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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Like an audience in search of a happy ending, economists and industry analysts are pointing to an accumulation of positive statistics as evidence that the nation’s longest and most painful downturn since the Great Depression is finally ending. But if this is in fact, the recession’s final act, it promises to be a long one. Even the optimists (still a relative term) are predicting that job losses, curbs on consumer spending, charge-offs for financial institutions and a poor climate for manufacturers and retailers will likely continue well into next year, even as the economy begins what most predict will be a slow and far from robust recovery.

“There are emerging signs that the economy is stabilizing,” Chris Varvares, president of the National Association for Business Economics, said in a recent press statement. But, he added, there is also every reason to expect that the recovery “may be considerably more moderate than those typically experienced following steep declines.”

Signs of Stability

Whatever shape the recovery assumes and however protracted it turns out to be, the signs of stability are welcome and seem to be multiplying. A few examples:

  • New orders posted by manufacturers increased in May for the first time since the recession began in December, 2007, boosting the Institute of Supply Management’s manufacturing index from 40.1 to 42.8 – still in recession territory (below 50) but moving in the right direction.
  • Durable goods orders increased by 1.9 percent in April, beating the consensus forecast (a 0.4 percent gain) handily. Although March orders were revised downward, this index has increased in two of the past three months on rising demand for big-ticket items.
  • Construction spending increased by just under 1 percent in March, fueled by the first increase in residential construction in nearly a year.
  • The GDP – a measure of national economic growth – declined by an annualized rate of 5.7 percent in the first quarter, which doesn’t sound like good news, except that the decline was less than the 6.1 percent analysts had expected.
  • The Conference Board’s Index of Leading Economic Indicators increased by 1 percent in April posting its first gain in seven months and offsetting nearly two-thirds of the decline tallied since October. The positive trend indicates that while the recession will continue “in the near term,” Ken Goldstein, a Conference. Board economist said, “the declines will be less intense. The question is, how long before [less intense] declines in activity give way to small increases.”

You can find some of the small increases Goldstein and other economists want to see in the consumer data, although you have to look closely to spot them. Personal income eked out a 0.5 percent increase in April following a 0.2 percent decline in March, and consumer spending increased by 1.5 percent in the first quarter, despite declines of 0.3 percent in March and 0.1 percent in April, indicating that consumers may be relaxing the death grip on their wallets, but not very much or very fast.

Consumers Feeling Better

Although the savings rate reached 5.7 percent of income in April – the highest level in nearly 15 years – the consumer mood appears to be brightening. The Conference Board’s Consumer Confidence Index jumped to 54.9 in April from 40.8 in March – the largest one-month jump in six years and the highest level for this index since September. The present situations index only increased a little – from 35.5 to 28.9 – but the future expectations reading soared from 51 to 72.3. Confidence levels remain weak “by historical standards,” Lynn Franco, director of the Conference Board’s Consumer Research Center, acknowledged. “But as far as consumers are concerned, the worst is now behind us.”

That confidence is shared – to varying degrees and with caveats about the length and strength of the recovery – by many economists. More than 75 percent of those responding to a recent National Association of Business Economics survey agreed that the recession will probably end by the third of r fourth quarter of this year. On the outer edge of the optimism scale, Marco Annunziata, chief economist of UniCredit SpA, told Bloomberg News, “The global economy has turned the corner and the worst is now behind us. A moderate dose of optimism can no longer be dismissed as foolishness.”

While less optimistic analysts agree that the worst of the downturn is ending, they caution that consumer confidence may be running ahead of economic fundamentals. While it is possible that growing confidence may pull the economy up, it is also possible, these analysts say, that a still weak economy may pull consumer confidence down. The Federal Reserve reported that consumer credit declined at a 7.4 percent annual rate in April, the second largest drop on record, and most retailers reported disappointing results for May, indicating that consumer spending has not yet rebounded.

Housing Concerns

The weak housing market remains a major source of uncertainty and concern for analysts and consumers. But as with the economy generally, the housing statistics are beginning to improve on the margins, if not yet overall. New home sales were essentially flat in April – 0.3 percent above March sales, which were revised downward to n annualized rate of 351,000. April’s annual pace (352,000 units) fell short of expectations, reflecting competition from foreclosure sales, which accounted for fully 45 percent of all existing home sales in April and for the 15.4 percent decline in median home values, according to the National Association of Realtors (NAR). Higher-end sales remain stalled, however, suffering from a dearth of financing available for jumbo loans and economic fears that are making many prospective buyers who could climb higher on the housing ladder reluctant to trade up.

Priced on average at 20 percent below non-distressed properties, foreclosure sales have been attracting first-time buyers, who accounted for approximately half of the first quarter sales, the NAR reported, helping to push existing home sales up by nearly 3 percent in April. But while the inventory of new homes for sale declined by 4.2 percent – an encouraging sign for home builders —the existing home inventory increased by almost 9 percent, as prospective home sellers, encouraged by reports of an improving outlook, added their homes to a market already crowded with bank foreclosure sales.

“We still need a continuing and consistent rise in home sales to get the inventory down,” Lawrence Yun, the NAR’s chief economist said. The recent increase in mortgage rates clearly won’t help; nor will the flood of foreclosures, which continues to resist varied government efforts to help homeowners struggling with mortgages they can’t afford.

A record 12 percent – one of every eight homeowners with mortgages – were delinquent or in foreclosure at the end of the first quarter, according to the Mortgage Bankers Association (MBA), the highest delinquency level ever reported in the MBA survey. Significantly, the number of fixed-rate, prime mortgages in foreclosure doubled in the last year; as a result, reversing the trend a year ago, prime foreclosures now outpace subprime foreclosures, indicating that job losses, combined with falling home prices, have replaced poor underwriting as a major cause of homeowner distress.

“Every job loss, every divorce, every incident like that is going to be turning into a foreclosure, because [homeowners] are so far under water with their homes already,” Jay Brinkmann, chief economist for the National Association of Home Builders (NAHB), said in a press statement commenting on the delinquency report. “We clearly haven’t hit the top yet in terms of delinquencies, or the bottom of the housing market,” he added.

Brinkmann and other analysts agree that the foreclosure numbers won’t decline significantly until the employment picture begins to improve, and that picture remains mixed. The Labor Department reported last week that employers slashed 345,000 jobs in May, fewer than economists had anticipated and the smallest number since September. In another encouraging sign, the number of unemployed workers drawing unemployment insurance also declined for the first time in 20 weeks, falling to 621,000 from a revised total of 625,000 for the previous week. But the unemployment rate jumped to 9.4 percent, reaching its highest level in 25 years, and some analysts predict the rate will go higher before employers stop shedding jobs and start creating them again.

While the employment numbers look better, that’s not enough, Kevin Rendino, a senior fund manager at Black Rock, Inc., told Bloomberg Television. “We need good numbers as opposed to less bad numbers,” he argued, adding, “When you look at 600,000 jobless claims,” he added, “no matter how you slice it, that’s still a bad number.”