Chairman Bernanke will testify about the economy on February 14 and 15. The FOMC policy statement of January 31 retained the hawkish posture of prior statements and inflation was cited as the major concern while considerations about growth remained on the radar screen.
Based on incoming new information, real GDP growth of the fourth quarter is most likely to be revised down substantially because the contribution of wholesale inventories assumed in the advance estimate was higher than actual estimates of wholesale inventories. Therefore, the economy did not grow as rapidly as the advance estimate implies.
Core inflation is decelerating but it is still above the FOMC’s comfort zone. 1.0% - 2.0% core inflation is the Fed’s preferred range of core inflation. The core personal consumption expenditure price index rose 2.22% in December, down 22 bps from the 2.44% peak of August 2006.
The core CPI, all items less food and energy, increased 2.57% in December, which is a deceleration of core prices from a peak of 2.93% in September. A large part of the upward trend in the core CPI is from the rent component. Core CPI less homeowner’s equivalent rent advanced 4.3% in December 2006 vs. a 2.46% reading in December 2005. Excluding homeowner’s equivalent rent, the core CPI moved up 1.82% in December on a year-to-year basis (se chart 2). In other words, the there was a 75 bps difference between the overall core CPI and core CPI excluding homeowner’s equivalent rent in December 2006.
The prospect of a significant moderation in the rent component of CPI is large because the number of vacant homes without owner’s residing in them is at a record high mark (see chart 3).
At the same time, labor compensation measures are sending conflicting signals. Hourly earnings data and the Employment Cost Index (ECI) show that wages gains are stabilizing (see chart 4).
But unit labor costs and compensation per hour tell a less satisfying story (chart 5).
The housing sector remains at the center of macroeconomic policy. There is mixed opinion about what the latest numbers have to say about the housing market. The Fed presented its view in the minutes of the December FOMC meeting that the ripple effects of the housing downturn are contained. Bernanke’s latest view about the housing market will be one of the areas of interest to financial markets. In our opinion, the bottom of the housing market is ahead (see comments of February 8, 2006). Sales of new homes rose in November and December and sales of existing homes advanced in October and November but lost ground in December. Housing market data are partly misleading because cancellations are not reflected in sales or inventories data. Also, many discouraged homeowners may have decided to remove the “for sale” signs after disappointing bids or weak traffic of potential buyers.
Stay tuned for comments on Bernanke’s testimony on February 14 and 15.
