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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It’s too soon to know if the Cliff (in fiscal cliff) will join the Chad (in ‘hanging chad’ from the Florida election recount) on the list of names no one chooses any more for their newborns. But ‘debt’ and ‘ceiling’ not being likely choices for girls or boys, the crisis-in-waiting over the national debt ceiling isn’t likely to expand the endangered names list.

That is probably the only positive observation to be made about this looming debate, which will almost certainly continue the prolonged and thus far fruitless wrangling over the national budget and the fiscal priorities it should reflect, specifically the appropriate balance between tax increases and spending cuts —between policies that will stimulate growth and policies that will reduce the deficit. The fiscal cliff debate raised all of those questions, but the eleventh hour agreement ending it resolved none of them.

One crucial question is whether the debt ceiling debate, which is really a debate over whether the country will default on its financial obligations, will unnerve businesses and consumers enough to curb growth and possibly trigger another recession – the inevitable results, analysts had warned, if Congress and the president failed to avoid the automatic tax hikes and spending cuts that would have pushed the country over that fiscal cliff.

Better than Expected

As it turned out, the cliff debate did not have nearly the negative economic impacts analysts had feared, at least, not initially. Durable goods orders increased by 0.7 percent in November, beating more pessimistic forecasts, and orders for nondefense capital goods increased by 2.7 percent – the second consecutive gain for this indicator of business investments.

Consumers also appeared initially to be shrugging off the fiscal cliff political stalemate, which showed no signs of resolution in November. Income, savings and spending all increased that month, creating “the best trifecta one could hope for,” the Washington Post reported.

The consumer mood shifted downward in December, however. The Conference Board reported that confidence levels plummeted to 65.1 from 71.5 in November. The Thomson-Reuters index followed the same trajectory, falling to 72.9 from 82.7 in November, the lowest reading for this index since July. Both surveys found consumers more optimistic about their current prospects but very worried about the next six months, evidence, analysts said, that fiscal cliff concerns might cripple holiday spending.

But even here, the results proved to be not as bad as feared. While some major retailers missed their projections, sales at stores open at least a year increased by 4.5 percent overall as consumer spending picked up later in December after a slow start –not a stellar performance, but better than the 3.3 percent growth analysts had predicted.

The service sector also beat projections for December, growing at its fastest pace in 10 months, and the Institute for Supply Management’s manufacturing index gained some ground as well, adding even more unexpected good news for the month.

Employment Gains

The employment numbers were also positive, if not robust, as employers added 155,000 workers to their payrolls and the unemployment rate remained unchanged at 7.8 percent. A separate index showed that payrolls increased in 30 states in November and the unemployment rate declined in 45, despite the drags created by Hurricane Sandy and stormy weather nationwide.

“The labor market should strengthen in the months ahead,” Russell Price, a senior economist at Ameriprise Financial Inc., told Bloomberg News. “As long as Washington is able to resolve many of the issues that remain on the table,” he predicted, “the economy should get much stronger.”

The prospects for a speedy resolution of those issues — or any resolution at all —don’t appear particularly bright at the moment, as Republican lawmakers are threatening to use the debt ceiling as a lever to extract more spending cuts, and president Obama has vowed not to negotiate on that issue at all.

A Welcome Distraction

Anyone who was frustrated by the fiscal cliff debate (is there anyone who wasn’t frustrated by it?) isn’t likely to feel any better about the debt ceiling clash on the horizon. But for those who want to focus on something else, continuing good news in the housing market provides a happy, if temporary, distraction.

The Standard & Poor’s/Case-Shiller index of home prices for 20 cities increased by 4.3 percent in October – the largest annual increase in this closely-watched housing barometer since May of 2010 — as 18 of the 20 major markets tracked posted year-over-year gains.

Existing home sales increased by nearly 6 percent in November, rising to a seasonally adjusted rate of 5.04 million and putting this sector on track for its strongest annual performance in 5 years. Pending sales, an indicator of future transactions, increased by 1.7 percent, hitting a 2.5-year high for the month.

New home sales increased by 4.4 percent in November, reaching their highest level in 2.5 years. While starts slipped a bit compared with October, they were still more than 20 percent higher, year-over-year. Permits for new construction jumped by 31 percent and builder confidence reached a 6.5 year high.

“Permits matter more than starts in this report,” Patrick Newport, an economist at Global Insight, noted in a recent commentary. And the current numbers, he suggested, provide “a good reason to feel optimistic about Newport believes. “We just don’t have enough homes right now and we need to start building.”

Michael Widner, an analyst with Stifel Nicolaus & Co., sounded an equally optimistic note in a note to investors, predicting that rising demand for housing will create a “virtuous circle” (the opposite of a vicious cycle), fueling new construction, which will drive economic growth and create even more housing demand.

It’s not at all certain that these optimistic forecasts will survive the impending debate over the debt ceiling, but Widner’s “virtuous circle” is far more pleasant to contemplate than yet another round of political brinksmanship in Washington.