Fed Is Finding Confirmation Of Its Forecast

By: Paul Kasriel | Tue, May 16, 2006
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"The Committee sees growth as likely to moderate to a more sustainable pace, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices." This is the statement issued by the FOMC on May 10 when it raised the fed funds rate to 5%. Is it getting confirmation that growth is moderating led by the housing market? You bet. Today the National Association of Homebuilders (NAHB) released their index of new home demand and it was ugly. The composite index fell to a level of 45 - its lowest reading since June 1995 (see Chart 1). In the current cycle, this index peaked in June of last year and has been in a free fall since November. The behavior of the housing sector typically leads the behavior of other sectors of the economy at inflection points. We would expect this even more in the current cycle inasmuch as housing has been a major support of employment and consumer spending, the latter as a result of mortgage equity withdrawal. In many of its public pronouncements, including the one quoted above, the Fed specifically mentions housing as a sector it is watching for confirmation of the validity of its medium term economic forecast. The Fed also mentions the behavior of the housing sector as the greatest downside risk to its economic forecast. Today's NAHB index might have set off some alarm bells at the Fed.

Chart 1

As mentioned, housing has been a major contributor to employment growth this cycle. The direct contribution from the construction industry appears to be softening as shown in Chart 2. In March and April, new hires in the construction category of nonfarm payrolls have been only 6,000 and 10,000 respectively, less than half the 12-month moving average. In the past several months, two large mortgage-related financial institutions, Ameriquest and Washington Mutual, have announced staff reductions of 3,800 and 2,500 respectively.

Chart 2

Another confirmation of the Fed's forecast is in recent consumer spending data. Retail sales in April, excluding the price-inflated gasoline component, were up only 0.1%. If the April level of retail sales ex gasoline were to persist in May and June, second quarter retail sales ex gasoline will have grown at an annual rate of 1.0% vs. 14.2% in the first quarter.

We believe the Fed's economic forecast is on track. Actually, we believe that the Fed's economic forecast might be a bit optimistic. The FOMC wants to pause in its interest rate hikes now. The data on the economic growth side of the ledger are coming in to support that desire. The question is whether the core inflation data for April and May will allow a new Fed chairman with perceived squishy inflation-fighting credentials (unjustly perceived in our view) the luxury of pausing so as to avoid a recession in 2007.



Paul Kasriel

Author: Paul Kasriel

Paul L. Kasriel
Director of Economic Research
The Northern Trust Company
Economic Research Department
Positive Economic Commentary
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675

Paul Kasriel

Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community. The Northern's economic website was listed as one of the top ten most interesting by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets.

Paul began his career as a research economist at the Federal Reserve Bank of Chicago. He has taught courses in finance at the DePaul University Kellstadt Graduate School of Business and at the Northwestern University Kellogg Graduate School of Management. Paul serves on the Economic Advisory Committee of the American Bankers Association.

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