A Tale of Two Economic Views

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Last week the Federal Reserve issued the latest FOMC minutes. Let's take a look at what they see regarding the current economic conditions.

Labor market conditions deteriorated further in March. Private nonfarm payroll employment registered its fifth consecutive large monthly decrease, with losses widespread across industries. Moreover, the average workweek of production and nonsupervisory workers on private payrolls ticked down in March from the low level recorded in January and February, and total hours worked for this group stayed below the fourth-quarter average. The civilian unemployment rate climbed to 8.5 percent, and the labor force participation rate edged down from its February level. The four-week moving average of initial claims for unemployment insurance remained elevated in April, and the number of individuals receiving unemployment benefits relative to the size of the labor force reached its highest level since 1982.

Total employment is still heading lower and


The percentage change from last year in the establishment job survey is still dropping



Average weekly hours is still heading lower and


The unemployment rate is heading higher



The Federal Reserve calls this chart "elevated" -- which it is. However, I would add that it looks to be topping.

Industrial production fell substantially in March and for the first quarter as a whole, with cutbacks widespread across sectors, and manufacturing capacity utilization decreased to a very low level. First-quarter domestic production of light motor vehicles reached the lowest level in more than three decades as inventories of such vehicles, while low, remained high relative to sales. The output of high-technology products decreased in March and in the first quarter overall, with production of computers and semiconductors extending the downward trend that had begun in the second half of 2008. In contrast, the production of communications equipment edged up in the first quarter. The output of other consumer durables and business equipment stayed low, and broad indicators of near-term manufacturing activity suggested that factory output would contract over the next few months.

Industrial production is dropping hard and


Capacity utilization is at record lows. I should add -- these are the two numbers that scare me the most.

The available data suggested that real consumer spending rose moderately in the first quarter after having fallen in the second half of last year. Real spending on goods and services excluding motor vehicles fell in March but was up, on balance, for the first quarter as a whole. Real outlays on new and used motor vehicles expanded in the first quarter following six consecutive quarterly declines. Despite the upturn in consumer spending, the fundamentals for this sector remained weak: Wages and salaries dropped, house prices were markedly lower than a year ago, and, despite recent increases, equity prices were down substantially from their levels of 12 months earlier. As measured by the Reuters/University of Michigan survey, consumer sentiment strengthened a bit in early April, as households expressed somewhat more optimism about long-term economic conditions; however, even with this improvement, the measure was only slightly above the historical low for the series recorded last November.

We've been over this a few times. I think retail sales have bottomed. I outlined my arguments in this article. Nothing has changed since then to change my mind (although it could). However, this report from the San Francisco Federal Reserve explains the problems going forward for the household sector.

The latest readings from the housing market suggested that the contraction in housing activity might have moderated over the first quarter. Single-family housing starts flattened out in February and March, and, after adjusting for activity outside of permit-issuing areas, the level of permits in March remained above the level of starts. The contraction in the multifamily sector also showed signs of slowing, as the drop in starts in the first quarter was well below the pace experienced during the fourth quarter of 2008. Recent data also indicated that housing demand might have stabilized. Sales of new single-family homes held steady in March after edging up in February, but the level of such sales remained low, leaving the supply of new homes relative to the pace of sales very high by historical standards. Existing home sales in March were slightly below the average pace for January and February. Most national indexes of house prices stayed on a downward trajectory. Lower mortgage rates and house prices contributed to an increase in housing affordability. Rates for conforming 30-year fixed-rate mortgages extended the significant decline that began late last year. Rates on jumbo loans came down as well, although the spread between the rates on jumbo and conforming loans was still wide and the market for private-label nonprime MBS remained impaired.

As I've said many times, housing won't recover until prices stop falling. And prices won't stop falling until inventory comes down. And there is a ton of inventory right now:

A full recovery for housing, and maybe the broader economy, depends on a third step: Prices must stop falling. On that front, as with other economic data, the "second derivative" is improving -- things are still getting worse, but at a slower rate.

Unfortunately, the day when prices start rising might still be far away.

That is mainly due to a dizzying supply of housing, which can keep a lid on prices even as demand rises. This glacier is melting slowly: Existing-home inventories are down to 9.8 months' supply, higher than their long-term average of six months, but off their recent peak of 11.3 months.

There is a massive shadow inventory of bank- and investor-owned homes, enough to push existing-home supply to 12 months, notes David Rosenberg, chief economist at Gluskin Sheff, a Toronto wealth-management firm.

So -- the economy is terrible, right? Well -- maybe not.

More Thoughts On the Fed

With a week (more or less) between the Fed's rate cut hopefully we can gain a little more perspective on what their action means and why they did it. The Fed sees very interested in letting us know why they acted with a 5 BP rate cut:

Federal Reserve Vice Chairman Donald Kohn defended the central bank's aggressive interest-rate cut, saying it was driven by concerns about the broader economy rather than an interest in protecting investors or the value of housing.

And fellow Fed Governor Kevin Warsh said the Fed's next move depends on economic events, rather than on financial markets. "The goal of our policy...is not to look at any particular asset class" but instead is to watch "what's happening in the real economy," Mr. Warsh said after a speech at the State University of New York at Albany. "We are going to stay very closely focused on real-time indicators and forward indicators."

I don't want to sound unsympathetic to the Fed's point; there are troubling signs coming from the economy.

However, I don't think I'm alone in being very confused by the divergence between the Fed's statements and their action. Up until August 7 the Fed's public statements were "we're more concerned about inflation than threats to growth." However, between August 7 and the rate cut last week something obviously changed. The Fed not only cut rates, but cut them sharply. This action was very much out of character with their previous statements, which sounded very cautious regarding policy.

It's entirely likely the Fed was putting on a united front about the economy until August 7 and after. They are after all some of the leading people we look to about what is happening. They can't appear to be scared. And Fed jawboning can have an impact on people's psychology. After all, if the Fed says things are OK, maybe they know something that we don't.

But the size of the cut just doesn't jibe with a calm and reasoned outlook. Until last week, the Fed's actions were very prudent. First, they had injected liquidity into the market. Then they cut the discount rate -- a rate specifically target to the financial markets. The Fed was acting very responsibly. Mose importantly, they were acting maturely. Their actions were slow but deliberate.

Last week's action looks very much like a "holy shit" variety. Instead of looking reasoned and responsible, the Fed is looking like they are desperately trying to play catch-up with a situation that is getting out of hand. In short, the Fed looks like they are behind the curve rather than driving it. And that gives me a great deal of concern about this Fed's ability to steer the economy.

The Fed is Spooked

I'll do a market recap in the morning.

Let's go back to the beginning of the year and look at every Fed policy statement.

January 31:

Readings on core inflation have improved modestly in recent months, and inflation pressures seem likely to moderate over time. However, the high level of resource utilization has the potential to sustain inflation pressures.

The Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

March 21

Recent readings on core inflation have been somewhat elevated. Although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures.

In these circumstances, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

May 9

Core inflation remains somewhat elevated. Although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures.

In these circumstances, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

June 28

Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.

In these circumstances, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

August 7

Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.

Although the downside risks to growth have increased somewhat, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the outlook for both inflation and economic growth, as implied by incoming information.

August 17

Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.

September 18

Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

Developments in financial markets since the Committee’s last regular meeting have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

Until August 7, the Fed was primarily concerned about inflation. However, even at that meeting the Fed observed:

Economic growth was moderate during the first half of the year. Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.

So even at that meeting, the Fed thought growth would be OK. That was a month and a half ago. In a month and a half the enough things have gone wrong to warrant a 50 BP cut. And even then, the Fed is still concerned about inflation.

In other words, enough indicators have turned negative in the last month and a half to warrant exposing the economy to a higher-inflation monetary policy even at a time when the Fed is concerned about increasing inflation.

Fed Cuts 50 BP

WOW -- that is something I was not expecting in any way.

Here's a link to the statement

Here's the money parts:

Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.

Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

Developments in financial markets since the Committee’s last regular meeting have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

Allow me to pay myself on the back. I was right in 2/3 of my predictions. Not bad.

Bernanke Sets The Right Tone

I've been very critical of Bernanke over the last few weeks, largely because I viewed his cut in the discount rate as the first move in a cut in the Fed Funds rate. My concern here was the Fed engaging in a policy which would encourage more reckless lending behavior. This is the exact same policy that got us into the current mess in the first place.

But his speech today set the perfect tone. Here is the money quote:

It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy. In a statement issued simultaneously with the discount window announcement, the FOMC indicated that the deterioration in financial market conditions and the tightening of credit since its August 7 meeting had appreciably increased the downside risks to growth. In particular, the further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally.

The incoming data indicate that the economy continued to expand at a moderate pace into the summer, despite the sharp correction in the housing sector. However, in light of recent financial developments, economic data bearing on past months or quarters may be less useful than usual for our forecasts of economic activity and inflation. Consequently, we will pay particularly close attention to the timeliest indicators, as well as information gleaned from our business and banking contacts around the country. Inevitably, the uncertainty surrounding the outlook will be greater than normal, presenting a challenge to policymakers to manage the risks to their growth and price stability objectives. The Committee continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets.

The emboldened sentences are key. Here's the translation.

1.) If you made a bunch of bad loans it's your fault, not ours. Don't expect a bail-out just because you're stupid.

2.) However, there are broader implications to what is happening in the credit markets. If the economy starts to really slow down because of what is happening, we'll have to do something.

He goes on to make some very important points as well.

3.) Recently released economic numbers should be discounted if their constituent parts occurred before the current mess started.

4.) Going forward, we will be especially sensitive to any sign that overall economic growth is slowing because of the problems in the credit markets.

Let's face facts -- Ben has a really hard job right now. He's caught between his mandate for controlling inflation (which may require an interest rate increase) and full employment (which may require a cut in rates). No matter what he does he'll be relentlessly criticized.

But this statement is the perfect compromise because he's essentially saying the following.

1.) We won't bail-out people who were stupid.

2.) We will act to help alleviate the effect of stupid business decisions if those effects start to really hamper growth, and

3.) The economic numbers over the next few months are very important.

While I am still concerned that lower rates will lead to a de-facto bail-out, the underlying reason for lower rates won't be a bail-out but instead to help the broader economy if needed. I can live with that -- and I bet the markets can, too.

Fed Minutes

The Fed released the minutes of the August 7 meeting. Because the Fed's perception of the economy is so incredibly important right now, let's take a detailed look at what the Fed is seeing.

The information reviewed at the August meeting suggested that economic activity picked up in the second quarter from the slow pace in the first quarter. On average, the economy expanded at a moderate pace during the first half of the year despite the ongoing drag from the housing sector. While the growth of consumer spending slowed in the second quarter from its rapid pace in prior quarters, wages and salaries increased solidly and household sentiment appeared supportive of further gains in spending. Business fixed investment picked up in the second quarter after little net change in the preceding two quarters. Inventories generally appeared to be well aligned with sales at midyear. Overall inflation receded in June because of a decline in energy prices, while the core personal consumption expenditure (PCE) price index rose bit less than its average pace over the past year.

The basic overall picture is OK. Things aren't too hot or cold. Barry Ritholtz over at the Big Picture has called growth "lumpy" which I think is a really good phrase to describe the general trend. Some areas are doing well and others are clearly dragging.

Private nonfarm payroll employment continued to increase at a healthy pace; the rise in July was about equal to the average increase over the first half of the year.

Bulls have argued employment is one of the big areas of strength in the economy, usually citing the 4.6% unemployment rate. The Fed is confirming this view. A serious drop in employment would be a clear signal there was a problem. However, so long as the Fed thinks employment is on solid ground, they will feel far less pressured to lower the Fed funds rate.

Industrial production picked up in the second quarter after little net change over the preceding two quarters.

This observation ties in with this point:

Economic activity in advanced foreign economies expanded somewhat less rapidly in the second quarter than in the prior quarter, but nonetheless appeared to have grown faster than trend, reflecting upbeat business and consumer confidence as well as favorable labor market conditions.

Another general consensus emerging is growth in US trading partners will help to alleviate the housing slowdown in the US. Starting in the first quarter of this year many commentators (including myself) observed that foreign profits were a big reason for the the first quarter profit increases from the big multi-nationals. So long as other countries continue to grow, US exports should as well.

Outlays for nonresidential construction rose rapidly in the second quarter. Business spending on equipment and software, other than transportation equipment, posted a solid increase after being flat, on net, in the preceding two quarter

Non-residential construction increased at a 22% seasonally adjusted annual rate in the second quarter. This pace is not sustainable. My thought is we are seeing the last hurrah (as it were) from the non-residential construction sector.

In addition, we saw some decent increases in business technology investment.

The growth of real consumer spending slowed considerably in the second quarter after substantial increases earlier in the year. The deceleration primarily reflected sharply slower growth in outlays for goods as purchases of motor vehicles decreased noticeably.

.....

Demand for housing in the second quarter was restrained by higher interest rates and by tightening credit conditions in the subprime mortgage market.

Short version: the consumer -- which is responsible for 70% of US economic growth -- is spending less. This is not a good development.

The statement announcing the policy decision noted that economic growth appeared to have been moderate during the first half of the year, despite the ongoing adjustment in the housing sector. The economy seemed likely to continue to expand at a moderate pace over coming quarters. Readings on core inflation had improved modestly in recent months. However, a sustained moderation in inflation pressures had yet to be convincingly demonstrated. Moreover, the high level of resource utilization had the potential to sustain those pressures. The Committee's predominant policy concern remained the risk that inflation would fail to moderate as expected. Future policy adjustments would depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

The bold-faced sentence from above is the real money quote from the meeting. The Fed is still concerned about inflation, and fighting inflation is still their primary policy orientation. This statement is currently sending markets lower.

The bottom line is this isn't a horrible picture. It says what we already know. Housing is in a nosedive. This is probably having a negative impact on consumer spending. However, other areas of the economy are doing OK. Given this outlook, the Fed is completely justified in not lowering interest rates.

Bernanke Bails Out the Street; Fed Lowers Discount Rate to 5.75%

From the FOMC:

Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.

First -- let's get some terminology down. The Discount Rate is, "The interest rate that an eligible depository institution is charged to borrow short-term funds directly from a Federal Reserve Bank." This is usually considered a bad move because it signals the borrower may be in trouble. Essentially, the discount rate is the rate of last resort.

This type of borrowing from the Fed is fairly limited. Institutions will often seek other means of meeting short-term liquidity needs. The Federal funds discount rate is one of two interest rates the Fed sets, the other being the overnight lending rate, or the Fed funds rate.

In other other words, this is as much a symbolic gesture as a practical one.

But the damage has been done. Bernanke has continued the the "Greenspan put" tradition. When financial markets screw-up and make a ton of bad loans, the Federal Reserve will bail them out.

As Bloomberg said:

Today's move also shows how Bernanke, like his predecessor, is prepared to temporarily abandon Fed growth forecasts and inflation objectives to offset the risk of a credit crunch. Former Chairman Alan Greenspan was known for his tendency to give financial market conditions a primary role in policy, and he came to the rescue on several occasions when turmoil struck.

`Greenspan Put'

Until now, Bernanke had shown every intention of shunning the so-called Greenspan put. He wanted more emphasis on the forecasts of the institution and policy less dependent on the whims of whoever occupies the chairman's suite.

FOMC Statement

From the Federal Reserve:

Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.

Although the downside risks to growth have increased somewhat, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the outlook for both inflation and economic growth, as implied by incoming information.

Translation: we're not lowering interest rates.

Or -- this isn't Greenspan's "throw a ton of money at any problem" Fed anymore.

FOMC Minutes

Here is a link to the Fed Minutes from May 9, 2007. Let's see how the Fed saw the economy a little under a month ago:

The information reviewed at the May meeting suggested that economic activity had expanded at a below-trend pace in recent months.

We pretty much already knew that.

The average monthly increase in payroll employment through the first four months of this year was well below the relatively strong pace recorded in the fourth quarter of 2006. In April, the construction industry continued to shed jobs, manufacturing employment declined further, and retailers reduced hiring after a large gain in March. The unemployment rate stood at 4.5 percent in April, similar to its average in the first quarter, and the labor force participation rate moved down.

This isn't that good, either. Weak job growth is always bad.

Industrial production increased at a modest annual rate of 1.4 percent in the first quarter, with the monthly pattern reflecting fluctuations in the output of utilities, which was influenced importantly by swings in weather conditions.

The Fed noted the last month was strong across the board, but that was only 1 month.

Real consumer expenditures increased at a brisk pace in the first quarter, although monthly gains in spending slowed over the course of the quarter, in part because of swings in weather-related outlays on energy goods and energy services.

This has been the real story of this slowdown -- the strength in consumer spending. It has remained strong for the last 4 quarters when other areas of the economy were slowing.

Residential construction activity remained soft as builders attempted to work off elevated inventories of unsold new homes.

I've covered this to death.

Real spending on equipment and software rose modestly in the first quarter after having fallen in the fourth quarter of 2006. Spending on high-tech equipment, boosted by a surge in outlays on computers, posted a substantial increase in the first quarter. In addition, purchases of communications equipment--which tend to be volatile quarter to quarter--rebounded strongly after a fourth-quarter dip. By contrast, spending on transportation equipment declined significantly:

One sub-area of business investment declined and one increased, making total growth "moderate".

Real nonfarm inventory investment excluding motor vehicles increased at a slower pace in the first quarter of 2007 than in the previous quarter. The downshift in inventory investment had helped to reduce the apparent overhangs that had emerged in late 2006.

In other words, business is stocking up on less stuff.

Economic activity in advanced foreign economies appeared to have grown at a steady rate in the first part of the year.

This is what may keep the US out of a recession. With a cheap dollar and the rest of the world's growth picking up, the US may be able to export enough to keep growth barely positive for the next quarter or so.

The total PCE price index rose substantially in both February and March. The advance in February was distributed across a broad range of categories, while the March increase was driven largely by a jump in the index for energy. Core PCE prices were unchanged in March after an upswing in February. Smoothing through the high-frequency movements, the twelve-month change in the core PCE price index in March was just a touch higher than the increase over the year-earlier period

OK -- I'll say this one more time. The Fed is not comfortable with inflation's current level. They've said it repeatedly for the last 6 months or so.

So -- where does this leave us?

1.) The economy is slowing, but we're not in a recession. While housing is slowing down, business investment is moderate and the consumer continues to spend at high rates. Job growth is weak. This makes Friday's number really important. Also remember, the 1st GDP revision comes out tomorrow.

2.) Inflation is too high for the Fed.

3.) Rates aren't coming own anytime soon.

FOMC Statement: RATES AREN'T COMING DOWN

Here's a link to the statement:

Economic growth slowed in the first part of this year and the adjustment in the housing sector is ongoing. Nevertheless, the economy seems likely to expand at a moderate pace over coming quarters.

Core inflation remains somewhat elevated. Although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures.

In these circumstances, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

This is very clear. There is no question about it. Rates aren't coming down.

I should add: the Fed has been saying this for the last few months. It's the markets that weren't listening.

The Fed on the Economy

Here are some bullet points on the economy that come from the FOMC minutes.

1.) Employment gains moderated in early 2007

2.) Industrial production rose strongly in February and was revised up for both December and January.

3.) Real consumer spending appeared on track to rise at a robust pace in the first quarter, buoyed in part by a weather-related surge in spending on energy services and by a jump in sales of light motor vehicles. Outside of these areas, however, real consumer spending moderated

4.) Housing starts declined in January, extending the downward trend that had been in place since early 2006, but bounced back in February. However, adjusted permit issuance in the single-family sector continued to step down, suggesting that builders were still slowing the pace of new construction to work off elevated inventories.

5.) Business fixed investment had been sluggish in recent months.

6.) Businesses accumulated inventories of items other than motor vehicles at a slower pace in January than in the previous two quarter

7.) The U.S. international trade deficit narrowed considerably in the fourth quarter. Exports rose, partly reflecting a robust increase in deliveries of civilian aircraft to foreign buyers, while imports were pushed down by a fall in the volume and price of imported oil

8.) Economic activity in the advanced foreign economies accelerated in the fourth quarter.

So, lets sum up with a "good/bod analysis":

Good: International trade deficit decreasing, other countries economies doing well and industrial production. We'll put consumer spending in this category as well, largely because of today's retail sales report.

Bad: Housing and business investment.

In-between: OK - I added a category. Employment belongs here. Although the BLS has revised the last two months higher and the latest report was a pretty good 180,000, growth is slowing and service sector jobs decreased last month by 7000.

So, according to the Fed, we're running lukewarm right now.

Vizier Vic makes a good point in the comments:

Does anyone believe that foreign buyers have suddenly started snapping up all of the industrial production which is theoretically pouring off American production lines. That's the only thing which might account for the purported rise in industrial production given the rest of this report. Business fixed investment and inventory builds and residential construction are down (and house sales too) which all mean domestic consumption of industrially-produced products are down too. Where's the growth source? Can anybody identify it? Is it restricted solely to light trucks and automotive? It sure looks like it and that's a pretty slender reed on which to base an economy. Or, is it restricted to kilowatt-hours and barrels of oil? That's an even more treacherous sink hole.

According to the BEA's latest GDP report, exports totaled $1.523 trillion in the 4th quarter, up from $1.488.3 trillion in the third quarter. That's about 11% of the US economy.

Fed Concerned About Inflation

From the FOMC Minutes:

Most participants continued to expect a gradual decline in core inflation over the next year or two, fostered by stable inflation expectations, a likely deceleration in shelter costs, and a slight easing of pressures on resources. Nonetheless, all meeting participants expressed concern about the risks to this outlook. The latest readings on core inflation were higher than expected, and it was difficult to discern whether the apparent downward trend in core inflation during the past few quarters was continuing. Also, the recent increases in prices for energy and some non-energy imports likely would boost overall inflation in the near term and might put upward pressure on prices of some core goods and services. Moreover, rates of resource utilization that were near the high end of historical experience suggested a possibility that inflation pressures could build. Participants agreed that risks around the expected and desired path of a gradual decline in core inflation remained mainly to the upside; some noted that upside risks to inflation appeared to have increased slightly in recent months.

Can we PLEASE stop talking about a rate cut now?

Fed Keeps Rates Unchanged; Inflation Still a Concern

Here's the text of their statement:

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5-1/4 percent.

Recent indicators have been mixed and the adjustment in the housing sector is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters.

Recent readings on core inflation have been somewhat elevated. Although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures.

In these circumstances, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Cathy E. Minehan; Frederic S. Mishkin; Michael H. Moskow; William Poole; and Kevin M. Warsh.

Translation: Inflation is too high; it hasn't come down as expected. We're still expecting a slowing economy to lower inflation.

We're not lowering rates anytime soon.

Oil, Inflation and Interest Rates

From Bernanke's recent Congressional testimony:

I turn now to the inflation situation. As I noted earlier, there are some indications that inflation pressures are beginning to diminish. The monthly data are noisy, however, and it will consequently be some time before we can be confident that underlying inflation is moderating as anticipated. Recent declines in overall inflation have primarily reflected lower prices for crude oil, which have fed through to the prices of gasoline, heating oil, and other energy products used by consumers. After moving higher in the first half of 2006, core consumer price inflation has also edged lower recently, reflecting a relatively broad-based deceleration in the prices of core goods. That deceleration is probably also due to some extent to lower energy prices, which have reduced costs of production and thereby lessened one source of pressure on the prices of final goods and services. The ebbing of core inflation has likely been promoted as well by the stability of inflation expectations.

Translation: Lower oil prices are a big reason for declining inflation.

Here's an oil chart the includes today's close:



Ben's not happy right now.

FOMC Statement

From the FOMC

All meeting participants expressed some concern about the outlook for inflation. To be sure, incoming data had suggested some improvement in core inflation, and a further gradual decline was seen as the most likely outcome, fostered in part by the continued stability of inflation expectations. However, participants did not yet see a downtrend in core inflation as definitively established. Although lower energy prices, declining core import prices, and a deceleration in owners' equivalent rent were expected to contribute to slower core inflation in coming months, the effects of some of these factors on inflation could well be temporary. The influence of more enduring factors, importantly including pressures in labor and product markets and the behavior of inflation expectations, would primarily determine the extent of more persistent progress. In light of the apparent underlying strength in aggregate demand, risks around the desired path of a further gradual decline in core inflation remained mainly to the upside. Participants emphasized that a failure of inflation to moderate as expected could impair the long-term performance of the economy.

Today's news didn't help. Rates aren't coming down anytime soon. Anyone who thinks differently just isn't reading.

FOMC Statement

From the Fed:

Recent indicators have suggested somewhat firmer economic growth, and some tentative signs of stabilization have appeared in the housing market. Overall, the economy seems likely to expand at a moderate pace over coming quarters.

Readings on core inflation have improved modestly in recent months, and inflation pressures seem likely to moderate over time. However, the high level of resource utilization has the potential to sustain inflation pressures.

The Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

I have no idea why the markets were so excited about this statement. The Fed gave themselves ample wiggle room to raise rates if they need to. While the inflation number from the GDP report was encouraging, oil is creeping back up. There's still something to be concerned about for the Fed.

Fed Still Worried About Inflation

Here's the money quote from the FOMC minutes:

All meeting participants remained concerned about the outlook for inflation. Although readings on core inflation had improved modestly since the spring, nearly all participants viewed core inflation as uncomfortably high and stressed the importance of further moderation. Participants expected core inflation to edge lower over time, in part as the pass-through of higher prices for energy and other commodities ran its course and as the moderate growth in aggregate demand likely led to a modest easing of pressures on resources. Some participants also highlighted the impact that movements in the prices of individual components of the price index, such as owners' equivalent rent and medical costs, could have on near-term readings on core inflation. More generally, participants stressed there was considerable uncertainty as to the probable pace and extent of the moderation in core inflation and that the risks around this desired downward path remained to the upside. Moreover, participants expressed concern that a failure of inflation to moderate as expected could entail significant costs if an upward drift in inflation expectations ensued.

OK -- let's translate this eco-geek talk.

1.) Everybody -- each Fed Governor -- was concerned about the inflation outlook. That means everybody from the most dovish to the most hawkish governor.

2.) Nearly everybody -- which I translate as more than a simple majority and most likely at least a super-majority (2/3) -- don't like the current inflation level.

3.) Individual CPI components -- Owner's equivalent rent and medical costs -- are raising eyebrows.

4.) The Fed has used language to the effect of "inflation will moderate over time" for the last few meetings. The problem is, "when"? We know inflation is on everybody's mind and most governor's don't like the current level. Despite the recent downward movement in CPI, the governors are still concerned.

So -- what are the Fed governors looking for? Looking at the latest CPI report, we see a gradual decline in core CPI. For overall CPI, September and October we see declines of .5% and in November we see a 0% advance. The bottom line is the raw numbers don't look half bad.

However -- let's look at the Cleveland Fed's median CPI:

According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.2% (3.0% annualized rate) in November. The median CPI is a measure of core inflation calculated by the Federal Reserve Bank of Cleveland based on data released in the Bureau of Labor Statistics’ (BLS) monthly CPI report.

Then there is the Dallas Fed's Trimmed Mean PCE:

The trimmed mean PCE inflation rate for November was an annualized 1.2 percent. According to the BEA, the overall PCE inflation rate for November was 0.1 percent, annualized, while the inflation rate for PCE excluding food and energy was 0.5 percent.

The 12-month rate of change was 2.4%. While the 12-month number has decreased for the last 3 months, it is still at an uncomfortable level for the Fed.

I am beginning to suspect these alternate inflation measures carry a bit more weight with the Fed than they are letting on.