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Soft Patch or Double-Dip?

The latest batch of lousy economic data took a sharp turn for the worse this morning with an awful new home sales reportfor the month of May.

New home sales plunged a record 33 percent to a record four-decade low.

In addition, the April number was revised lower and inventories jumped from 5.8 months in April to 8.5.

This ain’t good.

Making matters worse, existing home salessurprised to the downside yesterday with a 2 percent decline. Before that, we had big drops in housing starts, retail sales and an upward tilt to weekly jobless claims. So it’s really no surprise that there’s growing debate over whether we’re muddling through a soft patch, or a double-dip recession lies ahead.

Housing does look particularly vulnerable to a double-dip. All of these temporary, goofy, Big Government tax credits, mortgage modifications, and other forms of temporary stimulus merely steal economic activity from the future. They are shortsighted thieves. As the late Milton Friedman successfully argued in his permanent income theory decades ago, they simply do not work. Friedman's work of course won him a Nobel Prize in economics.

The only bright spot out there? A v-shaped recovery in manufacturing. It may be the only strong story out there.

It's been about six weeks since I first recommended that investors take some stock market profits off the table, before the IRS does it for them next year. Since then, the market has roiled around a 10 percent correction since late April. I’m still sticking to my call. The Tax Man is coming. Take profits on up days.

The Fed will announce its interest rate policy decisionlater this afternoon. Here's one conundrum: I believe that market prices are smarter than Fed computer models. The very strong King Dollar is suggesting a deflationary trend in the economy which would call for a Fed easing. And yet, the soaring gold price is suggesting an inflationary trend calling for a Fed rate hike. So what will they do? In the short run, until it levels out, the deflationary rising dollar is a bigger influence on the economy. Longer run, gold is screaming for a normalized Fed policy.

One particularly interesting story I’ll be paying attention to is hawkish Kansas City Fed chief Thomas Hoenig. Will Hoenig abandon his tightening stance in light of all this lousy economic data? Now that would be a big deal.

As for me, I remain in the slow growth camp. No double-dip, just slow, muddied growth. I also think that an overly strong dollar—neglected by many on Wall Street—is interrupting the rate of recovery speed.

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Questions? Comments, send your emails to: lkudlow@kudlow.com

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