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Chairman Bernanke's Testimony: Easing is on the table, but inflation remains a concern

Thu, Feb 28 2008, 00:53 GMT
by Asha Bangalore

Northern Trust

Chairman Bernanke’s Testimony: Easing is on the table, but inflation remains a concern

Bernanke’s testimony addressed expected issues, the only surprise was that his remarks about inflation were quite extensive. A lower federal funds rate is nearly certain on March 18, with the February employment report, auto sales, auto retail sales, and financial market conditions determining the magnitude of the rate cut. Following a repetition of the FOMC’s forecasts, previously published, Bernanke noted that “the risks to this outlook remain to the downside. The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further,” which ensures additional easing.

Speaking about the risks with regard to inflation, he summarized his concern as follows:
“The rate of inflation that is actually realized will of course depend on a variety of factors. Inflation could be lower than we anticipate if slower-than-expected global growth moderates the pressure on the prices of energy and other commodities or if rates of domestic resource utilization fall more than we currently expect. Upside risks to the inflation projection are also present, however, including the possibilities that energy and food prices do not flatten out or that the pass-through to core prices from higher commodity prices and from the weaker dollar may be greater than we anticipate. Indeed, the further increases in the prices of energy and other commodities in recent weeks, together with the latest data on consumer prices, suggest slightly greater upside risks to the projections of both overall and core inflation than we saw last month. Should high rates of overall inflation persist, the possibility also exists that inflation expectations could become less well anchored. Any tendency of inflation expectations to become unmoored or for the Fed's inflation-fighting credibility to be eroded could greatly complicate the task of sustaining price stability and could reduce the flexibility of the FOMC to counter shortfalls in growth in the future.” Inflation expectations, as measured by the difference between the nominal Treasury note yield and the Treasury Inflation-Protected securities, have risen noticeably since the lows seen in January 23 (see chart 1). The Fed is watching this closely to assess whether inflation expectations remain well anchored.

New Homes: Sales and Prices Decline, Inventories Keep Climbing

The story and headlines about new and existing homes are identical. Sales of new single-family homes fell 2.8% to an annual rate of 588,000 in January, the lowest since February 1995. On a year-to-year basis, sales of new single-family homes have dropped 34.9% in January. Sales of new single-family homes have now fallen 57.7% from the high seen in July 2005 (1.389 million annual rate).

A turnaround in home sales in the very near term is not imminent, with a possibility of stabilization only in the final months of 2008. A handy way to evaluate the extent of the underlying weakness is from inventories of unsold homes. Unfortunately, inventories of unsold homes, both existing and new homes, have risen significantly (see chart 3). There was a 9.9-month supply of unsold new homes and a 10.1-month supply of existing homes in January.

Consequently, the inventory situation has translated into a sharp reduction in prices of both existing and new single-family homes. The median price of a new single-family home fell 1.5% from December to $216,000 but it has fallen 15.1% from a year ago, the largest drop on record.

The supply situation in the market for homes is strongly discouraging because it is taking about 6.7 months to sell a completed home (highest since May 1992, see chart 5) and there is a record supply of new completed homes for sale (see chart 6) in the market. On a year-to-year basis, these numbers show a small improvement. However, the supply-demand situation is the housing market suggests additional price declines before the market stabilizes.

The combined sales of new and existing homes has fallen 35.4% from the peak established in July 2005 (7.629 million homes).

Durable Goods: Aircraft and Defense Led the Weakness in Orders

Orders of durable goods fell 5.3% in January after a 4.4% drop in December. A 19.9% decline in defense items after an 83% increase in December was part of the reason for the weakness in orders. In addition, orders for civilian aircraft fell 30.5% in January. Orders of non-defense capital goods excluding aircraft declined 1.4% in January following a 5.2% increase in the prior month. Among the major components of durable goods, orders of primary metals held steady and that of electrical equipment rose 1.4%. But, orders of machinery (-1.5%), computers and electronic products (-2.7%) and autos (-0.8%) fell in January.

Shipments of durable goods advanced 1.8% in January after two consecutive declines. A large part of the increase in shipments was from computers and electronic products (+7.1%) and electrical equipment (+2.5%).

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Published on  Thu, Feb 28 2008, 00:59 GMT