Key economic data released over the past fortnight revived angst about a stagflation in the U.S. economy, an unwelcome combination of slowing growth and persistent inflation. Economic jitters finally caught up with U.S. capital spending as new orders for manufactured durable goods plummeted by 5.3% MoM in January after having climbed substantially (4.4% MoM) in December 2007. The housing market continued to plummet as January new home sales declined by 2.8% (588k vs. 605k previously), thereby posting the weakest reading since February 1995. An iffy labor market has begun to weigh heavily on consumer confidence, which fell to its lowest reading since March 2003. Meanwhile, inflation qualms came to the fore, fueled by oil’s rally to records over USD 100 a barrel. US headline CPI increases 0.4% MoM in January, a pace akin to that in the previous month. Inflation of core prices (excluding volatile food and energy costs), which is closely watched by the Fed, edged up to 0.3% MoM (the fastest pace since June 2006) from a steady 0.2% in each of the preceding 9 months.
While the higher than expected CPI data release had caused some apprehension amongst market participants about the future Fed stance, the Federal Reserve Chairman Ben Bernanke’s semi annual testimony before the House Financial Services Committee effectively dispelled any doubts on this front. Although the chairman did acknowledge that inflation risks are skewed slightly to the high side, he made it clear that the growth still remains the Fed’s primary concern. Offering no indication that the struggling housing sector is approaching a bottom, Mr. Bernanke noted that housing would weigh on the economy “in current quarters” and that nonresidential construction which had held up well so far “is likely to decelerate sharply”. He acknowledged that the contagion had begun to affect other sectors of the economy like consumer and business spending, which had survived the housing turmoil for most of 2007. Noting that some small banks could yet fail because of the recent housing crunch, the Chairman reminded investors of possible risks remaining in the financial sector .He added that financial markets remained under ‘considerable stress’ and that officials will monitor financial developments ‘closely’.
Bernanke’s dovish comments reverberated Donald Kohn’s speech earlier in the week. The Vice Chairman had warned that the turmoil in credit markets and the possibility of even slower economic growth posed a ‘greater threat’ than inflation. He had also added that the housing correction had further to go, and financial market recovery was likely to be prolonged. In line with the gloomy outlook, the FOMC members lowered their growth forecasts for 2008 which were released along with the minutes of the January 30th FOMC meeting. While the minutes clearly focused on the downside risks to growth in the near term, the real GDP central tendency range was shifted down from 1.8 - 2.5 to 1.3 - 2.0 for 2008 and unemployment rate moved higher to 5.0 - 5.3. Although the minutes did revise its inflation forecast higher to 2.0-2.2% for 2008, the focus remained on inflation expectations, which are believed to be still under control.
Recent speeches by top Fed officials coupled with the dismal nature of economic and financial news over the past fortnight strongly suggest that the Fed officials are prepared to ease interest rates further in order to stave off a possible recession in the U.S. This has further reinforces another 50 bs cut in the Fed funds rate at the March 18th FOMC meeting with risks definitely skewed on the downside
While the higher than expected CPI data release had caused some apprehension amongst market participants about the future Fed stance, the Federal Reserve Chairman Ben Bernanke’s semi annual testimony before the House Financial Services Committee effectively dispelled any doubts on this front. Although the chairman did acknowledge that inflation risks are skewed slightly to the high side, he made it clear that the growth still remains the Fed’s primary concern. Offering no indication that the struggling housing sector is approaching a bottom, Mr. Bernanke noted that housing would weigh on the economy “in current quarters” and that nonresidential construction which had held up well so far “is likely to decelerate sharply”. He acknowledged that the contagion had begun to affect other sectors of the economy like consumer and business spending, which had survived the housing turmoil for most of 2007. Noting that some small banks could yet fail because of the recent housing crunch, the Chairman reminded investors of possible risks remaining in the financial sector .He added that financial markets remained under ‘considerable stress’ and that officials will monitor financial developments ‘closely’.
Bernanke’s dovish comments reverberated Donald Kohn’s speech earlier in the week. The Vice Chairman had warned that the turmoil in credit markets and the possibility of even slower economic growth posed a ‘greater threat’ than inflation. He had also added that the housing correction had further to go, and financial market recovery was likely to be prolonged. In line with the gloomy outlook, the FOMC members lowered their growth forecasts for 2008 which were released along with the minutes of the January 30th FOMC meeting. While the minutes clearly focused on the downside risks to growth in the near term, the real GDP central tendency range was shifted down from 1.8 - 2.5 to 1.3 - 2.0 for 2008 and unemployment rate moved higher to 5.0 - 5.3. Although the minutes did revise its inflation forecast higher to 2.0-2.2% for 2008, the focus remained on inflation expectations, which are believed to be still under control.
Recent speeches by top Fed officials coupled with the dismal nature of economic and financial news over the past fortnight strongly suggest that the Fed officials are prepared to ease interest rates further in order to stave off a possible recession in the U.S. This has further reinforces another 50 bs cut in the Fed funds rate at the March 18th FOMC meeting with risks definitely skewed on the downside
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