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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Economists who have been speculating nervously about the prospects for a double dip in home prices are becoming even more concerned that the economy as a whole – not just one troubled component of it – may be slipping back into the recessionary bog from which it has not entirely escaped.

“Job growth has slowed. Consumers have cut back on discretionary spending because of higher gas and food prices. The battered housing market may have taken another turn for the worse. The red-hot manufacturing sector — the fastest growing part of the U.S. over the past two years — has cooled off. And the global economy seems to have downshifted,” a recent MarketWatch article reported glumly.

The recent employment report added to that litany of discouraging news. Employers added only 54,000 workers to their payrolls next year – a gain of 83,000 private sector jobs offsetting the loss of 29,000 government positions. Particularly disturbing – the manufacturing sector shed 5,000 jobs, the first such loss since October for the sector that has provided most of the juice for the economic recovery to date.

The unemployment rate inched up again to 9.1 percent as workers, encouraged by April’s strong labor report, returned to a market that still offers too few positions to accommodate them. The nation has lost 7 million jobs since the recession began in December of 2007, “by far the worst performance of job generation following any of the dozen recessions since the 1930s,” according to USA Today.

Temporary Reversal – or Something More?

Declines in retail sales, consumer spending and manufacturing activity have added to the sense that an economic recovery that was anemic, at best, is losing what little bit of steam it had. Some analysts think the accumulating parade of negative indicators suggests an economy that is closer to distress than recovery; others see the setbacks as serious, but temporary, a result of bad weather, bad news and natural disasters (Japan’s earthquake and tsunami primary among them) that are masking strengthening economic fundamentals, delaying but not aborting investment and hiring decisions that many corporate executives are poised to make.

"The key question is whether businesses are only temporarily hitting the pause button on hiring because of increased uncertainty about the economic outlook, or whether they are hunkering down for a longer period," Sal Guatieri, senior economist with BMO Capital Markets, told RTT News. “We still believe it's the former, but the next couple of months will tell."

Fed Chairman Ben Bernanke thinks the economy will strengthen later this year as the effects of Japan’s weather-related disasters recede and upward pressure on gasoline prices eases.

But at least for now, there is no question that the signs of weakness in areas that had been, or were expected to be, strong are unnerving analysts, corporate executives and consumers, alike.

Members of the National Association of Business Economists, who had been predicting that GDP would grow at a 3.3 percent rate, are now anticipating a 2.8 percent growth rate, reflecting their view that gasoline prices will remain high enough to keep a lid on consumer spending.

Consumer Fears

Consumer spending and confidence have ebbed as employment reports have veered from uncertain to disturbing. The Conference Board’s Consumer Confidence Index declined in May after improving a bit in April, as the view of current conditions dimmed and the outlook for the future soured.

“Consumers are considerably more apprehensive about future business and labor market conditions as well as their income prospects,” Lynn Franco, the board’s spokesman, said. The percentage of consumers expecting conditions to improve declined, as did the percentage anticipating an increase in employment opportunities. “Inflation concerns, which had eased last month, have picked up once again,” Franco noted – suggesting that consumers are likely to emphasize saving over spending, at least in the near term.

Housing Recovery “Sluggish”

The housing market, meanwhile, continues to demonstrate that, assertions to the contrary notwithstanding, conditions can, in fact, get worse. New home sales actually increased a bit in April compared with March, but the impact was the equivalent of tossing a pebble into the ocean. Sales were down more than 23 percent compared with the year-ago figure, which was, itself, close to dismal. Starts and building permits both declined, suggesting that construction isn’t going to be rebounding any time soon.

Optimism being something of an occupational requirement for real estate professionals, sales totals, no matter how weak, don’t “plummet,” or “nose dive” – they “pause,” “slow,” or “ease.” But whatever adjective you choose, the April existing home sales figures were nasty – nearly 13 percent below the April 2010 figure, leading the National Association of Realtors’ chief economist, Lawrence Yun, to acknowledge, “The recovery is very sluggish.”

Some analysts blamed overly conservative appraisals while others faulted stringent underwriting standards that are preventing many prospective buyers from qualifying for the mortgages they need. But the major problem, most agree, is foreclosures, which continue to spew unsold homes into a saturated market.

Nearly 25 percent of April sales were foreclosures compared with 16 percent the same month a year ago, and 40 percent of the homes sold in April sold for less than their original purchase price. It is not hard to understand why many prospective buyers fear that the home they purchase, like a car, will begin to depreciate immediately after they acquire it.

Prices Still Falling

The widely-watched Standard & Poor’s/Case Shiller index has re-enforced that fear. The index fell 4.2 percent in the first quarter – its third consecutive quarterly decline — leaving prices 34 percent below their 2006 national peak. Robert Shiller, a co-founder of the index, said recently that an additional decline of 10 percent to 25 percent over the next five years “wouldn’t surprise me at all.”

Analysts at Altos Research have a more optimistic – or at least, somewhat less pessimistic – view. Scott Sambucci, vice president of market analytics for the company, sees a “catfish” recovery. Like a catfish, he says, the market will creep along the bottom, surfacing periodically (and unpredictably) and then heading down again. The movement won’t have a “clear pattern or distinct trend,” he told reporters, “but if you understand volatility, there are possibilities to make money on these inflection points.”

The scenario Sambucci describes may offer opportunities for savvy investors with available cash, but it spells continued pain for homeowners struggling with properties that have declined in value, worth less now than they paid and, in many cases, less than the outstanding mortgage on them. A recent study by CoreLogic estimates that 22.7 percent of homeowners with mortgages – nearly 11 million owners – were underwater on their loans at the end of March.

“The implication is that there are still a lot of people who are at risk of default, so delinquency and default rates are going to reflect that large amount of negative equity for some time to come,” Jan Hatzius, chief U.S. economist for Goldman Sachs Group, told the Wall Street Journal.

Even under the most optimistic forecasts for economic growth – and current forecasts are becoming less optimistic by the day – the supply of homes will continue to outstrip buyer demand for the next year or more. The NAR estimates that it would take 9.2 months to absorb the backlog at the current sales pace, and that doesn’t count the “shadow inventory” of pending or soon-to-be-pending foreclosures, that will add another 4.5 million homes to the mix, according to some estimates.

Susan Wachter, a professor of real estate at Wharton, sees a “glimmer of hope” in the recent slowing of the foreclosures pace. But that hope is tempered by the reality that even if the foreclosure pressure eases, home prices will continue to fall. "The spring of 2011, when we were supposed to see a housing recovery, has been postponed," she noted recently in an interview on a Wharton Web site, adding, “we are three, four, or five years away from being back to what might be considered normal.”