Wednesday, June 20, 2012

Federal Reserve's Gloomy Outlook ... Unemployment Seen Not Dropping and Housing Is Still Awful

The Federal Reserve issued an updated economic forecast this afternoon. It foresees a slow economy, continuing high unemployment of 8%+, poor housing activity, low inflation and low interest rates for several more years. In other words, we're going to keep struggling as an economy.

In my opinion, there really isn't much the Fed can do at this point to hasten the recovery.

Unfortunately, there's not a whole lot the politicians can do either, even if they were inclined to grow up and act like adults. Which, of course, they aren't.

Economic Outlook

In any event, here's the Fed's revised forecast in Fed Issues Gloomier Forecasts:

"Economic projections released by the Federal Reserve on Wednesday saw officials expecting weaker growth, higher unemployment and softer inflation over the next few years.

The Fed’s “central tendency” for the U.S. gross domestic product now ranges from 1.9% to 2.4% this year, compared with the 2.4% to 2.9% gain predicted in April. Growth is seen between 2.2% and 2.8% in 2013, from the April view of 2.7% to 3.1%. U.S. GDP growth is seen between 3.0% to 3.5% in 2014.

The Fed’s outlook on hiring was also gloomier. It now sees the unemployment rate this year as coming in between 8.0% to 8.2%, from April’s projection of 7.8% to 8.0%. Next year the Fed sees the unemployment rate coming in between 7.5% to 8.0%, versus April’s projection of 7.3% to 7.7%. The Fed’s 2014 unemployment forecast is 7.0% to 7.7%.

On the prices front, Fed officials see a reduced inflation threat. In terms of overall price pressures this year, Fed officials expect the core personal consumption expenditures index to rise 1.2% to 1.7%, versus the April estimate of 1.9% to 2.0%. In 2013 inflation is seen between 1.5% to 2.0%, from the previous projection of 1.6% to 2%. The core PCE price index, which is stripped of food and energy, is seen rising 1.7% to 2.0% this year, and by 1.6% to 2.0% in 2013.

The release of the forecasts follows the decision of the Federal Open Market Committee to continue forward with a program to extend the average maturity of its balance sheet, rather than end the effort in June, as originally planned. The action was motivated by officials’ increased worry about the outlook for the U.S. economy. The Fed also reaffirmed its belief that if economic conditions play out the way officials expect, short-term interest rates will be kept essentially near zero until late 2014....

June’s forecasts contrasted with the views offered in late April. . . . The April outlook represented a slightly more aggressive stance for policymakers relative to earlier in the year. . . ."

Housing Situation

Here's what the housing picture looks like to the Fed as described in Housing, Like Generalissimo Franco, Is Still Dead:

"Back in its early days, Saturday Night Live had a running joke of reporting “Generalissimo Francisco Franco is still dead.” The Federal Reserve‘s attitude about housing is similar.

Once again Fed officials met and concluded housing was stuck in the mud. Wednesday’s policy statement said despite signs of improvement, “the housing sector remains depressed,” phrasing not much different from the assessments in January, March and April.

Housing’s weakness is a large reason why the current recovery is lagging. By extending Operation Twist, the Fed hopes to keep long-term interest rates, including mortgages, low. But monetary action isn’t likely to help housing much.

It isn’t usually that way. The severe 1981-82 U.S. recession also saw a plunge in housing activity. Starts fell nearly in half from their late-1970s level.

But that was by the Fed’s design. By hiking interest rates in order to choke off inflationary pressures in the overall economy, the Fed made it extremely expensive to buy a home. (With a 30-year mortgage rate topping out above 18% in 1981, it’s amazing anyone bought a home during that recession.)

Once inflation was conquered, the Fed allowed rates to fall. Home demand and building took off. Residential construction contributed a large 1.33 percentage points to economic growth of 4.5% in 1983.

Fast forward to the Great Recession which was triggered in large part by the collapse of housing and its underlying mortgages. Although the sector has improved since the recession’s nadir, housing is still hobbled by its own internal problems, including oversupply and foreclosures.

One goal of the Fed’s announced move to purchase Treasurys with maturities up to 30 years is to keep downward pressure on rates through the end of this year. In theory, lower mortgage rates should push up home demand.

However, the 30-year conforming mortgage rate is already down to 3.87%, according to the Mortgage Bankers Association. That cheap rate has enabled current homeowners to refinance (a plus for consumer spending), but potential homebuyers are still holding back.

Why so much fence-sitting? Part reflects still-tight lending standards at banks. But many potential buyers are nervous about weak job growth and stagnant wages. Until consumers feel confident about their long-run employment prospects, would-be homeowners will stay on the sidelines.

It comes down to what’s good for the job markets will be good for housing. And it’s hard to see how the Fed purchases of long-dated securities will boost the mood of businesses to hire."

My Take

Monetary policy is about out of bullets.

Interest rates can't fall much more and people won't become optimistic until economic and unemployment conditions improve. And the necessary resumption of solid economic growth is not now in the picture, at least for the foreseeable future.

With the Fed almost out of ammo, it's up to the White House and Congress to resolve to get out of the private sector's way and let the free market forces work their magic.

That said, there will be no short term fix to this economic mess. This is going to be a long slog.

But while we definitely have a long way to go to recover, we won't ever get there unless we begin moving in the right direction.

Summing Up

Taking economic growth for granted has been a long time approach by our "progressive" U.S. politicians. Well, the frog is about boiled.

And during the "boiling" process, our nation's debt load has now reached a precarious state.

This Keynesian big spending, demand driven, ongoing stimulus approach by our government has clearly flunked the course. For most of us, that's easy to see.

Unfortunately, public sector unions and the Democratic party are both heavily invested in Keynesian policies and the ways of big government.

Their "government knows best" efforts, albeit perhaps well intentioned, to keep growing government at the expense of the private sector won't help our recovery. Not in the slightest.

Thanks. Bob.

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