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THE FED’S DIM VIEW OF THE ECONOMY

By Comstock Partners:

For some time we have been emphasizing the weakness of the economic recovery and the reasons why we think it is unsustainable.  Now you don’t have to take our word for it.  Just read the recently-released minutes for the FOMC March 16th meeting.  It essentially confirms most of the doubts we have about the prospects for meaningful economic growth in the period ahead.  For your convenience we quote the important points below.

The staff (made) modest downward adjustments to its projection for real GDP growth in response to the unfavorable news on housing activity, unexpectedly weak spending by state and local governments, and a substantial reduction in the estimated level of household income in the second half of 2009…housing starts.remained flat at a depressed level, investment in non-residential structures was still declining, and state and local government expenditures were being depressed by lower revenues.  Moreover, consumer sentiment continued to be damped by very weak labor market conditions, and firms remained reluctant to add to payrolls or to commit to new capital projects…participants also highlighted a variety of factors that would be likely to restrain the overall pace of recovery, especially in light of the waning effects of fiscal stimulus and inventory rebalancing over coming quarters.

“While recent data pointed to a noticeable pickup in the pace of consumer spending during the first quarter, participants agreed that household spending going forward was likely to remain constrained by weak labor market conditions, lower housing wealth, tight credit, and modest income growth.  For example, real disposable income in January was virtually unchanged from a year earlier and would have been even lower in the absence of a substantial rise in federal transfer payments  to households.  Business spending on equipment and software picked up substantially over recent months, but anecdotal information suggested that this pickup was driven mainly by increased spending on maintaining existing capital and updating technology rather than expanding capacity.

“…a few participants noted the possibility that fiscal retrenchments in some foreign countries could trigger a slowdown in those economies and hence weigh on the demand for U.S. exports…participants were concerned about the scarcity of job openings, the elevated level of unemployment, and the extent of longer-term unemployment, which was seen as potentially leading to a loss of worker skills.  Moreover the downward trend in initial unemployment claims appeared to have leveled off in recent weeks, while hiring remained at historically low rates.  Information from business contacts and evidence from regional surveys generally underscored the degree to which firms’ reluctance to add to payrolls or start large capital projects reflected their concerns about the economic outlook and uncertainty regarding future government policies.

“Participants were also concerned that activity in the housing sector appeared to be leveling off in most regions despite various forms of government support, and they noted that commercial and industrial real estate markets continued to weaken.  Indeed, housing sales and starts had flattened out at depressed levels, suggesting that previous improvements in these indicators may have largely reflected transitory effects from the first-time homebuyer tax credit rather than a fundamental strengthening of housing activity.  Participants noted that the pace of foreclosures was likely to remain quite high; indeed, recent data on the incidence of seriously delinquent mortgages pointed to the possibility that the foreclosure rate could move higher over coming quarters.  Moreover, the prospect of further additions to the already very large inventory of vacant homes posed downside risks to home prices”

The above paragraphs, quoted directly from the FOMC minutes, strongly support our negative views of the economic recovery, and repeat most of the themes we have been emphasizing in our past comments.  Given its views on the economy, it is abundantly clear why the Fed remains so reluctant to raise rates anytime soon.  The Fed’s view is also in direct contrast to the current optimism reflected in the stock market and much of the media headlines. Most value metrics indicate that the market is anywhere from 20%-to-25% overvalued after it big runup over the past year.  Any disappointment in the economy will trigger a major market decline.

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