – but for how long?

We only had time for one quick beer before heading back to the airport, at Welcome to the Johnsons in the Lower East Side. A year ago a can of Pabst Blue Ribbon there was $1. Now it’s a punitive $1.50. A sad indication of the global food price inflation trend. Elsewhere in the Manhattan bar scene we heard that prohibition style speakeasies are making a comeback, with drinking dens hidden behind, for example, telephone booths. The US prohibition ran from 1920 to 1933, covering the period of the Wall Street Crash and early years of the Great Depression – but that is surely coincidental.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

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