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 economic recovery seems to be following the zigzag pattern many analysts have predicted: Strong gains in some sectors followed by setbacks in others — two steps forward, a step or two back, a few steps sideways. Looking more like a Rorschach test than a road map, the picture is far from clear.

But most analysts agree that the trends are pointing generally upward, as the economy drags itself haltingly from the swamp in which it has been mired. Even so, the recession’s impacts linger painfully, like a fire only partly contained that continues to scorch forests and char houses as the flames are beaten back.

The labor market clearly still feels the recession’s heat. The unemployment rate passed the 10 percent mark in October as the economy shed another 190,000 jobs. If you add part-time workers who want full-time jobs but can’t find them, and discouraged workers who are no longer counted as job-seekers, because they have given up, the “real” unemployment rate is 17.5 percent.

Analysts had been predicting that unemployment would each double digits, but not until next year. Hitting that benchmark earlier is good news if you think unemployment has peaked and will now decline sooner than expected – bad news if you think the peak will come later and be higher than analysts had predicted.

Some statistics support the more optimistic view. The number of announced job cuts and the number of first-time unemployment claims both declined in October, as the pace of job losses continued to slow. The 512,000 unemployment claims reported for the last week in October represented the lowest rate in 10 months and beat economists’ projections, but still remained well above the 400,000 rate that signals an expanding labor market. In a double-edged economic sword, productivity increased by a surprising 9.5 percent -- good news for employers, who can delay hiring plans, but bad news for unemployed workers hoping to find new jobs.

John Challenger, CEO of Challenger, Gray & Christmas, the company that tracks corporate job cut announcements, thinks “the light a the end of the tunnel is fully visible” in the labor market reports. Brian Bethune, chief financial economist at HIS Global Insight thinks that light is an oncoming train, signaling further declines in employment and compensation ahead. “It is no surprise,” he told CNN-MONEY “that consumer confidence is back-pedaling and the outlook for consumer spending is poor.”

Confidence Ebbs

Consumer confidence readings definitely fall into the ‘two-steps-back’ category for the current economic reports as the consumer mood, which had shown signs of brightening, turned dour again. The Conference Board’s Consumer Confidence Index plunged 6 points in October, falling from September’s 53.4 to 47.5. All three gauges (measuring present conditions, the six-month economic outlook and the employment market) fell, bringing the index down for the first time in five months.

The Reuters/University of Michigan confidence index also fell, but these readings, less tied to the economic outlook, were somewhat less negative. The overall index fell to 70.6 from 73.5 in September, its highest reading in more than a year, indicating that “consumer fundamentals are still weak, but slowly improving,” analysts at Moody’ said.

The improvement may be too slow to rescue the holiday shopping season for retailers. Doing an early imitation of Scrooge, Jonathan Basile, chief economist for Credit Suisse, told Bloomberg News: “Consumers are going to be selective and not necessarily aggressive going into the holiday season.”

Joshua Shapiro, chief U.S. economist for Maria Fiorini Ramirez (MFR), a national forecasting firm, agreed, noting in the same Bloomberg News article, “There really isn’t any scope for us to see sustained gains in consumer spending for quite some time.”

Recent reports provide no indication that consumers are going to be easing the grip on their wallets any time soon. The Commerce Department reported that consumer spending slipped by 0.5 percent in September, reversing a 1.4 percent gain in August that was fueled largely by “cash-for-clunkers’ auto sales, and illustrating just how important government incentive programs like that one have been.

Assisted Growth

“With so much of the [recent economic] growth relying on government spending, and many of these programs either expired or expiring, “ a recent Wall Street Journal article noted, “it is unclear if consumers and businesses have regained the strength to propel the economy on their own.”

That question looms large in the housing market, where a tax credit for first-time buyers helped reverse a disappointing September swoon, boosting October home sales by 9.4 percent to the highest level in more than two years. The pending sales index meanwhile rose to a three-year high in September – its eighth consecutive monthly increase – as buyers raced to complete purchases before November 30, when the credit was originally slated to end. Congress recently voted both to extend the credit and to expand eligibility to include trade-up as well as first-time buyers. (See related item in News Briefs.)

New home sales for September also reflected the anticipated end of the credit, but not in a good way, as buyers who couldn’t complete their purchases before the anticipated November 30 deadline pulled back, sending October sales down by 3.6 percent in October and ending five consecutive monthly gains in the new home market.

Home starts and permits –signaling future construction – also declined. In September, but a closer look at the residential construction statistics indicates a somewhat brighter picture. The decline was concentrated in the volatile multi-family market, where starts plummeted by nearly 15 percent after soaring by more than 20 percent in August. Single-family starts flipped in the other direction, increasing by 3.9 percent following a 4.7 percent decline in August.

Inventory levels of both new and existing homes continued to decline in October – by 2.8 percent and 7.5 percent, respectively. Existing home inventories have declined by 15 percent in the past 12 months and are now at their lowest level in two-and-a-half years, the National Association of Realtors (NAR) reports. “If we could continue to absorb inventory at this pace,” Lawrence Yun, the NAR’s chief economist, said, “home prices would return to normal, modest appreciation patterns next year.”

Price Points

On the price front, the closely-watched Standard& Poors/Case-Shiller index posted its third consecutive month-over-month gain in August, rising by 1 percent and providing more evidence to some analysts that the worst of the housing downturn has ended. “There are a lot of dangers still out there,” economist Karl case, co-founder of the index, told the New York Times, “But housing is as affordable as it’s been in 20 years. I don’t see a very rapid recovery,” he added, “but I think we’ve seen the bottom.”

Others are considerably less optimistic. Analysts at Fiserv, for example, view the recent uptick in the price index as only a temporary pause in a decline that will continue next year. They are predicting that prices in 342 of 381 markets will decline by an average of 11.3 percent as foreclosures depress values and dump more homes on the market.

Of particular concern to Fiserv and other housing analysts is the increasing proportion of foreclosures involving higher-priced homes and conventional rather than subprime mortgages. Prime mortgages represented 58 percent of the foreclosures initiated in the second quarter, compared with 44 percent a year ago, according to a Mortgage Bankers Association report. A separate analysis by found that 30 percent of the June foreclosures involved homes in the top third of the price range compared with 16 percent three years ago. Also boding ill for the near-term, a Fitch ratings study found that 46 percent of the payment –option adjustable rate mortgages (used primarily to purchase more expensive homes) were already delinquent in September, even though only 12 percent of them have re-set at higher payment levels.

A patch of blue in this gray sky emerges from another Zillow report, indicating that the number under water owners, with homes now worth less than the mortgages on them, declined slightly in the third quarter, from 23 percent to 21 percent – “a positive sign, directly attributable to the stabilization of home values from the second quarter to the third,” Stan Humphries, chief economist for Zillow, said in a press statement. Considerably less encouraging, Humprhies also noted that at least some of the previously underwater owners are no longer under water because they have lost their homes to foreclosure.

Analysts looking at these indicators warn that home price declines, job losses and shrinking incomes are freezing many existing owners in place, leaving them without the equity, income or both they need to trade up and pushing increasing numbers of them into foreclosure. A housing recovery is coming, Shapiro, the MFR economist quoted earlier, agrees, but he thinks it is still several months away. And between now and then, Shapiro told the Times, “There is plenty of pain yet to come.”