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Daily Global Commentary

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Fed On Hold, Arguments in Favor of Policy Supporting Growth Outweigh Inflation Concern

Tue, Aug 26 2008, 23:18 GMT
by Asha Bangalore

Northern Trust

Fed On Hold, Arguments in Favor of Policy Supporting Growth Outweigh Inflation Concern

The main message from the minutes of the August 5 FOMC meeting is that the Fed is on hold for several meetings, barring unexpected developments. That said, the minutes lean toward favoring policy supportive of economic growth in the inflation-growth debate. Inflation did feature extensively, but growth and financial market stability are at the top of the list of concerns. The concern about inflation expectations appears overdone because, for now, the market is less concerned about inflation (see chart 1) than a few weeks ago.

It is also interesting to note the following:
“Most members did not see the current stance of policy as particularly accommodative, given that many households and businesses were facing elevated borrowing costs and reduced credit availability due to the effects of financial market strains as well as macroeconomic risks. Although members generally anticipated that the next policy move would likely be a tightening, the timing and extent of any change in policy stance would depend on evolving economic and financial developments and the implications for the outlook for economic growth and inflation.”

New Home Sales and Home Price Indexes

Sales of new single-family homes increased 2.4% to an annual rate of 515,000 in July, after a revised sales mark of 503,000 in June (previously estimated as 530,000). Sales of new homes in May were also revised to 514,000, down from the earlier count of 533,000. Effectively, the sales pace is still lower than the April reading of 542,000. The level of new home sales is close to the cycle low of 513,000 set in March 2008. Sales of new single-family homes are down nearly 63% from the peak in July 2005.

On a regional basis, sales of new single-family homes rose sharply in the Northeast (+38.9%) and West (+9.9%) but dropped in the South (-2.5%) and Midwest (-8.2%). The median price of a single-family home rose to 230,700 from $230,300 in June but fell 6.3% from a year ago. The pace of decline in the median price of a new single-family home has accelerated from a 2.3% drop in June.

A large part of the reason for the continued drop in prices is the elevated level of inventories. There was a 10.1-month supply of unsold new homes in the marketplace in July, down from a 10.7-month supply in June but still very bothersome (see chart 4). The median number of months to sell a home was longer in July (8.5 months) compared with June (8.3 months).

After several months of declining sales and prices, what is the status of the market for new homes? The inventory situation and the home builders survey point to more gloomy news in the months ahead.

In other related news, the Case-Shiller and OFHEO Price Indexes were published this morning. The Case-Shiller Home Price Index fell 15.4% on a year-to-year basis in the second quarter compared with a 14.2% drop in the first quarter and a 9.0% drop in the fourth quarter of 2007. These numbers are pointing to a moderation in the pace of decline in home prices.

The OFHEO Price Index sends a similar message of a slower drop in prices in the second quarter (-4.8% year-to-year change) compared with the first quarter (-3.0% and -0.6% in 2007:Q4). But, as mentioned earlier, the July median price for new and existing homes fell more sharply in July compared with June. Information about the Case-Shiller Home Price Index for July will be published on September 30.

Consumer Confidence Gains, But Details Are Not Encouraging

The Conference Board’s Consumer Confidence Index rose to 56.9 in August vs. 51.9 in July. The decline in oil price appears to have helped in improving the outlook of consumers. The Present Situation Index (63.2 vs. 65.8 in July) fell but the Expectations Index (52.8 vs. 42.7 in July) advanced.

However, the number of respondents viewing jobs as hard to get advanced to 32.0% from 30.2% in July and those indicating plentiful fell to 13.1% from 13.6% in July. The net of these two indexes rose to 18.9 from 16.6 in July, which suggests a higher unemployment rate in August.

German Data Suggest Euro-zone is Headed For Recession

So much for hope that Euro-zone growth will improve in Q3. Data releases from Germany today underline the fact that the ‘zone’s powerhouse economy is flirting with a technical recession, and the details of those releases point to negative developments for the Euro-zone as a whole.

The Ifo business climate index for August dropped to 94.8 from 97.5 in July, the weakest since June 2005. While this is still well above the lows recorded in late 2002, the last time Germany was headed into recession, the speed of the recent fall is disconcerting. Coming hard on the heels of last month’s plunge, the August fall brings the two-month decline to 7.5 points, the sharpest since reunification in 1990. The gauge of current conditions slipped from 105.6 to 103.2 while the expectations index dropped from 89.9 to 87.0, its lowest since February 1993. And, the sub-component on manufacturing fell from +2.0 in July to a surprisingly-weak -6.8 in August.

Today also brought confirmation of negative real GDP growth in Q2, with a contraction of 0.5% on the quarter (+3.1% on the year), weighed down by weaker private consumption and investment. Consumer spending was down 0.4% q-o-q, and although trade actually made a positive contribution to Q2 GDP this was only because imports fell by more than exports. Gross capital investment was also down 0.4%, although mostly thanks to the contraction in construction investment, with equipment investment unchanged on the quarter. This at least raises the hope that there is not a massive level of overcapacity that needs to be worked off, and that investment will recover by the end of this year.

Finally, GfK’s forward-looking consumer sentiment indicator fell to a new five-year low of 1.5 going into September, from a downwardly-revised 1.9 in August. While this is still above zero, signaling that private consumption growth should remain positive year-over-year, the trend is downward. With investments weakening and investment stalling, this underscores the risk that Germany will suffer a second consecutive quarter of negative real GDP growth in Q3, i.e., a technical recession.

And where does this leave the Euro-zone? Today’s Ifo release noted that German companies see a weaker export outlook. However, as noted last week, the latest Belgian National Bank business confidence index (a leading indicator for Euro-zone growth about six months out), had pointed to a more hopeful outlook for the ‘zone. Recall that the August reading nudged up to -5.9 from -7.6 in July. While the retail sales sub-component had dropped even further, from -12.5 to -14.2, the manufacturing sub-component had improved from -8.1 to -5.6.

So, the bad news is that the Euro-zone will almost certainly see a second quarter of contraction in Q3, with Germany, France, and Italy headed that way and Spain almost certain to drop into negative territory too. The good news is that, for now at least, it looks as if the ‘zone will stall rather than fall right off a cliff, implying signs of recovery could crop up by the end of this year. But watch those leading indicators.

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Published on  Tue, Aug 26 2008, 23:24 GMT