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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Jobs, jobs, jobs. There were more of them in February than January (also a good month) and more than analysts had been predicting, many of them that “the labor market has found its legs.”

Employers added 227,000 jobs in February, marking the third consecutive month in which gains topped 200,000 and the best six-month job total in six years. December and January actually turned out to be better than initially reported, according to the Department of Labor, which revised job totals for both months upward.

The job gains didn’t make a dent in the unemployment rate, which remained unchanged at 8.3 percent. But that was also a positive indicator, suggesting that previously discouraged workers are returning to the labor market, more confident now of their ability to find available jobs.

The Labor Department estimates that nearly 500,000 workers entered the market in February, boosting the “participation rate” (the percentage of working-age people in the labor force), which had been declining steadily, to 63.9 from 63.7 in January. The “underemployment rate”, reflecting workers who want full-time jobs but have accepted part-time, declined from 15.1 percent to 14.9 percent – a three-year low. The number of workers classified as “long-term” unemployed also declined from 42.9 percent to 42.6 percent.

“For the first time since the recession started, there is good news for the U.S. economy,” John Graham, director of the survey and a finance professor at Duke University’s Fuqua School of Business, told Bloomberg News.

Curb Your Enthusiasm

Federal Reserve Chairman Ben Bernanke sounded a more cautious note in a recent report to Congress, describing the current economic recovery as “uneven and modest by historical standards.” Speaking before the February employment numbers were announced, Bernanke said, “The unemployment rate remains elevated, long-term unemployment is still near record levels and the number of persons working part time for economic reasons is very high.” And while job gains have been “relatively widespread across industries,” he told reporters in a press conference, “the fundamentals that support spending continue to be weak.”

The statistics confirm that assessment. Consumer spending was flat in January, after rising in November and December, and rising gas prices will almost certainly restrain spending going forward, many analysts agree. However, consumer debt levels increased in the third quarter for the first time in nearly four years, the Federal Reserve reported. And rising debt levels usually presage an increase in consumer spending.

“For the first time since the recession, we're starting to see bank credit increase. [And] that historically has been the catalyst for strong economic growth," said Paul Kasriel, chief economist at Northern Trust, observed in a recent note to investors. "It's what has been lacking up until recently in this economy," he added.

Some analysts fear that rising debt levels may be cause for concern that consumers are heading once again into deep and dangerous financial waters. But the Fed’s recent “Flow of Funds” report noted that after-tax income increased faster than debt, reducing the national debt-to-income ratio to 112.8 percent – still high by historical levels, but well below the 2007 peak of 130 percent.

Consumer Confidence

Consumers are also becoming more confident – another reason to expect that spending levels may increase this year. The Conference Board’s confidence index reached its highest level in more than a year in February, while the Thomson Reuters/University of Michigan confidence gauge rose for the sixth consecutive month, its longest sustained increase in nearly 15 years.

As the positive data accumulates, economic forecasts generally are turning more positive, if not robust, with many economists now anticipating stronger growth rates this year than they had predicted and some even forecasting an upturn in the battered, bruised and (by most accounts) still ailing housing market.

Fannie Mae economists expect that the housing market will contribute “modestly” to economic growth this year, the first time in seven years it has been a net plus rather than a net drain on the economy.

Frank Nothaft, Freddie Mac’s chief economist, also sees “cautious signs” of improvement in the housing market and the overall economy this year, with “more warmth” in 2013,

Gaining Momentum

“The US economy continues to build on the momentum from the end of last year,” Nothaft said in his monthly report. “Our outlook anticipates gradual, but steady, improvement in the economy and the housing market, supported by low interest rates and brightening job market prospects.”

Recent housing starts – at least some of them – have been encouraging. Existing homes sold at their fastest pace in nearly two years in January, reaching an annual rate of 4.05 million, 3.8 percent above the December pace. Pending sales – an indicator of future activity – also increased more than analysts expected, the National Association of Realtors reported, while the inventory of unsold homes fell to a 6.1 month’s supply down from a peak of 12.1 months in July 2010 and the lowest level since April 2006.

Green Shoots

“There are definitely green shoots in the housing market, no argument about that,” Peter de Bruin, an economist at ABN Amro Group Economics, told Bloomberg.

New home sales – the weakest component of a very weak market – were flat in January, but that was better than the decline most analysts were expecting. An upward revision in the December figures compiled by the Commerce Department increased the seasonally adjusted annual pace to 321,000 units

"Outside of the upwardly revised December number, this is actually the best sales pace we've seen since April of 2010, when the homebuyer tax credit was in effect," Barry Rutenberg, chairman of the National Association of Home Builders, said in a press release.

Housing starts increased by 1.5 percent in January, largely because of activity in the multi-family sector; single family starts actually declined by 1 percent, but permits increased by nearly the same amount to an annual rate of 676,000 units, reflecting increasing confidence on the part of home builders. In the most recent NAHB/Wells Fargo confidence survey, builders in 98 metropolitan markets reported improving conditions.

“The trend is up, not down,” Dean Maki, U.S. economist at Barclays Capital Inc., told reporters. “That is a big change from where we’ve been over the last several years. We’re a long way from really good times in the housing market,” he added. But we are seeing some improved trajectory.”

Prices: More Room to Fall

The same can’t be said of home prices. The S&P/Case-Shiller home price fell by 3.9 percent last year, reaching its lowest point since the housing downturn began six years ago, pushing prices nearly 35 percent below their pre-crash peak, with 19 of the 20 cities in the index reporting year-over-year declines.

“The pickup in the economy has simply not been strong enough to keep home prices stabilized,” David Blitzer, chairman of the S&P index committee, said in a statement. “If anything, it looks like we might have re-entered a period of decline as we begin 2012.”

Distressed sales continue to pull prices down, offsetting any positive impact from increased home buying activity. Foreclosures and short sales represented 35 percent of January transactions, according to the NAR. And with the negotiation of an agreement resolving the ‘robo-signing’ dispute, foreclosure actions, which that had been stalled for several months, are expected to accelerate.

That trend has already begun. One in every 624 U.S. households received a foreclosure notice in January, up 3 percent from the previous month, according to a new RealtyTrac report.

While analysts say foreclosure sales will help to clear and stabilize the housing market, they will also put continued downward pressure on home prices. But the rate at which prices are declining will slow, nonetheless, many analysts believe.

Fitch is now predicting that home prices will decline by another 9.1 percent before stabilizing – hardly good news (especially for homeowners looking to sell this year), but still better than the 13.1 percent decline Fitch was predicting just a few weeks ago. And when adjusted for inflation, Fitch analysts point out in a recent report, the projected price decline is actually closer to 6 percent.

“The bottom is behind us,” Paul Dales, an economist with Capital Economics, Ltd., told Bloomberg. “I don’t think we will return to anything like the exceptional booming market we had five years ago. We will have a very steady, slow recovery,” he added, “but a recovery nonetheless.”