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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For years, if not decades, economists have been wringing their hands over the nation’s anemic, and sometimes negative, savings rate.


Now consumers are saving more, responding rationally, it would seem, to what is generally acknowledged to be the worst economic setback since the Depression.  But economists are warning that the reduction in consumer spending is deepening the downturn and further destabilizing an already wobbly economy.

Consumer spending declined 0.6 percent in November following a 1 percent dip in October, accurately predicting what turned out to be the weakest Christmas shopping season in recent retailing memory.   Although average incomes declined, spending declined more, pushing the savings rate up by 2.4 percent in October and by 2.8 percent in November.  The precipitous decline in gas prices accounted for a large chunk of the spending decline; excluding that obvious boon to consumer balance sheets, spending would actually have increased by 0.6 percent in November. 

“Grim” Outlook

Still, the spending trend is pointing definitively downward, boding ill for our consumer-dependent economy.  The overall 3.8 percent spending decline in the third quarter was the steepest in nearly three decades and “the outlook continues to look pretty grim,” James Sullivan, a senior economist at UBS Securities, told Bloomberg News last month.  Sullivan predicts that spending will remain “weak” through the first quarter and won’t begin to stabilize before the middle of this year – if then.

As Americans saw their net worth evaporate last year – shrinking by nearly $3 trillion between the second and third quarters —they reduced household debt levels, which declined at an annual rate of .75 percent in the third quarter – the first such decline since the Federal Reserve began keeping these records 50 years ago. 

Consumer confidence, not surprisingly, has been sagging, but polls differ on just how discouraged consumers are.  The Conference Board’s consumer confidence index fell sharply in December to 38 from November’s reading of 44.7.  The present-situation reading was particularly dismal, falling from 42.3 in November to 29.4 as concerns about the job market crowded out relief over declining gas prices.

A Reuters – University of Michigan survey conducted about the same time found consumers more upbeat about current conditions , but still pessimistic about the future.  This index increased from 55.3 to 59.1 overall – “not nearly enough to suggest a rebound in spending,” Stephen Gallagher, chief US economist for Société Générale, told reporters, “but it could suggest a stabilizing” in downward spending trends.”

A third survey, by USA Today and Gallup, found the consumer mood to be pretty dismal, with 60 percent describing current economic conditions as the “worst” in their lifetime and nearly 80 percent fearful that a full-blown depression is coming.  But despite those concerns, 11 percent of the respondents described their personal financial situation as excellent (up from 7 percent in April); nearly 20 percent said they were not confident they could maintain their current standard of living, but 24 percent had expressed that concern in September. 

Economic Indicators

Unlike the consumer confidence barometers, which reflect some ambiguity, other economic indicators remain almost uniformly negative. 

The U.S. unemployment rate rocketed to a 15-year high 7.2 percent in December, as employers shed another 524,000 jobs on top of the 533,000 positions axed the previous month.  That pushed the job loss total for the year to nearly 2.6 million – a figure the country hasn’t seen since 1945. And the downward spiral hasn’t ended yet.  The Andersen School of Management is predicting that employers will eliminate another 2 million jobs in the first half of this year.

The index of leading economic indicators fell by 0.3 percent in November, the fifth dip in this measure in the past 7 months; the future gauge of  conditions over the next 3 to 6 months fell 0.4 percent following a 0.9 percent reduction in October, as the decline in home building permits  whacked nearly half-a point from the November reading.

The nation’s Gross Domestic Product (GDP) fell at an annual rate of 0.5 percent in the third quarter and economists are predicting that the fourth quarter decline will be at an annual rate of 6 percent, which would be the economy’s worst performance in 26 years.

The Consumer Price Index fell by 1.7 percent in November following a 1 percent decline in October, easing the pressure on household budgets but fueling fears of a deflationary spiral, which many economists warn, would be harder to revere and more damaging than an inflationary trend.

Turning Back the Tide 

Congress and Administration officials (George Bush’s outgoing administration and Barack Obama’s incoming one) are using a combination of traditional strategies (rate cuts) and non-traditional ones – the $700 billion Troubled Asset Relief Program (TARP) — to stabilize the financial markets and turn back the recession tides.  Obama’s call for a government stimulus program combining tax cuts and infrastructure spending falls generally  in the conventional category, but its size, estimated at as much as $1 trillion, arguably will push it into nonconventional territory.

There are signs that actions by the Fed and its Central Bank counterparts in other countries to pump capital into the financial system have begun to thaw frozen credit markets, at least on the edges.  LIBOR – the benchmark for lending between banks — has fallen to its lowest level since the Lehman Brothers bankruptcy tipped the financial dominos last fall.

Consumer credit – for mortgages and credit cards — remains tight, as lenders continue to shun risks and horde cash.  But speculation that Congress will approve a stimulus package early this year pushed interest rates down late last year, triggering a significant but short-lived surge in refinancing activity. And analysts are predicting that the Fed’s planned purchase of $500 billion in mortgages securities from Fannie Mae and Freddie Mac, now under way, will push mortgage rates even lower and keep them at low enough levels to trigger a sustained increase in mortgage lending this year.  Another refinancing surge in the past two weeks provides some support for that prediction. 

Hope for Housing?

These indicators could bring a bit of welcome and rare good news for housing markets, still struggling under the weight of soaring foreclosures, declining sales and falling prices.  The closely watched S&P/Case-Shiller Index indicates that home prices nationally declined by nearly 20 percent in the past 12 months, pushing this barometer down by 23 percent from its 2006 peak.  A separate report from Zillow Real Estate estimates that Americans had collectively lost more than $2 trillion in home value as of the end of last year.

Sales of new and existing homes continued their downward spiral in November, falling by nearly 3 percent and 8.6 percent, respectively, with inventory levels above 11 percent in both sectors.  Foreclosures, which nearly tripled in some major markets, accounted for 45 percent of the resale activity reported for November, according to the National Association of Realtors (NAR), and the association’s pending sales index – an indicator of future sales – does not provide much hope for near-term improvement. The index fell by nearly 4 percent in November, a much steeper drop than even pessimistic analysts had predicted.  In the new home sector, “starts and permits are in a free-fall.  There is no bottom,” Nouriel Roubini, chairman of Roubini Global Economics, said in a year-end Bloomberg Television interview. 

The Realtors and home builders are counting on government assistance— through Obama’s planned stimulus package and other initiatives — to help turn housing markets around.  The president-elect has begun to disclose the broad outlines of the program he intends to propose, while repeating his campaign promise to “start helping homeowners in a serious way.”

Congressional leaders, meanwhile continue to press Treasury Secretary Henry Paulson to use at least some of the remaining TARP funds to facilitate mortgage modifications on a broad scale for struggling homeowners.  It is almost certain that Paulson’s designated successor, New York Fed President Timothy Geitner, will move in that direction, even if Paulson refuses to do so.  

Analysts generally agree that these and other government initiatives will bear collective fruit at some point, but they differ on the timing.  Allen Sinai, president of Decision Economics, thinks the economy “will begin moving up” by late this year and 2010, in his view “should be a recovery year.” 

That qualifies as wishful thinking for Moody’s’s Mark Zandi, who predicts that the first half of this year will be “very painful,” the second half “just painful,” and 2010 “uncomfortable.”  While Zandi’s prediction isn’t likely to move many people to break out the bubbly in advance, “uncomfortable” would at least represent an improvement over where many lenders, businesses, investors and consumers are sitting now.