Inflation Pressures Are Easing but Rate Cut Forecast Remains Uncertain

The New Year is beginning where the old one ended -- with uncertainty about when – or whether – the Federal Reserve will begin cutting interest rates.

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The employment picture brightened again in July as employers added more than 200,000 workers to their payrolls for the sixth consecutive month and June’s strong figure was revised upward to just under 300,000.  The improved jobs outlook drew more sidelined workers into the market, pushing the unemployment rate up slightly, from 6.1 percent to 6.2 percent.

The employment report cheered economists looking for signs that the economy is strengthening, but unnerved investors, who fear that continued signs of economic strength will push the Federal Reserve to begin raising interest rates. 

So while economists predicted that the employment gains will trigger a “virtuous” cycle – more jobs creating more consumer demand creating more jobs – the stock market tanked by more than 300 percent the day the labor report was announced. 

Seeking a Balance

The Fed meanwhile sought to balance confidence that the economy is improving with reassurance that interest rates won’t rise in the near term.  Reflecting confidence, the Fed continued its quantitative easing, slashing bond purchases by another $10 billion.  But Fed Chairman Janet Yellen also emphasized that the labor market is still weaker than the agency would like, and so will keep interest rates low “for a considerable time.”

There was certainly no shortage of good news in the July economic reports.  Among the highlights;

  • The economy grew at a 4 percent annual rate in the second quarter, easing fears stirred by the first quarter’s unexpected decline.  That decline ― 2.1 percent — turned out to be less severe than the nearly 3 percent initially reported.
  • Barometers of manufacturing activity increased as did business investment in equipment, which increased by 7 percent in the second quarter after declining by 1 percent in the first.
    Consumer spending increased by 2.5 percent in the second quarter, reversing and handily overcoming a 1.2 percent decline in the previous three-month period.
  • Notwithstanding the consumer spending gains, consumer confidence reports were mixed.  The Conference Board’s confidence index hit 90.9 in July, blowing past the most optimistic predictions to reach its highest level since October of 2007.  But the Thomson-Reuters/University of Michigan index lost ground, falling to 81.8 in July from 82.5 in June.

“Despite the recent improvement, consumers have yet to take recent economic gains to indicate that more robust growth in jobs and wages will be forthcoming,” Richard Curtin, the survey director, said in a press statement. 

No Housing Lift 

That uncertainty appears to be creating a continuing drag on the nation’s low-flying housing market, which has not yet reached the altitude analysts have been predicting.   Existing home sales fell by 2.3 percent year-over-year in June.  Although the annualized pace topped 5 million units for the first time since October of last year, the decline reflected a still uncertain recovery that some analysts warn has not yet established a firm toehold.   

Pending sales, an indicator of future activity, also declined by more than 1 percent in June after an encouraging 6.6 percent gain in May.  New home sales were even weaker – falling by more than 8 percent in June to post their largest decline since July of last year.  And May’s annual new home sales rate (more than 500,000), which some analysts had greeted as evidence of a long-awaited turnaround in this segment of the market, was ratcheted down to 442,000 units.   

Lawrence Yun, chief economist for the National Association of Realtors (NAR), blamed limited inventories in many markets for the slower-than-anticipated pace of existing home sales.  Higher inventory levels (6.5 percent higher than they were a year ago) and slower annual appreciation rates (the Case-Shiller index reported a 9.3 percent gain in May compared with 10.8 percent in April – the smallest year-over-year increase since February of 2013) bode well for the balance of the year, Yun said.  The improving employment outlook will also help, he agreed.  But sluggish wage gains and strict underwriting requirements “are leaving many prospective buyers on the sidelines,” he noted in a recent report. 

New home construction activity will also have to ramp up considerably – by at least 5 percent, he believes ― in order to ease price pressure and boost inventories enough to meet potential buyer demand.

Where’s the Strength? 

The most recent reports don’t seem to offer much hope of the construction surge Yun wants to see, however.  Construction starts fell by 9.3 percent in June to a 930,000 annual rate and permits were off by 4.2 percent, suggesting that the market has not yet exhibited the underlying strength that some analysts have been insisting would begin to fuel strong sales and more construction. 

But a closer look at the current reports suggests that the numbers may not be quite as grim as they appear.  For example:  The decline in new home sales was concentrated entirely in the south; the other regions all reported gains. And the volatile multi-family sector was responsible for the decline in construction permits; single-family permits actually increased by 2.6 percent.
Builders, meanwhile, have been reporting more activity in their showrooms, which probably explains why their confidence levels, reflected in an industry index, climbed to 53 in June from 49 the previous month, The outlook for future sales hit 64 — the highest level for this marker since September of last year.   

Notwithstanding the somewhat disappointing June housing reports, “the general direction of housing production is trending upward,” David Crowe, chief economist for the National Association of Home Builders (NAHB), said in a press statement.  For that reason, the industry trade association remains optimistic. “We expect 2014 to be a positive year,” he said.