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Thursday Dec. 7
Posted 3 p.m. Eastern
Previewing Tuesday's FOMC Meeting
The Federal Open Market Committee meets Tuesday Dec. 12
in their final scheduled interest rate meeting of 2006. Let's put
to rest any notion that the Fed will alter interest rates at this
meeting by noting that the pricing of Fed funds futures contracts
on the Chicago Board of Trade indicates a scant 9 percent chance
of a rate cut at this meeting.
Some of you optimists out there may see odds of 9 percent
and say, "Hey, there's a chance." I'll remind you of the
scene from the movie "Dumb and Dumber" when Jim Carrey's
dorky character asks Lauren Holly if they could ever be together.
When she told him that his odds weren't good, at one-in-a-million,
he replied enthusiastically "So you're saying there's a chance!"
Statistically, yes. Realistically, no.
Okay, so the Fed won't cut rates at this meeting. Hopefully
we can all agree on that much. But is a rate cut in the offing at
an upcoming meeting? With the economy growing at a slower pace and
the housing market still in transition, it is indeed likely that
a rate cut or two will be on the menu in 2007.
However, first we crawl, then we walk. Before the Fed
cuts interest rates, we're likely to see some alteration to the
wording of their post-meeting statements, specifically the part
that says "the Committee judges that some inflation risks remain."
Since the Fed won't cut rates if inflation risks still
loom, we'll have to get to the point where the Fed can comfortably
acknowledge the absence of inflation risks. Are we there yet? No.
In fact, oil prices have quietly crept back above the $60 per barrel
threshold, so expect the Fed to maintain a watchful stance on inflation
at least through the January meeting.
There are also other acknowledged pressures on inflation,
such as "the high level of resource utilization" mentioned
by the Fed in previous statements. This is Fedspeak for two things
- a tight labor market and capacity utilization that currently exceeds
80 percent. In addition to adding obvious inflation pressures, neither
of these readings is indicative of an economy going into hibernation.
My sense is that easing in this area would need to be seen as well
before the Fed would institute any rate cut.
With economic data continuing to be a mixed bag, but
any movement in labor market and capacity utilization coming at
a slower pace, any rate cuts are unlikely earlier than the March
2007 meeting. Even then, we may be in a similar mode as we are at
present with the Fed remaining on hold.
Yes, I think we'll see some rate cuts in 2007 but don't
hold your breath waiting. It likely will be awhile.
Economic releases: Here is a recap of some economic
data from earlier in the week.
The Institute for Supply Management's Services Index
proved to be the opposite of the ISM Manufacturing Index, with Tuesday's
announcement showing a hearty advance from the prior month and bucking
expectations for a decline. At 58.9 the services sector of the economy
is solidly in expansion territory.
In other economic news, factory orders slowed sharply
in October while third quarter productivity growth was revised upward
to 0.2 percent from an initial flat reading. While this is a pittance
compared to what has been seen in prior quarters, any advance in
productivity is helpful in containing inflation.
Tomorrow brings the monthly employment report. I'll
blog tomorrow following its release.
Wednesday Nov. 29
Posted 10:55 a.m. Eastern
Economic growth rate revised
upward in 3rd quarter
This morning brought the release of the first revision to
third quarter economic growth. "Upon further review" as
they say in the NFL, the pace is now 2.2 percent annualized in the
July-through-September quarter. This represents a hearty revision
from the initial estimate of 1.6 percent and handily beats expectations
of a 1.8 percent post-revision pace. We will get one further revision
at the end of December.
On the inflation front, while the GDP price index
held at a 1.8 percent annualized pace in the third quarter, the
core personal consumption expenditures index rose to 2.2 percent.
This is important, as the Fed watches the PCE as an inflation indicator.
How do we know? Evidence came as recently as yesterday when Ben
Bernanke mentioned it in his speech.
Much is made of the slowing economy, but allow me to
share my perspective on this, if I may. The fact that we are seeing
consistently slower growth with each successive quarter in 2006
is not a crisis, and it is not alarming. Instead, I view it as inevitable.
In the context of rising interest rates, the end of "Housing
Mania," a negative household savings rate and escalating consumer
debt burdens, slower growth was inevitable. Heck, the fact that
we still have growth at all despite those aforementioned headwinds,
is remarkable.
The economy moves in cycles, and much like the seasons
of the year, we mustn't be alarmed by a shift from strong growth
to a slower, more consistent pace, any more than we worry once trees
begin shedding their leaves and daylight ends earlier. Instead,
what we should worry about are the extremes. Colder temperatures
during the winter are to be expected -- that's why people don coats,
hats and gloves. But subzero temperatures for any length of time
are clearly an abnormal circumstance, as would be a period of negative
economic growth (recession).
Unlike weather extremes where we are powerless against
Mother Nature, the Fed is charged with avoiding the extremes of
excessive growth or the absence of it altogether. A slower rate
of growth is as predictable as colder temperatures at this juncture,
and based on the latest GDP figures, the Fed is engineering a very
mild economic winter. We'll see if that forecast persists.
Tuesday Nov. 28
Posted 2:40 p.m. Eastern
Bernanke maintains focus on inflation
Fed Chairman Ben Bernanke gave a speech this afternoon on
the economic outlook. If words such as inflation, economic growth
and housing market are enough to get your blood pumping, well you
have come to the right place. Bernanke addressed each of those subjects
in his remarks.
On the economy, Bernanke noted, "The deceleration
in economic activity currently under way appears to be taking place
roughly along the lines envisioned in the Federal Reserve's July
report." He later said "the indicators in hand suggest
that real GDP growth this quarter is likely to be in the same general
range that it was in the second and third quarters."
For reference, the range of real economic growth in
the preceding two quarters, pending subsequent revision, is between
1.6 percent and 2.6 percent. If Bernanke envisions economic growth
remaining in this neighborhood, that puts to rest any immediate
concerns about a sharper slowdown or outright recession. That too,
is dependent upon the fate of the housing market, something noted
by Bernanke, as well.
For a global perspective, Bernanke offered these comments.
"The global economy continues to be strong, with cyclical recoveries
under way in Europe and Japan and ongoing growth in the emerging-market
economies; this growth abroad should support the continuing expansion
of U.S. exports of goods and services."
Turning to the housing market, Bernanke offered some
sobering words for anyone still in need of them. "No real or
financial asset can be counted upon to pay a higher risk-adjusted
return than other assets year after year, and housing is no exception.
Thus, a slowing in the pace of house-price appreciation was inevitable."
The dominoes fell this way, according to Bernanke.
"Declining affordability ultimately served to limit the demand
for housing, leading to a deceleration in house prices and slowing
home purchases."
Of course, ultimately the health of the economy boils
down to the state of consumer spending. Bernanke offered some reassurance
on this front, saying "The data in hand indicate that the slowdown
in housing notwithstanding, inflation-adjusted outlays for personal
consumption increased in the third quarter at about the average
rate seen since the current economic expansion began in late 2001."
The outlook for the Fed's course is closely tied to
the outlook for inflation. Bernanke reserved his heaviest comments
for this subject, saying "... the level of the core inflation
rate remains uncomfortably high."
Bernanke went on to say, "Looking forward, core
inflation seems likely to moderate gradually over the next year
or so."
But what if it doesn't? "Given the current level
of inflation, a failure of inflation to moderate as expected would
be especially troublesome."
Bernanke closed by offering this familiar assessment
on where the Fed goes from here. "Whether further policy action
against inflation will be required depends on the incoming data
and in particular on how these data affect the FOMC's medium-term
forecasts of both inflation and output growth."
Economic data: This is a busy week of economic data
and it got kicked off today with existing home sales and durable
goods orders.
The number of existing home sales posted a small, but
surprising uptick in October and comes on top of the upward revision
to September's tally. Median prices declined 3.5 percent in the
previous 12 months (which is why the conforming loan limit will
remain at $417,000 for the next year), and inventory levels also
increased -- again. Joel Naroff of Naroff Economic Advisors sums
it up by saying, "As for prices, they continue to go downhill
and with the number of homes still on the market, it would be surprising
if prices don't continue to drop."
Durable goods orders for the month of October were
also released today. Orders for durable goods, those expected to
last at least three years, are notoriously volatile, and you can
understand why. After all, we're talking about a significant outlay
of cash and a host of accounting considerations as well, such as
write-downs on other goods that are being replaced earlier than
expected. But despite that notorious fickle volatility, the October
release was still weak -- even after excluding the impact of aircraft
orders.
Although durable goods showed a big decline, there
was continued growth in backlogs and that, my friends, is what you
call closure. Oops. Sorry. I had a "Friends" flashback
there. I mean, the growth in backlogs is what you call an indicator
of strength, not weakness in the economy. Perhaps the durable goods
orders are just "on a break." (You "Friends"
fans will get that one, too.)
The Fed still needs the human touch: An interesting
Bloomberg News article by Scott Lanman referred to a computer model
that incorporates as many as 150 different economic variables, real
time, in deciphering the economy's direction. This isn't a new undertaking.
In fact, the article mentions how Bernanke conducted
some research during his days at Princeton University, "to
see what would have happened if a computer had set monetary policy
from 1987 to 1998." The outcome was one of greater volatility
in both unemployment and inflation than what had been experienced
in actuality. Good news for the FOMC. They won't be downsized due
to automation any time soon.
Wednesday Nov. 22
Posted 11:20 a.m. Eastern
Banks post 2nd most profitable
quarter in history
The third quarter results are in and the banking industry's
cumulative profits were the second-highest ever recorded, down from
the record high in the second quarter. This despite a decline in
net interest margins -- the difference between what it costs a bank
to borrow and what is earns by lending -- for the fifth time in
six quarters. The industry's net interest margin is the lowest since
1989.
"How can this be?" you ask. There are a
couple reasons. The most obvious is one that customers are quite
familiar with, the increased reliance on fee-based income. The increase
in fee income, whether that be account service charges, loan origination
fees or asset management fees, has served to decrease the reliance
on volatile interest margins.
This move is nothing new. Instead, it has been a continual
shift over the past 10 years in preparation for times such as this.
Clearly, the diversified revenue stream is justified by the fact
that interest margins are at a 17-year low, while profitability
is the second-highest ever.
Because fee income has proven so vital to weathering
unfavorable interest rate climates, the message to you, the consumer,
is that fees aren't going away. Rather, expect them to increase
in prominence.
Another reason for the banking industry's sustained
profitability that may not be so apparent to outside observers is
credit quality. According to the FDIC's Quarterly Banking Profile,
"... the overall percentage of loans that are noncurrent remains
near an all-time low." Banks don't realize income if loan payments
aren't made, and profitability is eroded if loan payments aren't
made on time. Credit quality is one area of industry focus as interest
rates have increased and economic growth slows. While not yet worrisome,
signs of stress can be detected. Noncurrent loans, defined as those
past due by 90 days or more, have increased in each of the past
two quarters and will remain something to keep an eye on.
Fedspeak: Federal Reserve
Board Governor Kevin Warsh gave a speech at the New York Stock Exchange
yesterday. It contained the usual and obligatory statements about
inflation. Here are two of Warsh's comments on that matter:
"Inflation, though down somewhat from its level
earlier this year, remains uncomfortably elevated. Financial market
prices imply that inflation will continue its gradual but persistent
downward track during the forecast period. There remain, I believe,
clear upside risks to that inflation outlook."
"In contrast, my own judgmental forecast includes
a wider range of possible outcomes than is implicit in these market-based
measures."
Recall that the Fed is exploring better communication
with the markets, perhaps including, but not limited to, the use
of an inflation target. Warsh closed with these comments.
"You watch us and react to our actions, while
simultaneously we monitor you and respond as best we can to the
signals you provide about evolving economic and financial conditions.
To do our part in preventing the signals from getting crossed, I
believe that we at the Federal Reserve should continue our efforts
to make our communications and intentions as clear as possible."
Economic calendar: There
hasn't been much movement in bond yields this week, owing to the
light economic calendar and the shortened holiday schedule in the
markets. The economic calendar will heat up again next week, however.
Here is a glimpse at what is on tap.
Tuesday -- durable goods orders, consumer confidence
and existing home sales
Wednesday -- revision to third quarter Gross Domestic
Product, new home sales, Fed's Beige Book
Thursday -- personal income and personal spending for
October
Friday -- Institute for Supply Management's manufacturing
index
That's it for me this week, folks. Happy Thanksgiving
to all.
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