Article: National Economic Conditions - 1st Quarter 2012

The FOMC determined in March that it is “appropriate to maintain the existing highly accomodative stance of monetary policy.”[3] As a result, the target range for the federal funds rate remained unchanged at 0% to 0.25%, and the FOMC does not anticipate any changes to the range in the near future:

…[the Committee] currently anticipates that economic conditions—including low rates of resource utilization and a subdued outlook for inflation over the medium run—are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.[4]

GROSS DOMESTIC PRODUCT

The most commonly cited measure of general economic conditions is growth in real GDP. Real GDP is the real (adjusted for inflation) dollar value of all goods and services produced within the country in a given period. The Bureau of Economic Analysis (“BEA”) quarterly measure of real GDP is seasonally-adjusted at annual rates (SAAR), which means that the figure has been annualized with seasonal effects removed.

The following table summarizes historical rates of growth in GDP:

[5]

The increase in real GDP in the first quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, private inventory investment, and residential fixed investment that were partly offset by negative contributions from federal government spending, nonresidential fixed investment, and state and local government spending. Imports which are a subtraction in the calculation of GDP, increased. The deceleration in real GDP in the first quarter primarily reflected a deceleration in private inventory investment and a downturn in nonresidential fixed investment that were partly offset by accelerations in PCE and in exports.[6]

In the April release of the FOMC’s Summary of Economic Projections, participants predicted that real GDP growth would have central tendencies between 2.4% and 2.9%, between 2.7% and 3.1%, and between 3.1% and 3.6% during 2012, 2013, and 2014, respectively. In its longer-run projection, the FOMC predicted that real GDP growth would have a central tendency between 2.3% and 2.6% (consistent with its previous projection).[7]

First quarter projections of GDP, as provided by the Philadelphia Federal Reserve Survey of Professional Forecasters (the “Philly Survey”) and the April Wall Street Journal Survey of Economic Forecasters (the “WSJ Survey”), are summarized in the table below:

[8]

The majority of economists agree that the primary catalyst of the first quarter growth in real GDP was a significant increase in consumer spending. The 2.9% increase in consumer spending in the first quarter was fueled primarily by savings, “with Americans stashing away cash at a slower 3.9 percent rate, compared to 4.5 percent in the fourth quarter.”[9] Despite decreased savings, the increase in consumer spending convinced many economists that improvements in the performance of GDP during the upcoming quarters are possible. Economists’ expectations of future expansion, however, are largely predicated on the assumption that certain economic factors will progress beyond their subpar performances in the first quarter. According to a Wall Street Journal report, these areas of improvement include business investment (corporate spending) and government spending:

…many sectors that once helped drive the recovery are now becoming a drag on growth. Nonresidential fixed investment – a measure of business spending on everything from factories to computers – fell for the first time in more than two years…Government spending, which helped prop up the economy during the recession, has also become a big drag in recent years.”[10]

For the first time since the fourth quarter of 2009, aggregate business purchases fell. Although a number of economists believe the decline is temporary (as it is most likely attributable to the expiration of certain corporate tax incentives), “business spending fell at a 2.1 percent pace after rising 5.2 percent in the fourth quarter.”[11] Furthermore, government purchases, which dropped for a sixth straight quarter, declined 5.6% in the first quarter of 2012 after falling 6.9% in the fourth quarter of 2011.

The Wall Street Journal article also indicated that some economists have their doubts regarding the sustainability of elevated consumer spending over the coming quarters:

…the acceleration in consumer spending is likely to be fleeting. After three consecutive months of relatively strong job growth, employers added fewer workers in March, and a recent uptick in layoffs suggest the sluggish growth likely continued in April. Disposable income barely grew in the first quarter, forcing workers to save less in order to keep up their spending.[12]

Despite concerns of weak growth in the near future, the U.S. economy’s first quarter performance indicates that conditions in the U.S. are far better than the prevailing economic conditions of several major countries, including the United Kingdom, which slipped into its first double-dip recession since the 1970’s.

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The FOMC downplayed fears that the economic situation in Europe would have a negative impact on the US economy:  “…recent policy actions in the euro area had helped reduce financial stresses and lower downside risks in the short term; however, increased volatility financial markets remained a possibility if measures to address the longer-term fiscal and banking issues in the euro area were not put in place in a timely fashion.”[14]

PRICES AND INFLATION

Inflation is the increase in the general price level of goods and services in an economy. The Consumer Price Index (CPI) is the most commonly cited measure of inflation. The CPI measures the price of a standard market basket of goods designed to be representative of the items purchased by a typical urban consumer.

The following table summarizes historical rates of change in the CPI for all items:

[15]

The table below summarizes the near-term projections for the CPI (as provided by the Philly Survey and the WSJ Survey):

[16]

The Bureau of Labor Statistics (BLS) also provides consumer price indexes for major groups of consumer expenditures, including (among others) food, energy, and all items less food and energy (the BLS provides indexes for items within each group, and for special categories).

The following table summarizes historical rates of change in the different categories of the CPI:

[17]

The indexes for food, energy, and all items less food and energy all increased in March. The gasoline index continued to rise, more than offsetting a decline in the household energy index and leading to a 0.9 percent increase in the energy index. The food index rose 0.2 percent as the index for meats, poultry, fish, and eggs increased notably…The index for all items less food and energy rose 0.2 percent in March after increasing 0.1 percent in February. Most of the major components increased in March, with the indexes for shelter and used cars and trucks accounting for about half the total increase for all items less food and energy.[18]

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Despite recent increases in the price of oil and gasoline, the FOMC generally expects the changes in inflation to match prior expectations:

With longer-run inflation expectations still well anchored, most participants anticipated that after the temporary effect of the rise in oil and gasoline prices had run its course, inflation would be at or below the 2 percent rate that they judge most consistent with the Committee’s dual mandate. Indeed, a few participants were concerned that, with the persistence of considerable resource slack, inflation might be below the mandate-consistent rate for some time. Other participants, however, were worried that inflation pressures could increase as the expansion continued; these participants argued that, particularly in light of the recent rise in oil and gasoline prices, maintaining the current highly accommodative stance of monetary policy over the medium run could erode the stability of inflation expectations and risk higher inflation.[20]

Producer Price Index

The Producer Price Index (PPI) is another commonly cited measure of inflation. The PPI measures the price of a standard market basket of goods designed to be representative of the items purchased by a typical producer.

The following table summarizes historical changes in the PPI:

[21]

The Producer Price Index for finished goods was unchanged in March [on a month-over-month basis], seasonally adjusted, the U.S. Bureau of Labor Statistics reported today. Finished goods prices rose 0.4 percent in February and 0.1 percent in January. At the earlier stages of processing, prices received by manufacturers of intermediate goods climbed 0.7 percent in March, and the crude goods index declined 2.5 percent. On an unadjusted basis, prices for finished goods moved up 2.8 percent for the 12 months ended March 2012, the smallest year-over-year increase since a 2.7-percent rise in June 2010.[22]

[23]

Average Price per Barrel of Oil

The following table summarizes historical oil prices:

[24]

The WSJ Survey projects the price per barrel of oil will be $103.92 by June 30, 2012. It further projects the price per barrel of oil to be $104.01 by December 31, 2012.[25]

IBISWorld expects that the price per barrel of oil will experience annual changes of approximately 11.4%, 0.0%, 4.7%, and 3.5% in 2012, 2013, 2014, and 2015, respectively. Over the five years to 2017, IBISWorld expects the price per barrel of oil will grow at an average annual rate of approximately 2.9%.[26]

 [27]

TRADE DEFICIT

The following table summarizes historical fluctuations in the level of real net exports:

[28]

The table below summarizes the near-term projections for real net exports (as provided by the Philly Survey):

[29]

Net exports of goods and services is the difference between U.S. exports of goods and services and U.S. imports of goods and services. Exports measures the portion of total U.S. production of goods and services—gross domestic product (GDP)—that is provided to the rest of the world…Imports measures the portion of total U.S. expenditures—gross domestic purchases—that is accounted for by goods and services provided by the rest of the world…The impact of imports on the U.S. economy depends on the degree to which they act as substitutes for, or as complements to, domestic production.

Together, the two measures reflect the extent to which the United States participates in the global marketplace, which provides broad opportunities for specialization and other economic efficiencies.[30]

 [31]

INTEREST RATES

In general, interest rates remained stable during the first quarter of 2012.

Federal Funds

The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.

The following table summarizes historical changes in the federal funds rate:

[32]

The minutes to the FOMC’s March meeting provides a review of the participants’ agreement to continue a target range for the federal funds rate of 0% to 0.25%:

…members agreed that it would be appropriate to maintain the existing highly accommodative stance of monetary policy. In particular, they agreed to keep the target range for the federal funds rate at 0 to ¼ percent, to continue the program of extending the average maturity of the Federal Reserve’s holdings of securities as announced in September, and to retain the existing policies regarding the reinvestment of principal payments from Federal Reserve holdings of securities.[33]

Bond Yields and Fixed-Rate Home Mortgages

The following table summarizes historical changes in the yields to maturity for 20-year U.S. Treasuries and Aaa rated (Moody’s) Corporate bonds:

[34]

Discount Window

The discount window rate remained constant at 0.75%, as it had for the majority of 2010 and for all of 2011. The 0.75% rate is an increase from the rate of interest prevalent throughout 2009 (0.50%), a historically low rate that was the result of a downward trend that began in July 2007 (6.25%).[35]

The following table summarizes historical variations in the discount window rate:

[36]

The Discount Window functions as a safety valve in relieving pressures in reserve markets; extensions of credit can help relieve liquidity strains in a depository institution and in the banking system as a whole. The Window also helps ensure the basic stability of the payment system more generally by supplying liquidity during times of systemic stress.[37]

 [38]

FINANCIAL MARKETS

Each of the major financial market indices (i.e., Dow Jones Industrial Average, S&P 500, and NASDAQ) increased during the first quarter of 2012 (from December 31, 2011 to March 31, 2012).

Dow Jones Industrial Average

The Dow Jones Industrial Average (DJIA) is an index of the relative fluctuations in the share prices of thirty major industrial companies, many of which are traded on the New York Stock Exchange. In general, fluctuations in the average provide investors with a broad picture of the state of the market.

The following table summarizes historical fluctuations in the DJIA:

[39]

The DJIA peaked on October 11, 2007 at 14,279.96 and then reached a recent low of 6,440.08 on March 9, 2009.[40]

S&P 500

The S&P 500 is an index of 500 stocks (which are chosen based on factors including market size, liquidity, and industry grouping) that is designed to provide a leading indicator of U.S. equities as well as reflect both the risk and return characteristics of the large cap universe.

The following table summarizes historical fluctuations in the S&P 500:

[41]

The S&P 500 hit a recent high of 1,576.09 on October 11, 2007 and a recent low of 666.79 on March 6, 2009.[42]

NASDAQ

The NASDAQ Composite Index (NASDAQ) is a market-cap weighted index of the more than 3,000 common equities listed on the NASDAQ stock exchange. Unlike other market indices, the NASDAQ is not limited to companies that have U.S. headquarters.

The following table summarizes historical fluctuations in the NASDAQ:

[43]

The NASDAQ reached a pre-recession high of 2,859.12 in October of 2007, and it bottomed at 1,265.62 on March 9, 2009. The NASDAQ is the only major index to have exceeded its pre-recession high, climbing to 3,134.17 on March 27, 2012.[44]

[45]

HOUSING, CONSTRUCTION, AND REAL ESTATE

In February 2012, the average 30-year conventional mortgage rate reached an all-time low of 3.89%. Despite this unprecedented mark, the U.S. housing market demonstrated few signs of improvement as housing starts, homes for sale, houses sold, and the total months of supply of homes for sale decreased during the first quarter.

Mortgage Rates

The following table summarizes historical changes in the average 30-year conventional mortgage rate:

[46]

According to IBISWorld, the average annual 30-year conventional mortgage rates during 2010 and 2011 were approximately 4.69% and 4.50, respectively. Moreover, IBISWorld projects average annual 30-year mortgage rates of 44.43%, 4.95%, 5.22%, 5.30%, and 5.45% during the five years to 2017, respectively.[47]

[48]

Housing Starts

Housing starts hit a recent peak of 2.3 million (seasonally-adjusted at annual rates, SAAR) in January 2006 and a recent low of 477 thousand (SAAR) in April 2009. During the first quarter of 2012, housing starts total approximately 654 thousand (SAAR).[49]

The following table summarizes historical fluctuations in the total number of housing starts:

[50]

The Philly Survey projects total housing starts will reach an annual rate of approximately 680,000 in the second quarter of 2012, and then grow to starts totaling 710,000, 740,000, and 770,000 in the third and fourth quarters of 2012 and first quarter of 2013, respectively. The Philly Survey estimates that in 2011 there were approximately 610,000 housing starts. In addition to its quarterly projections, the Philly Survey predicts annual housing starts will total 700,000 in 2012.[51]

As of April, the WSJ Survey predicts that annual housing starts will reach 740,000 in 2012.[52]

Houses Sold

The July 2005 rate of approximately 1.4 million (SAAR) houses sold was the highest in recorded history (with data dating back to January 1963) and the August 2010 rate of 278 thousand (SAAR) houses sold was the lowest. During the first quarter of 2012, the number of houses sold totaled approximately 328 thousand.

The following table summarizes historical fluctuations in the total number of houses sold:

[53]

Houses for Sale

The total number of houses for sale at the conclusion of the first quarter of 2012 (144 thousand) is the lowest figure in a recorded history that dates back to January 1963. In comparison, the total number of houses for sale reached an all-time high of 572 thousand in July 2006.

The following table summarizes historical fluctuations in the total number of houses for sale:

[54]

Months of Supply of Houses for Sale

The months of supply of houses for sale represents the number of months it would take to sell all of the houses currently up for sale at the existing sales rate (seasonally adjusted). The months of supply of houses for sale reached a peak of 12.1 in January 2009 (with data dating back to January 1963) and a low of 3.5 several times throughout the measure’s recorded history (most recently in August 2003).

[55]

In a January 4, 2012 white paper, written by Ben Bernanke (Chairman of the Federal Reserve Board of Governors) and addressed to the Chairman and Ranking Member of the Committee on Banking, Housing, and Urban Affairs (of the U.S. Senate), Mr. Bernanke provides the following conclusion regarding the current conditions of, and policy considerations specific to, the U.S. housing market:

The challenges faced by the U.S. housing market today reflect, in part, major changes taking place in housing finance; a persistent excess supply of homes on the market; and losses arising from an often costly and inefficient foreclosure process (and from problems in the current servicing model more generally)… Thus, the challenge for policymakers is to find ways to help reconcile the existing size and mix of the housing stock and the current environment for housing finance.

… Restoring the health of the housing market is a necessary part of a broader strategy for economic recovery. As this paper suggests, however, there is unfortunately no single solution for the problems the housing market faces. Instead, progress will come only through persistent and careful efforts to address a range of difficult and interdependent issues.[56]

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UNEMPLOYMENT 

The unemployment rate reflects the numbers of persons unemployed as a percent of the labor force. The Department of Labor Bureau of Labor Statistics defines “unemployment” as the following:

Persons are classified as unemployed if they do not have a job, have actively looked for work in the prior 4 weeks, and are currently available for work. Persons who were not working and were waiting to be recalled to a job from which they had been temporarily laid off are also included as unemployed. Receiving benefits from the Unemployment Insurance (UI) program has no bearing on whether a person is classified as unemployed.[58]

The following table summarizes historical fluctuations in the rate of unemployment:

[59]

In its April 2012 Summary of Economic Projections, the FOMC projected the unemployment rate would have central tendencies between 7.8% and 8.0%, between 7.3% and 7.7%, and between 6.7% and 7.4% during 2012, 2013, and 2014, respectively. The FOMC projects the longer-run central tendency for the unemployment rate will be between 5.2% and 6.0%.[60]

The Philly Survey projects average annual unemployment rates of 8.3%, 7.9%, and 7.4% over the three years to 2014, respectively.[61]

The WSJ Survey predicts the unemployment rate will be 8.2% at June 2012, with the rate declining over the course of this year and the next to 8.0% at December 2012 and 7.7% at June 2013.[62]

Although the unemployment rate has declined in recent months, many analysts continue to express concern over the painfully slow rate at which unemployment is dropping. Brian Hamilton, CEO of the financial information company Sageworks, provided some perspective on the pace of contraction in the unemployment rate:

Historically, it has taken approximately 12 to 20 months for unemployment to fall in an expansion to roughly pre-recession levels. Right now, we are into the 34^th month of the recovery, and, yet unemployment remains too high.[63]

The FOMC expressed similar ambivalence to improvements in the unemployment rate during its meeting in March:

Labor market conditions had continued to improve and unemployment had declined in recent months, but almost all members saw the unemployment rate as still elevated relative to levels that they viewed as consistent with the Committee’s mandate over the longer run. With the economy facing continuing headwinds, members generally expected a moderate pace of economic growth over coming quarters, with gradual further declines in the unemployment rate.[64]

[65]

FORWARD LOOKING INDICATORS

The Index of Consumer Sentiment (ICS) is a measure of overall consumer expectations and a predictor of consumer spending and economic conditions. A higher ICS indicates that consumers have higher confidence in the economy and are consequently more likely to spend. Similar in its efforts to predict future economic activity, the Conference Board’s Leading Economic Index (LEI) is a signalling measure of the business cycle in which cyclical turning points of the LEI have historically taken place “before those in aggregate economic activity.” The LEI is an average of ten “leading” indicators.[66]

Index of Consumer Sentiment

With data dating back to November 1952, the ICS reached an all-time high of 112.0 in January 2000 and a low of 51.7 in May 1980. At the conclusion of the first quarter 2012, the ICS totaled 76.2.

The following table summarizes historical fluctuations in the ICS (no annual data is available):

[67]

Richard Curtin, the Survey of Consumers’ chief economist, acknowledged the increase in consumer confidence in March, but warned against overconfidence:

Although consumers are not yet optimistic about future economic pros-pects, pessimism has recently faded at a rapid pace. Perhaps too rapidly, as expected job and income gains may be unrealistically high for the economy to meet. Typically those least affected by the downturn can create enough activity to maintain upward economic momentum. This time it will be more challenging as housing gains can be expected to remain sluggish as record numbers reported they would lose money if they sold their home to purchase another, and upper income households may hesitate in the months ahead due to uncertainties about next year’s taxes.[68]

 [69]

Leading Economic Index

The LEI for the U.S. increased 0.3% in March to 95.7 (2004 = 100) after increases of 0.2% and 0.7% in January and February of this year, respectively.

The following excerpt regarding the release of March’s LEI was offered by Ken Goldstein, an economist at The Conference Board:

Despite relatively weak data on jobs, home building and output in the past month or two, the indicators signal continued economic momentum. We expect a gradual improvement in growth past the summer months.[70]

INDUSTRIAL PRODUCTION

According to the Federal Reserve, the index of industrial production measures the real output of the manufacturing, mining, and electric and gas utilities industries (the reference period for the index is 2007).[71] The capacity utilization rate measures the usage of the total production capacity for 89 detailed U.S. industries (71 in manufacturing, 16 in mining, and 2 in utilities). The capacity utilization rate is calculated by dividing the seasonally-adjusted output index by the capacity index of these industries.[72] In general, the industrial detail provided by these measures helps illuminate structural developments in the economy.

Industrial Production[73]

The following table summarizes historical fluctuations in the industrial production index:

[74]

The Philly Survey predicts the index will increase 3.4%, 3.1%, 3.0%, and 3.3% in the second, third, and fourth quarters of 2012 and the first quarter of 2013, respectively. On an annual basis, the Philly Survey anticipates the index will increase 3.5% and 3.3% in 2012 and 2013, respectively.[75]

Capacity Utilization

The following table summarizes historical fluctuations in the capacity utilization rate:

[76]

At its March meeting, the FOMC attributed the expansion of economic activity in the first quarter, in part, to an increase in capacity utilization:

Manufacturing production increased considerably in January, and the rate of manufacturing capacity utilization stepped up. Factory output was boosted by a sizable expansion in the production of motor vehicles, but there also were solid and widespread gains in other industries. In February, motor vehicle assemblies remained near the strong pace recorded in January; they were scheduled to edge up, on net, through the second quarter. Broader indicators of manufacturing activity, such as the diffusion indexes of new orders from the national and regional manufacturing surveys, were at levels suggesting moderate increases in factory production in the coming months.[77]

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DISCLAIMER STATEMENT

This Decosimo Advisory Services National Economic Conditions report summarizes general economic conditions as of March 31, 2012. It was prepared as of May 2, 2012. Information was gathered from sources we believed to be reliable using data available as of the date shown in the respective footnote. DAS accepts no responsibility for the accuracy of information provided in this summary. No statement in this report is to be considered advice for any purpose. It is the responsibility of the user of this report to verify the accuracy of the information herein and to relate the information contained herein to the particular application of its use. Tables of Data referenced in footnotes are available upon request from Decosimo Advisory Services.