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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April showers are supposed to bring flowers in May. But the month’s economic reports produced more weeds – the kind that could choke off a recovery – than blossoms signaling its growing strength.

The largest of those weeds, by far, was the disappointing employment report. Employers added only 115,000 jobs in April, the slowest hiring pace in six months and the third consecutive month in which employment totals have fallen short of expectations.

Upward revisions in the employment data for February and March – adding a combined total of 54,000 jobs to the totals – provided some cheer, as did the slight decline in the unemployment rate, from 8.2 to 8.1 percent – a three-year low. But it came not because more unemployed workers found jobs, but because more of them gave up on the hope of doing so; the labor participation rate fell to 70 percent – its lowest level since 1948, when the Labor Department began compiling this data.

Some analysts suggested that the tepid employment figures don’t necessarily indicate a slowing economy – an unusually warm winter may have pulled some of the spring hiring activity forward, and the April figures, like those for February and March, could still be revised upward.

Better than it Looks?

Averaging the figures for the year to date puts the monthly job creation level in the 200,000 range, suggesting that the employment picture is much brighter than the April report indicates – but still not nearly strong enough to recover the ground lost during the recession. Of the 8.8 million jobs lost, the economy has recaptured only 3.7 million of them, according to the Labor Department figures.

Even cast in the more favorable light, the April employment report seemed to confirm the cautionary note the Federal Reserve has been sounding all year and maintained in its most recent policy statement following the Federal Open Market Committee’s (FOMC) April meeting.

The committee, which sets monetary policy for the Fed, said it expects economic growth to “remain moderate” over coming quarters and then to “pick up gradually,” with unemployment declining only “gradually” over the next two years.

Threading a policy-making needle, Fed Chairman Ben Bernanke reaffirmed the Fed’s plan to hold interest rates low through next year, but he also rejected as “reckless” suggestions that the agency should ramp up efforts to reduce the unemployment rate. More aggressive action would carry a high risk of fueling inflation, Bernanke told reporters, while producing an impact on growth that would be “quite tentative and perhaps doubtful.…The question is, ‘Does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased pace of reduction in the unemployment rate?’ The view of the committee is that would be very reckless.”

No Boost from the Fed

Bernanke’s comments indicated that the Fed is willing to accept, if not cheer, an economic growth rate that has been slower than hoped – too slow to fuel a faster repair of the tattered employment market. The economy grew at a 2.2 percent annual rate in the first quarter of this year, slowing from the 3.3 percent pace in the final three quarters of 2011. Some economists think the growth rate is sustainable; utters fret that it is fragile and easily derailed. Most seem to be leaning toward the more optimistic assessment.

"Despite the weak start to slow but the year, the economy appears solid," Scott Hoyt, senior director of consumer economics at Moody’s Analytics, told Housing Wire. The current growth rate, while “hardly a boom pace,” he said, is, nonetheless “strong enough to expand employment and reduce joblessness especially as some of the current drags wane in the second half of the year."

Julia Coronado, chief economist for North America at BNP Paribas, was more cautious. Although consumer spending – a pleasant surprise thus far – has been “remarkably stable and steady,” she said in the Housing Wire report, it has not been strong enough to provide much heft to the economy. “We’ll need to see final demand continue to improve,” before the economy really picks up speed. For now, she said, “We’re still in muddling- along territory.”

Consumers Hanging Tough

Consumer spending, as Coronado indicated, provided an unexpected lift. The nearly 3 percent increase in April added 2 percentage points to GDP, pretty much offsetting the 2.2 percent decline resulting from a sharp drop in business investment – the first decline in that key area since the fourth quarter of 2009. But the consumer spending news was bittersweet, fueled not by employment gains (real disposable income increased by only 0.4 percent) but by a decline in the savings rate, which fell to 3.9 percent compared with an average of 4.5 percent in the fourth quarter of last year.

Consumer finances continued to improve overall, as indicated by the S&P/Experian composite consumer credit default rate, which fell to 1.96 percent in March from 2.09 percent in February. But consumer confidence dipped slightly, falling to 69.2 in April in the Conference Board’s survey, from a downwardly revised 69.5. Although consumers are feeling somewhat better about current conditions, Lynn Franco, director of the Conference Board Consumer Research Center, said in a statement, they remain only “cautiously optimistic” and still more uncertain than not about the economic outlook.

Business confidence levels are mixed – up for executives at the larger companies represented in the National Association of Business Economists’ survey, but down for small business executives. In the NABE’s April survey, 60 percent of the economists responding reported increasing sales at their companies and 40 percent reported higher profit margins, and nearly 40 percent predicted that their companies will boost hiring over the next six months.

In the NFIB’s most recent survey, by contrast, the confidence level declined by nearly two points, as small business executives reflected nervousness in virtually every category. Although hiring levels in March were higher than they have been in more than a year for these companies, the NFIB said, future hiring plans have declined, with equal numbers now planning to hire and reduce staff. In the March survey, companies planning to hire had a 4 percent edge.

"Small businesses expect lower sales, higher costs, and feel pressure to increase their prices,'' Leslie Levesque, an economist with IHS Global, wrote in a recent report. “Under these conditions it is no surprise they do not feel like going on a hiring spree anytime soon.”

A Lift from Housing

The housing market, uncharacteristically of late, provided some relatively good news – not spectacular, but more positive than not. Investment in residential construction increased by nearly 20 percent in the first quarter, the fastest pace since the second quarter of 2010. As a result, housing actually added 0.4 percent to GDP – a pleasant change from the albatross role the market has been playing since the downturn began.

Pending sales, an indicator of future home buying activity, rose to their highest level in two years in March in a National Association of Realtors (NAR) index, climbing nearly 11 percent over the year-ago reading; the first quarter total was the highest in five years.

Existing home sales – that is, deals that have actually been completed -declined in March (pending sales have yet to be consummated) declined in March – the third month-over-month decline in the past four months. But sales in January and February added up to the best winter market for housing in the past five years, according to the NAR. And January’s 4.62 million annual sales pace was the highest since May, 2010 – the last month before the federal tax credit for home purchases expired.

Turning the Corner

“The housing market has clearly turned the corner,” Lawrence Yun, the NAR’s chief economist, said in a press statement. “Rising sales are bringing down inventory and creating much more balanced conditions ... which means home prices will be rising in more areas as the year progresses,” he added.

New home sales, on the other hand, are “still bumping along the bottom,” Jacob Oubina, senior U.S. economist at RBC Capital Markets, told Bloomberg. March sales fell 7.1 percent compared with February, to a seasonally adjusted annual rate of 328,000 units. That was the slowest pace in the past four months, but still better than analysts had predicted. Adding another encouraging note, the sales total for February was revised upward, for the strongest performance since November of 2009.

Housing starts declined in March, disappointing analysts who had predicted a better showing, but permits – an indicator of future construction activity, rose by 4.5 percent, reaching their highest level in 3-1/2 years. And the 5.8 percent decline in starts was concentrated almost entirely in the volatile multi-family sector, down by nearly 17 percent after surging by double digits in January and February. Single-family starts slipped only fractionally, by 0.2 percent.

Supply and Demand

Home prices continue to seek a still-elusive bottom. The S&P/Case Shiller index of property values fell by 3.5 percent in February year-over-year, as most of the markets tracked reached post-crisis lows. But some analysts attribute the decline largely, if not entirely, to distressed sales generally (representing nearly half of all sales in March) and a surge in short sales in particular, which represented nearly 20 percent of sales in the first quarter of this year. The report also indicated that the average short sale price was 10 percent lower in January of this year than in the same month of 2011.

Looking at the housing market overall, particularly the existing home market, analysts say the recent sales decline is attributable more to a lack of inventory than a lack of demand, as sellers are either unwilling or unable to list their homes at prices depressed by the continued dominance of distressed sales.

Inventories are nearly 22 percent below year-ago levels, according to industry reports, creating bidding wars in some markets and apparently boosting the confidence of some reluctant sellers. Median asking prices in March jumped by 5.6 percent over the year-ago level and were 1 percent higher than in February, according to data compiled by the research firm Zelman & Associates.

“The biggest challenge that we've had over the past four years is fear — fear that the economy is collapsing, that property values are collapsing, that the world is coming to an end," noted Mark Prather, a broker at ERA Buy America Real Estate in La Palma, CA, quoted in a recent Associated Press report. "The fear factor,” he said, “is all but gone.”