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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In a recent speech, Federal Reserve Chairman Ben Bernanke said the financial markets are “stabilizing” but remain “far from normal.” That assessment might also apply generally to the economy, which is hardly “normal,” if your definition of normal includes even moderate growth and a housing market that isn’t on life-support. Whether the economy is stabilizing remains an open question, however, as economists continue to debate whether we are heading into a recession, have already stumbled into one, or still have some hope of avoiding a serious downturn entirely.

“The data certainly reflect a weak economy, but not one in recession,” Ken Goldstein, an economist for the Conference Board, noted recently. He was responding to the slight (0.1 percent) increase in the leading economic indicators in April, equaling the March gain and providing statistical support for those who say a recession is not inevitable. The odds-makers are now rating the likelihood of a downturn at 45 percent, down from 90 percent just a few weeks ago. Even Alan Greenspan, the former Fed chairman, who had been predicting the most severe downturn in decades, is now saying what while we may actually be in a recession, “it’s an awfully pale one.”

What the statistics say or don’t say about the state of the economy is probably less significant than how consumers feel about it, and recent surveys suggest that the national mood is glum. The Consumer Confidence Index declined in May for the fifth consecutive month, leaving the current reading (57.2) at about half what it was this time last year. A Washington Post-ABC poll found that 7/10 Americans are worried about maintaining their standard of living, echoing the results of another poll that found the level of economic anxiety at its highest level since 1981. The combined effects of minimal job growth, lagging wages (which aren’t keeping pace with inflation) soaring gas prices , and higher prices for food and just about everything else, are clearly taking a toll – and not just on low- and middle-income consumers. In the Spectrem Group’s most recent survey of “affluent” consumers (with $500,000 or more in investable assets), 64 percent of the respondents said they planned to cut back on luxury purchases, 65 percent said they plan to keep their car for longer than in the past, and 38 percent are cutting back on travel this year because of their concerns about the economic outlook.

No Boost in Lending

The Fed’s interest rate cuts (seven since September), its bail-out of Bear Sterns and the infusion of more than $900 billion in the credit markets have eliminated the sense of impending crisis that gripped the financial sector a few weeks ago. But those efforts haven’t done as much as policy-makers had hoped to boost lending. The Fed’s most recent survey of loan officers reported that half the banks had tightened their underwriting standards of commercial and industrial loans, up from 30 percent in the January survey. Financial institutions are also reporting stricter guidelines for residential mortgages, which will come as no surprise to anyone who has tried to purchase a home recently – or to to the real estate agents and mortgage brokers working with them.

The housing market’s woes, described almost daily in the media, show no signs of abating, as home prices nationally continue their unnerving and largely unprecedented decline. The Office of Federal Housing Enterprise Oversight (OFHEO) reported that prices declined 3.1 percent , year-over-year in the first quarter, the steepest decline in the 17-years the agency has been tracking these numbers. The 1.7 percent drop between the fourth quarter of last year and the first quarter of 20078 was the largest quarterly decline ever, according to the OFHEO.

The Case-Shiller/Standard & Poors index, which tracks a broader cross-section of homes, reported a 14.1 percent year-over-year decline – the largest in its 20-year history, with 19/20 metropolitan areas reporting price reversals and six of them reporting declines of more than 20 percent.

“There are very few silver linings” in these numbers, David Blitzer, chairman of the S&P Index Committee told reporters. Joel Naroff, principal in Naroff Economic Advisors, similarly described the data as “ugly. Everything is working in the direction of more price declines,” he told the Wall Street Journal.

Foreclosures Still Rising

Foreclosures are a large part of the problem. RealtyTrac reported a record total of 243,353 foreclosure filings in April, up 65 percent in the past year and representing 1/519 households. Hope Now, the voluntary program through which banks are trying to stem the foreclosure tide, reported that participating institutions completed 183,000 work-outs in April – a record volume for the program, but not enough to keep pace with foreclosures. According to RealtyTrac, banks took possession of another 54,574 homes in April, up 145 percent compared with the same month last year. The company predicts that banks will repossess an average of 60,000 homes per month between now and the end of the year, by which time they could own a total of 1 million homes, representing one-fourth of the residential properties for sale.

As their REO portfolios balloon, many lenders are beginning to cut prices aggressively, and those efforts are stimulating sales in some hard-hit markets. Las Vegas, Sacramento, and Fort Myers, FL, which top the national foreclosure list, all reported increases in sales of existing homes in April, in marked contrast to the national sales trend, which remained firmly negative. The National Association of Realtors (NAR) reported that existing home sales “eased” in April – an interesting euphemism for an 18 percent year-over-year decline. But the rate of decline was even steeper (22 percent to 25 percent) in the fourth quarter last year, leading some analysts to suggest that the bottom of the housing downturn may be near. The sales increases reported in a few markets indicate that “sellers have moved into the acceptance mode, according to housing economist Thomas Lawler, who told the Wall Street Journal, “that’s the first good news for the housing market in months.”

The new home market seemed to provide some additional good news, in the form of a 3.3 percent increase in new home sales in April compared with March. But industry executives quickly dumped cold water on those reports, noting that sales remain 42 percent below the year-ago pace and are at their lowest level in 17 years.

No Cause for Celebration

“The fact that new home sales are up slightly from a dismal beginning to the spring home buying season in March is not much to celebrate,” Sandy Dunn, president of the National Association of Home Builders, observed. Robert Toll, CEO of Toll Brothers, confirmed that painful assessment in an interview with Bloomberg News, describing the number of prospective buyers viewing his company’s homes as “the worst we’ve ever seen.”

The inventory of new homes available for sale has declined slightly to a 10.6 month’s supply in April from 11.1 months in March, but the March inventory includes 189,000 completed homes plus another 200,000 homes still under construction and as yet unsold, and “those two figures have never been so close since the government began collecting that data in 1970,” the New York Times reported recently.

Existing home inventories are similarly bloated, with an 11.2 month’s supply in April —10.5 months if you exclude condominiums and town homes, which have a 14.2 month inventory of their own. And those statistics don’t include the “shadow inventory” of homes that owners have withdrawn from the market or declined even the attempt to sell.

“I’m not sure how you measure it, but there are a lot of pent-up sellers,” whose homes aren’t reflected in the inventory data, Mark Zandi, chief economist for Moody’s, told the Christian Science Monitor. Those “pent-up sellers” will return, Zandi says – and presumably, so will all the pent-up buyers – “once the market finds firmer ground.” The question is when that will be and the answer, based on current statistics is – probably not any time soon. 