Economics
US Economic Weekly
Peter E. Kretzmer
212.847.5046
Mickey Levy
212.847.5045
Gary Bigg
212.847.5980
Published February 22, 2008 for
week of February 18, 2008
Unpleasant prospects
Developments last week included evidence of rising inflation pressures, along with
deteriorating credit conditions and worsening consumer and business sentiment. While the
Fed is concerned about the inflation trend, which poses risk to its hard-won credibility and
contained inflation expectations, it will be forced in the near term to respond to the clear
downside risks to the economy. Fed officials lowered their economic forecasts last month,
but we still expect U.S. GDP growth to fall short of the central tendency forecast for 2008.
Accordingly, substantial easing likely remains, and we have adjusted our outlook accordingly.
Mounting inflation concerns,
underlined by broad-based
gains in January, complicate
the challenges facing the Fed.
Inflation concerns mounted last week, with headline and core CPI indices registering above-trend
rises in January. The headline CPI rose 0.4%, and is up 4.4% on a 12-month basis, while the core
CPI rose 0.3% last month. The 12-month core CPI inflation rate rose to 2.5% in January, its 5th
consecutive monthly rise since last August. Particularly notable last month was the widespread
nature of the contributions to rising inflation. Almost all categories rose at elevated rates, and
energy and food prices both rose 0.7%. Concerned with maintaining its inflation-fighting
credibility, the FOMC will be worried by this report, particularly by the specter of persistently
rising headline inflation in excess of upwardly trending core consumer inflation. Furthermore, the
widespread price increases make any particular reason for the inflation bulge less credible,
increasing the risk to the Fed.
Deteriorating credit
conditions and declining
business and consumer
sentiment indicate
continued downside risk to
the economy.
As we reported last week, a small rebound in retail sales and flat industrial production in January
were a slight upside surprise, suggesting that the economy was keeping its head above water. In
fact, the retail data may point to sustained—albeit very weak—consumer spending gains in Q1.
However, credit conditions have continued to deteriorate, as evidenced by failing auction markets
threatening student loan programs, continued risk to bond insurers, worsening financing
conditions for commercial real estate, and rising corporate yields. The growing financial strains
add to the evident downside risks to economic performance. A second consecutive weak
Philadelphia Fed survey added to the sense of pessimism late last week, as the headline reading
for February declined further, orders continued to shrink and shipments fell at a faster pace than in
January. Ominously, respondents also turned negative on the 6-month outlook for the first time
since January 2001, just months before the last recession began.
As we project even weaker
2008 GDP growth than the
Fed’s new downwardly-revised
forecast, we see appreciable
further Fed easing.
Tight credit conditions and
declining household net
worth may slow consumer
rebound.
The FOMC released its quarterly updated central tendency forecasts last week, reducing its shortterm outlook for economic growth, raising its 2008 unemployment forecast with gradual decline
expected in 2009-10, and indicating higher headline and core PCE inflation which is expected to
gradually dissipate in coming years. The forecasts did not present a pleasant set of prospects. We
note that (1) despite increased pessimism, Fed members still did not forecast recession as their
most likely outcome; and (2) Fed projections of 1.3% to 2% GDP growth in 2008 still lie well
above our latest Q4/Q4 forecast of 0.7% growth for 2008. While the Committee noted that a low
real fed funds rate is appropriate in view of current restraints on growth, we expect the Fed to
respond to weaker-than-projected GDP growth with appreciable further easing. We now expect a
50 basis point ease on March 18th, followed by two 25-basis point easings to 2% at midyear.
With credit conditions weak, falling housing prices restraining household wealth, and payroll
gains dissipating, a consumer rebound may be slow to take hold despite fiscal and monetary
stimulus. While the Fed will be concerned about promptly restoring a more typical funds rate
level in view of continued inflation concerns (explicitly mentioned in the FOMC minutes), credit
conditions will have to improve first. A gradual rebound in spending and economic growth would
likely imply an extended period of elevated unemployment, perhaps exerting significant
downward pressure on inflation and reducing the urgency of a quick Fed reversal. Clearly, large
uncertainties surround these potential developments.
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Economics
Figure 1. US Economic Indicators
Day
GMT
Indicator
Mon 25
15:00
Existing Home Sales
For
Jan
Tue 26
13:30
Producer Price Index
Jan
Mkt
Last
4.81 mn
4.89 mn
15:00
Consumer Confidence
Feb
15:00
Richmond Fed Survey
0.5%
0.3%
-0.3%
0.2%
Ex food & energy
Wed 27
BAC
4.85 mn
0.2%
0.2%
85.0
82.0
87.9
-7
-8
Feb
Thu 28
13:30
Durable Goods Orders
Jan
-4.0%
-4.0%
5.0%
15:00
New Home Sales
Jan
600k
600k
604k
13:30
Jobless Claims
Wk 02/23
13:30
GDP
Q4 prelim
Personal Income
Jan
2.6%
2.6%
Jan
13:30
0.6%
21
22
-0.1%
0.2%
0.5%
Consumer Spending
0.3%
0.2%
0.2%
Core PCE Deflator
Fri 29
Help-Wanted Index
349k
0.8%
2.6%
GDP Price Index
15:00
350k
0.5%
0.3%
0.2%
0.2%
70.0
69.6
48.0%
49.7%
51.5%
15:00
Consumer Sentiment
Feb
15:00
PMAC Survey
Feb
Source: Bank of America, Bloomberg and Haver Analytics.
Existing & New Home Sales
Home sales tumbled to multi-year lows in December. With employment stalling, home prices
declining and mortgage lending standards tightening, the near-term outlook for housing
demand remains grim. However, lower home prices and Fed easing are boosting customer
traffic, perhaps the beginning of a bottom in sales. Note that residential construction will
decline throughout 2008, as housing inventories remain swollen.
Producer Price Index
The rise in agricultural commodity and energy prices likely boosted the headline index. Core
price gains were likely restrained by flagging consumer and industrial demand.
Consumer Confidence
Weak employment, high gasoline prices, tightening credit conditions and financial market
turbulence likely pushed consumer confidence lower for the 6th time in the past 7 months.
Durable Goods Orders
A sharp fall in aircraft orders in January and a reversal in defense orders after December’s
impressive rise suggest that durable orders started the year on a weak note. Attention should
be concentrated on the trend in nondefense capital goods ex-aircraft activity.
GDP
Downward revisions to consumption and construction spending likely offset an upward
revision to net exports, resulting in little net revision to 4Q real GDP growth.
Personal Income
With rising hourly earnings more than offset by a moderate decline in aggregate hours
worked, we look for a rare decline in personal income in January. Weakening personal
income and household wealth suggest a second consecutive month of very sluggish real
consumption growth. Finally, rising apparel and medical care prices likely boosted the core
PCE deflator by an uncomfortably high 0.3% in January, leaving its year-over-year change at
2.2%, near the upper end of the Federal Reserve’s new central tendency forecast for 2008
core inflation.
US Economic Weekly
Peter E. Kretzmer 212.847.5046
Mickey D. Levy 212.847.5045
Economics
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US Economic Weekly
Peter E. Kretzmer 212.847.5046
Mickey D. Levy 212.847.5045
