Thursday, January 27, 2011

What the Fed Sees, Beige Book Redux and Possible Potholes

From the latest Fed statement:

Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions. Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, while investment in nonresidential structures is still weak. Employers remain reluctant to add to payrolls. The housing sector continues to be depressed. Although commodity prices have risen, longer-term inflation expectations have remained stable, and measures of underlying inflation have been trending downward.

Last week I went over the latest Beige Book and added detail from various economic reports. The above paragraph sums up the overall situation pretty well, although I would add the following points.

1.) Consumer spending is actually stronger than reported. PCEs have regained the levels seen at the height of the last expansion. Purchases of non-durable and durable goods have moved past previous highs. Anyone who is arguing the consumer hasn't returned isn't looking at the data.

2.) Manufacturing has also rebounded and is doing well. The drop we saw as the result of the EU situation (and to a lesser extent the BP crisis) has ended.

3.) Services are also picking up, although the overall tone is more muted. We're seeing a pick-up in orders, but there is still a sense that the pick-up won't be permanent.

We have the following weak points moving forward.

1.) Housing is still a basket case and will be for some time. The inventory of existing homes on the market is still very large which will probably keep prices depressed for the foreseeable future.

2.) Oil prices. While prices have recently fallen, we're only a few dollars shy of $90/bbl which is a psychologically important level. True, OPEC has recently announced it will increase production, but they only control 40% of the world's oil supply. And, we're in a cheap dollar environment.

3.) Employment. The current economic cycle is actually similar to the last two recoveries where employment growth was delayed at least a year after the end of the recession. In addition, it's important to remember that the last time we saw unemployment at these levels (the 1980s) it took an entire decade to hit full employment.

4.) China is experiencing higher than desired inflation, leading many to conclude they will start to take more aggressive interest rate action, thereby slowing their economy. Brazil is in the same boat as is India. In other words, the BRIC economies who have driven the recovery will probably start trying to slow their growth to prevent overheating.

5.) U.S. Congress. My God, but this institution continues to lower the bar regarding the definition of stupid. During my lifetime, I have seen the quality of Congressional representative continually decline to the current level of "lobotomy required to serve." God knows what kind of idiotic ideas they've got up their sleeve, but rest assured it will continue to redefine the word "incompetent." As such, Congressional action could conceivably screw up the recovery through some hair-brained scheme.