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Federal Reserve Chairman Ben Bernanke testified before the U.S. Senate’s Committee on the Budget on January 7th and was mildly optimistic about the economic recovery, saying “we have seen increased evidence that a self-sustaining recovery in consumer and business spending may be taking hold.” The Chairman reiterated the Fed’s commitment to its $600 billion asset purchase program, which is currently slated to run through June. Finally, he addressed fiscal policy, commenting that “the federal government is on an unsustainable fiscal path,” and in testimony following his speech, rejected the possibility that the Fed would step in to aid state and local governments should finances further deteriorate and bailout requests arise. Short term interest rates are expected to remain low into 2012, though more volatility may be expected as the Federal Reserve ends the QE2 program and eventually unwinds its balance sheet.
Residential Housing The residential housing market has shown few signs of improvement since the expiration of the first-time and existing home buyer tax credit in April. December housing starts fell 4.3% as single-family home starts fell to the lowest level in 14 months. Building permit applications, an indicator of future construction activity, jumped 17% in December, after hitting a 19-month low the month prior. New home sales vaulted 17.5% in December, driven by a $10,000 tax credit in California for purchasers of new homes that signed contracts by the end of 2010. The median price of a new home sales was up 8.5% from a year earlier. Existing home sales increased 12.3% in December and supply declined, bringing the current inventory down to an 8.1 months’ supply from 9.5 months in November. Distressed sales, however, accounted for 36% of existing home sales as the market struggles to gain footing. Spending In its first reading of Q4 GDP, the government reported that the economy expanded at a 3.2% annualized pace, above Q3’s 2.6% reading but below expectations of 3.5% growth. Consumer spending grew 4.4%, marking the fastest rate of growth in more than four years. Personal spending grew 0.7% in December after a 0.4% increase in the previous month. The University of Michigan’s final January gauge of consumer sentiment fell slightly to 74.2 from 74.5 in December and the measure of expectations for six months in the future rose to a 7-month high, increasing to 69.3 from 67.5. Retail sales rose for the sixth consecutive month in December, gaining 0.6%, while sales excluding autos, gasoline and building materials, the figure used in the calculation of GDP, grew 0.2%. Consumer credit unexpectedly surged by $7.0 billion in November as non-revolving debt, such as auto loans, grew $5.6 billion. Revolving debt, such as credit card debt, fell for the 27th consecutive month. On the business front, recent data from the manufacturing sector has been strong. In December, the ISM manufacturing index increased to 57.0, where readings above 50 indicate expansion, marking the highest level in 7 months. The ISM’s non-manufacturing index climbed more than expected in December to 57.1, which marked the fastest pace of expansion since May 2006 and the 12th consecutive month in expansion territory. Orders for durable goods fell in December, contracting 2.5%, though the less volatile figure for orders less transportation improved 0.5%, following a 4.5% increase in November. The Chicago Purchasing Managers Index for December rose to the highest level in 20 years as the employment measure, the gauge of new orders and the production index were all higher than the previous month. The December report accelerated even more sharply than the previous month as employment, new orders and production jumped several points each. The trade deficit unexpectedly shrank in November, falling 0.3% to $38.3B on strong growth in exports due to the weakening dollar. Labor Market The unemployment rate fell 0.4% to 9.4% in December, as total nonfarm payrolls disappointed, increasing by 105,000, compared to expectations of a 135,000 gain. The underemployment rate, which includes people who have given up looking for work and those working part-time for economic reasons, fell slightly to 16.7%. Initial jobless claims have gradually increased throughout January and the January 27th reading of 454,000 was attributable to a delay in filings from the prior week due to winter weather. Inflation Overall price pressures remain well below the Fed’s targets, allowing QE2 to continue unabated. The consumer price index (CPI) rose more than expected in December, increasing 0.5% after a 0.1% increase in the previous month and core CPI increased 0.1% after a matching gain in November. While overall consumer prices were up just 1.5% last year, core inflation was the lowest on record over the same time period. The producer price index grew 1.1% in December, while core PPI increased 0.2%. For all of 2010, core consumer prices were up 4%, while core producer prices were up 1.3%. The Fed’s preferred inflation gauge, the core personal consumption expenditures index, was unchanged in December and was up 0.7% from year-ago levels, the smallest year-over-year gain on record. The next FOMC meeting is scheduled for March 15th. With the Fed lowering their expectations for economic growth and continuing QE2 purchases, market participants currently expect the FOMC to leave the overnight lending rate unchanged until 2012.
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