Federal Reserve & Interest Rates

Inflation remains a non-factor as the Labor Department released it’s April numbers for the Consumer Price Index on Friday.  Thus far there has been little or no pressure on the Federal Reserve to change it’s current stance on interest rates.

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.2 percent in April before seasonal adjustment, the Bureau of Labor Statistics of the U.S. Department of Labor reported today.  This index has fallen 0.7 percent over the last 12 months, due primarily to a 25.2 percent drop in energy prices.  The year-over-year declines in March and April are the first since 1955.

The price of oil went up slightly in May so we can probably expect a slight rise next month’s numbers but global demand for energy remains constrained and that will likely be the case to the end of the year at least.  This is of course a far cry from last year’s numbers, when oil was still trading at well over $100 a barrel.

Over the past six months we’ve seen oil and other items fall considerably as the rally in commodities took a sharp nosedive last summer.  The numbers are starting to flatten out however as it seems the economy has finally reached an equilibrium with the shifting global demand from one of the worst recessions in decades.

Food and apparel fell slightly during April, although demand should receive a slight boost as millions of Americans start to receive stimulus checks in the mail.  Retailers have had a difficult time over the past year and the steadily worsening employment numbers aren’t helping matters any.

Consumer spending numbers are also expected to be weak for the rest of the year, once the stimulus boost ends.  It’s not clear whether the Fed is still concerned about deflation  or not but I’m sure their prepared to inject more money into the system if it’s warranted.

The market has very low inflation expectations for the next few years, 5 year Treasury yields have been hovering around 2% for quite some time now. 30 year fixed rate mortgages remain under 5% although they have risen slightly over the past month.

All this point to the fact that investors don’t see the economy heating up for quite some time, regardless of how much money the government has already spend trying to fix things.

The Labor Department released it’s April jobs report on Friday, which while was still a significant loss of jobs, was less than what many economists were forecasting.

Nonfarm payroll employment continued to decline in April (-539,000), and the unemployment rate rose from 8.5 to 8.9 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today.  Since the recession began in December 2007, 5.7 million jobs have been lost.  In April, job losses were large and widespread across nearly all major private-sector industries. Overall, private-sector employment fell by 611,000.

The country now has the highest unemployment rate since the recession of the early 80’s and employment is typically one of the last things to recover after a recession.  It is expected to hit double digits even if economic growth returns to the positive side by the end of the year, like the Federal Reserve is predicting.

The long recovery that is expected to take place will likely see slow job creation at least initially.  Manufacturers are still try to reduce inventory levels amid falling demand and it could be some time before production fully recovers.

The recently passed economic stimulus package is expected to created 2 to 3 million jobs over the over the next 3 years but that is still only half of the number of jobs that have been lost already and will likely be only a third of that number before employers starts to hire once again.

It’s going to have a serious impact on consumer spending over the next few years and this year’s stimulus payments will only give a boost for a few months at most.  Despite all the money the government has already spent over the past two years, there will likely be pressure on Congress and the administration to create additional stimulus packages in the upcoming years in order to replace all the jobs that will have been lost after the recession finally blows over.

Federal Reserve Chairman Ben Bernanke gave testimony before Congress today on the economic outlook for the country.  He sees the economy growing once again at the end of the year but acknowledges that a recovery could take quite some time.

The U.S. economy has contracted sharply since last autumn, with real gross domestic product (GDP) having dropped at an annual rate of more than 6 percent in the fourth quarter of 2008 and the first quarter of this year. Among the enormous costs of the downturn is the loss of some 5 million payroll jobs over the past 15 months. The most recent information on the labor market–the number of new and continuing claims for unemployment insurance through late April–suggests that we are likely to see further sizable job losses and increased unemployment in coming months.

We could very well see another 2 to 3 million more job losses to in the months ahead which may offset the benefits of this year’s stimulus payments on consumer spending.  Last year’s stimulus only had a seasonal effect for a few months but the employment picture wasn’t as bad, the pace of job losses have accelerated since November.

The mortgage securities market may take even longer to recover and the Fed will likely keep up efforts to spur the return private investment which has been pretty much nonexistent since the subprime collapse.  While it seems that the housing market has finally bottomed out, with no easy way for banks to rollover their loans, credit may continue to be scarce.

Of course much of the Fed’s outlook hinges on the state of the financial system and much of that will depend on how capable banks are to absorb losses in the next few months and how much of a lifeline the government will continue to extend to it.  The results of the stress test has been pushed back but for now it seems that most of the largest banks have adequate capital reserves.

Despite the Fed’s optimism it could take a long time for the economy to create new jobs to replace the ones lost in the last year and half.  It may very well take 2 to 3 years for the economy to recover fully, even in the best case scenarios.