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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The big news this month was the April employment report, which turned out to be better — in fact, considerably better —than most analysts had expected.

Payrolls expanded by 244,000 workers following a March gain that was revised upward to 221,000. Businesses added 268,000 jobs (the most since two years before the current recession began), offsetting the 24,000 jobs state and local government agencies eliminated and blowing past the 185,000 jobs in the consensus forecast, to produce the labor market’s best performance in five years.

Despite the overall hiring strength, the unemployment rate increased slightly from 8.8 percent to 9 percent, but analysts viewed that as a good sign, too, indicating that an improving jobs picture is encouraging more unemployed workers who had given up to re-enter the market.

Perversely Positive

Fortune Magazine identified another perversely positive indicator: The productivity rate has begun to decline. That means employers will soon accelerate their hiring plans “because they have no alternative,” Fortune columnist Colin Barr suggested.

“A productivity slowdown shows employers have harvested the low-hanging fruit of wage and employment cutbacks,” he explained, “leaving those that aim to grow through the next cycle with little choice but to start staffing up.”

Adding to the accumulating mound of upbeat labor data, the number of workers unemployed for six months or more declined in April and unemployment rates declined in 317 of 372 metropolitan areas.

Push and Pull

But these gains, while welcome, remain “moderate” in the view of most economists, neither large enough nor fast enough to energize an economic recovery that remains less dynamic than most want to see. That “better but not nearly good enough” analysis reflects the conflicting financial forces that are simultaneously propelling the economy toward recovery and blocking its forward progress.

  • Employment growth has boosted consumer confidence and encouraged more spending, but rising gas and food prices have made consumers reluctant to spend too much.
  • Lenders have finally begun to loosen their stranglehold on credit, but businesses that have been complaining about the dearth of financing have become less bullish about the economic outlook and less interested in borrowing money to expand.
  • The manufacturing sector continues to perform well, but growth here has slowed recently as the rising cost of raw materials (attributable to rising oil prices) is clouding the near-term outlook for this sector too.

Housing is one of the few areas that is not reflecting this duality, but that’s because the picture here remains unremittingly grim.

Here’s the Double Dip

The “double dip” in home prices that many analysts had been predicting was confirmed by the February S&P/Case-Shiller report. Both the 10-city and 20-city composite indices declined by 1.1 percent for the month — the eighth consecutive drop for this widely-watched housing barometer. Prices declined in 19 of 20 markets pushing the index 3.3 percent below the year-ago level and leaving it only a whisper above the 6-year low recorded in April of 2009.

Separately, the Federal Housing Finance Agency reported that prices declined across the country in February and adjusted the January decline downward, from the 0.3 percent reported originally to 1 percent.

“There is very little, if any, good news about housing,” David Blitzer, chairman of S&P’s index committee, said in a press statement. “Prices continue to weaken, [while] trends in sales and construction [remain] disappointing.”

New home sales increased in March, beating February’s anemic performance by 11 percent, but remaining below the year-ago figure and well below the 700,000 sales that economists view as a healthy market. This represents the fifth consecutive annual decline in home sales with little evidence that the trajectory is going to change.

Housing starts increased by 7.2 percent in March compared with February and building permits increased by 11.2 percent, but most of the gains were in the multi-family sector; single-family construction remains near a five-decade low. “You can’t put lipstick on this pig,” Diane Swonk, chief economist at Mesirow Financial, told the Washington Post. “The new housing market remains weak no matter how the data is cut.”

Not a Pretty Picture

The resale market doesn’t look much prettier. Existing home sales increased by nearly 4 percent over the February level, but the annual pace (5.1 million units) remains far from healthy and distress sales represented 40 percent of that far from robust total.

The NAR’s Pending Sales index – a measure of future activity – increased by 5.1 percent, but that was over a downwardly revised February reading. The index is more than 11 percent below the year-ago reading – far from encouraging, even considering that the 2010 measure was inflated artificially by buyers rushing to meet the deadline for the federal homebuyer tax credit.

Emphasizing the positive, the NAR’s chief economist, Lawrence Yun, noted that sales overall have improved since the market tanked last June. The modest and erratic improvement would be stronger and more consistent, Yun said, “if tight mortgage lending criteria returned to normal, safe standards.” He might also have noted that stronger employment growth and less cause for concern about the recovery’s strength and sustainability would no doubt help, as well.

Turning away from the housing market (an understandable reaction), it is possible to find more positives in other economic reports. In fact, notwithstanding the ‘yen-yang’ of conflicting trends noted earlier, many indicators are improving.

  • Consumer confidence, although inconsistent and somewhat fragile, has remained stronger than predicted, or at least declined less than feared in the wake of rising gas prices.
  • The Conference Board’s index of leading economic indicators increased by 0.4 percent in March, representing the ninth consecutive increase for this gauge of economic strength. And it came despite the impact of rising oil and food prices and the devastating earthquake in Japan.
  • Industrial production increased by 0.8 percent in March, beating projections and indicating continuing strength in the sector that has led the recovery thus far.
  • Retail sales posted their ninth consecutive monthly gain in March as consumers proved more resilient and less unnerved by rising gas prices than many analysts had expected.

More Upbeat and Less

The accumulation of positive indicators is leading some economists to paint their forecasts in slightly brighter colors. The most recent survey by the National Association for Business Economists found respondents noticeably more upbeat, with a majority reporting that their companies “appear to be positioning themselves for a firming economic environment.” Most (94 percent) of the economists are expecting the economy to grow by at least 2 percent this year.

“”The economy is really starting to take shape,” Bricklin Dwyer, an economist at BNP Paribas, told Bloomberg News recently.

Others, less encouraged by the positive indicators and more concerned about the downward pressures, say the shape the economy is taking remains fuzzy. A growth rate in the 2 percent to 3 percent range– the consensus forecast for this year – is far from robust, they point out, and the headwinds the recovery is facing are likely to become stronger as the impact of higher oil prices spreads throughout the economy.

“If gasoline prices were to stop rising, real consumption would bounce back in the second quarter,” Paul Dales, an economist with Capital Economics, told Bloomberg. “But even then,” he said, “jobs growth and wage growth are not strong enough to result in a significant and sustained acceleration in consumption growth.” The economy will continue to recover, he agrees, but the pace of the recovery, he predicts “will continue to disappoint both this year and next.”