Posted on 10/18/2007, 7:18:16 AM by bruinbirdman
Wednesday’s data on housing and inflation and the beige book survey of business sentiment make it more likely that the Federal Reserve will cut interest rates again when it meets at the end of this month.
This is not because the Fed places much emphasis on individual data points, but because Wednesday’s releases appear to confirm two important themes in the economy.
First, the housing downturn is getting sharply worse.
Second, inflation remains contained, in spite of higher commodity prices and a weaker dollar.
The former argues in favour of taking out additional insurance on growth – with a further rate cut. The latter suggests that the cost of this insurance – the risk taken with inflation – may not be excessive.
The beige book, meanwhile, suggests that the economy lost momentum around the end of the third quarter. This is significant, because the third-quarter numbers themselves will be strong, with growth likely above 3 per cent.
Importantly, commercial real estate now looks softer. The beige book also largely echoes the message that “competitive pressures” are preventing companies from passing on higher input costs.
With nearly two weeks to go before the next Fed meeting, a rate cut is far from guaranteed, however.
There is still not much evidence that the housing recession is spilling over into consumer spending or that other sectors of the economy are suffering any direct impact from the credit squeeze.
The beige book notes that business contacts are “wary” but adds: “Few see much evidence of such spillovers at this time.”
As Fed chairman, Ben Bernanke observed in a speech this week, the non-mortgage side of the credit market has improved significantly since the September rate cut, reducing the likelihood of serious direct strains outside housing.
That takes away one big downside risk to the economy: a generalised credit crunch. Consistent with this, the labour market still seems to be holding up quite well.
Yet the other big downside, risk – an intensifying housing recession that drags down house prices and eventually infects consumer spending – looks as serious now as it did in September.
As Mr Bernanke said in his speech, the mortgage finance market remains highly dysfunctional. This suggests that housing will remain under pressure from the credit squeeze, as well as from excess inventory.
The Fed probably now sees house prices falling by a moderate amount – perhaps 2 to 5 per cent – over the next year or two, rather than remaining flat, with a sizeable risk of a sharper price fall. The US central bank does not of course target house prices, nor does it have the tools to reverse a deflating asset bubble.
There is still no evidence of spillovers from housing, and if the equity market holds up, some of the negative wealth effect from housing may be offset by stock gains.
But spillovers operate with time lags, and as long as housing keeps getting worse, the “tail risk” of a deepening economic downturn will remain substantial.
Federal Reserve Chairman Ben Bernanke has said that anecdotal reports are critical for Fed policymakers at the moment because government statistics are not timely enough to detect the impact of the financial turmoil on the real economy." ... Morningstar
My guess is no rate cut in October, but a 25 bp cut in December. Reasons being that inflation for September came in at 2.8%, a bit too high. Jobless numbers are not too bad. But agree housing crisis plus potential spillover will mean continued rate cuts for a while.
What on earth are they talking about? Our economy is fundamentally strong and diverse. These guys make it sound like our country can’t operate without endless amounts of cheap debt.............
A 76% chance of a .25 cut...
The best indicator for the past decade or so is, what is Wall Street clamoring for? The Fed does exactly what Wall Street wants, and telegraphs it quite clearly and for quite some time before the actual event. I don’t hear much institutional begging for another rate cut yet and we’re less than two weeks away.
They’re probably busy with Treasury working on that $75-$100B bailout proposal for Citibank, Morgan Stanley, et al.
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