Federal Reserve & Interest Rates

The Commerce Department revised their estimate’s on GDP numbers for the first quarter in a report released today.   

The 0.9 percent gain at an annual pace in gross domestic product compares with an advance estimate of 0.6 percent, the Commerce Department said today in Washington. Fourth-quarter growth was 0.6 percent. Separate figures today showed the number of Americans continuing to receive jobless benefits rose to a four-year high this month.

Investors took that as a positive sign that the economy is remaining resilient despite the ongoing problems in the housing and credit markets.  Many economists have been predicting a recession for the U.S. economy and while growth has slowed considerably, it still remains in positive territory.

The unexpected rise in GDP has been attributed to the rapid growth of U.S. exports which is benefiting quite nicely from the decline of the dollar.  While the U.S. is still running a trade deficit, it’s has fallen to lowest level in six years.

Americans have also cut back on their consumption of imports, the prices of which have risen sharply over the past year.  While domestic purchases have increased, consumer spending has slowed which has dragged down economic growth.

If unemployment figures can remain stable for the upcoming quarters it may be possible for the economy to stay out of a recession.

While financial executives put a positive spin a month ago that the financial crisis was getting better due to the actions taken by the Fed, the fact remains that there is still no end in sight to the credit crunch gripping the U.S. banking system.  If the housing market doesn’t start to improve soon, the economy could be gripped in stagnant growth for years.

As long as home prices remain deflated, banks will be at risk from defaults and foreclosures.  This article in MarketWatch explains how the Federal Depository Insurance Corporation(FDIC) is preparing for a surge in bank failures in the next couple of years.

While loan growth soared in 2004 and 2005, most regulators failed to scrutinize many banks or restrain this heady expansion of credit. Now that the loans have been made and delinquencies are climbing, some banks may already be doomed.

At least 150 banks will fail in the U.S. during the next two to three years, according to a projection by Gerard Cassidy and his colleagues at RBC Capital Markets.

That’s a staggering number of lending institutions and brings back the bitter memories of the Savings & Loan era.  All these banks that mismanaged their risk perhaps deserve to fail but the economic fallout could be considerable.

I don’t see the Fed being able to do for all these prospective bank failures what they were able to do for Bear Stearns.  The most likely occurrence is that taxpayers will once again take it on the chin like they did for the S&L debacle.

The struggling U.S. economy could be in store for stagnant growth for an extended period of time. At the moment it’s difficult to see any kind of recovery until the housing market can rebound.

The number of unsold homes continue to build up at record levels, where it hit a 23 year high in the month of April.  This has led many analysts to the obvious conclusion that the housing slump has yet to hit bottom as is far from over.

Resales of U.S. houses and condos dropped 1% to a seasonally adjusted annualized rate of 4.89 million from 4.94 million in March. Economists expected sales to fall to 4.83 million.

The number of homes on the market represented an 11.2 month supply at the April sales pace, the biggest since the combined single-family/condo records began in 1999.

With the glut of supply on the market, how low home prices will fall is anybody’s guess and despite the Fed’s best efforts the mortgage market has remained tight  What is doubly troubling is that prices are falling despite the fact that the economy is entering an inflationary period, so that in actuality the real values of homes are falling faster than they appear.  The loss of real wealth for many Americans has put a damper on consumer spending which makes up a large factor in fueling economic growth.

There could also be more trouble in store ahead for credit markets as mortgage delinquencies continue to rise.  It could spell another wave of writedowns for an already beleaguered financial services sector.

Another question for financial markets, is how long can the Fed keep rates at their current level.  A downward spiraling dollar and soaring energy prices will put a lot of pressure on the Fed to reverse their rate cutting disposition.