Uneven, Uncertain, But Improving

On Wednesday the Federal Reserve policymakers did something they rarely do.  They cut rates even while suggesting the economy is improving.  Furthermore, they suggested they do not plan to tighten policy (raise rates) to preempt a potential burst of growth.  The Fed cut the benchmarkU.S.interest rate to a 45-year low of 1% to boost economic growth and prevent further slowing of inflation.  Their statements and actions suggest that rates will remain low, even fall further, for an extended period of time.  Basic economics suggests that as businesses and investors begin to accept that low interest rates are here to stay, they will begin investing in longer term and riskier projects to create economic growth.  But we know the major problem facing investors and business leaders today is a lack of confidence.  The latest cut is an attempt by the Fed to show that they are willing to do what is necessary to reinvigorate economic growth. 

The low rates have kept the consumer engaged in the economy.  A measure of consumer confidence, announced on Tuesday, was higher than expected in June, driven by optimism about the economy’s prospects six months from now, according to Bloomberg.  But Americans’ view of the current economic situation deteriorated some.  The New York-based Conference Board’s consumer confidence index fell to 83.5 in June from 83.6 in May, higher than an expected 82.  The index measuring consumers’ attitudes about conditions six months increased to 95.9 from 94.5, while the index measuring attitudes about the current economy fell to 64.9 from 67.3, the second monthly drop.  The major cause for declining confidence in the current economy is unemployment.  The jobs numbers reported in the past few weeks were still impacted by the effects of the war.  The weekly numbers coming out now show improvement in jobs with the positive outcome of the war.

The number of U.S. workers filing for state unemployment benefits fell more than expected last week to the lowest level in three months, suggesting the pace of job cuts may be easing.  Initial jobless claims declined to 404,000 in the week that ended Saturday from 426,000 the week before, the Labor Department said.  Bloomberg notes that last week’s total was the closest to 400,000, which some economists consider the dividing line between job creation and contraction, since the week ended March 22, when filings were 402,000.

Low interest rates continue to drive both new and existing home sales.  The Commerce Department reported on Wednesday that new home sales rose 12.5% in May to a new record annual rate of 1.157 million homes.  Sales of existing homes rose in May to the third-highest pace on record of 5.92 million homes.  Despite all the gloomy news headlines regarding unemployment, most Americans feel good enough about their employment situation to buy a first home, or a larger, or newer one.  Home purchase is the largest investment decision most Americans will make and they are doing it in record numbers.

Problems continue on the business side of the economy.  Durable goods orders unexpectedly dropped in May.  Economists expected an increase of 1%, particularly in light of the better-than-expected results last week for theNew Yorkand Philadelphia Feds regarding dramatic improvements in manufacturing in those regions.  This report reiterates expectations that the recovery will be choppy and geographically varied.

Yesterday, the government released its revised numbers for the growth of the U.S. economy.  Growth in Gross Domestic Product was 1.4%, slower than the 1.9% earlier reported.  The major contributors to the increase in real GDP in the first quarter were personal consumption expenditures and residential fixed investment.  The reduction primarily came in inventory reduction by companies.  Imports were down for the quarter, improving GDP modestly.

Today, the government announced that both consumer income and spending rose in May, providing further evidence that the consumer remains both able and willing to support this economy.  And the University of Michigan announced that the final results of their June confidence indicator were better than earlier reported.  The index was 89.7, higher than the 87.2 earlier reported, but still below May’s 92.1.

So, as the economic reports continue to roll in and corporations report their early reads on their second quarter results, we will stay tuned.  The market continues to show confidence in the prospects for economic recovery.  Stocks have had the biggest gain in 4 ½ years globally during the second quarter.  The rally was fueled by the end of the Iraqi war, optimism that the U.S. economy would accelerate, and hopes that the three-year bear market has ended.

It’s too early to know if the market is right, but positive evidence is mounting.  Just as important, the conditions for improvement could hardly be better; including low interest rates, lower taxes, lower gasoline costs, lessening global tensions, and huge supplies of cash on the sidelines.  Earnings will be coming soon and they will give us further evidence of recovery.  Markets will likely move sideways until the second quarter earnings reports come in, but improving moods and confidence could certainly cause investors to anticipate improvement rather than wait for it.