Transcript Defense for Ease

Economic Cycle Analysis
February 27, 2007
The Economy
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A panel of 60 economists who participated in the
WSJ's latest semiannual economic forecasting
survey offered an optimistic outlook for 2007: The
service sector should keep humming along as the
recent weakness in housing and manufacturing
abates and the Federal Reserve begins to reduce
interest rates. That would allow the economy to
expand at a rate fast enough to keep investors
happy, but slow enough to keep inflation at bay.
The Economy
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The world's central bankers are so confident that growth will
remain steady and inflation under control that their main worry
is less the immediate future than whether conditions are
breeding excessive speculation in financial markets
Indeed, though the U.S. economy has slowed substantially from
its torrid pace of a year ago, it has kept growing fast enough to
keep unemployment down despite the housing slump
Central bankers' latest concern is that investors are
underpricing risk, and bidding up prices of assets from
corporate bonds to houses and in the process driving down
returns on those assets, such as long-term interest rates.
The Economy
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Globally, inflation is still low by recent historical standards,
though higher than some central bankers would prefer. U.S.
consumer prices, excluding food and energy, rose 2.7% over
the past 12 months
Core inflation, now running at a 2.2% rate by the Fed's
preferred measure, remains higher than the 2% ceiling most
Fed officials are comfortable with
Oil prices are still down to where they were this time last year
Global stock markets are buoyant
Demand remains strong both home and abroad
Profits are still making healthy gains
Corporate balance sheets are in great shape
The Economy
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Outside of the housing slump, demand in
95% of all spending categories was up 4.4%
from a year ago, the fastest annual advance
in almost 7 years
Excluding the energy sections, profits in the
remaining 9 sectors of the S&P 500, are up
14.5%
GDP
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The U.S. economy rebounded at the end of the year
as GDP grew at a faster-than-expected 3.5% annual
rate in the fourth quarter, surpassing even
economists' raised forecasts
Consumer spending picked up amid lower gasoline
prices, and a price inflation gauge posted its
sharpest drop in 52 year
For all of 2006, GDP advanced 3.4%, compared to a
3.2% increase in 2005.
Federal Reserve
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Fed officials generally don't see market speculation
as a reason to tighten monetary policy, or even keep
it tight
They have cited the lack of spare economic capacity
and an elevated inflation rate as a reason to
maintain short-term interest rates at 5.25%, with a
bias to raising them further
An accompanying statement, meanwhile, was
upbeat on the outlook for "moderate" economic
growth and lower inflation, suggesting the Fed is
quite comfortable with rates where they stand.
Federal Reserve
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For decades, a simple rule has governed how the Federal Reserve
views the nation's economy: When unemployment falls too low,
inflation goes up, and vice versa.
Fed officials have rethought that notion. They believe it takes a far
bigger change in unemployment to affect inflation today than it did 25
years ago. Now, when inflation fluctuates, they are far more likely to
blame temporary factors, such as changes in oil prices or rents, than a
change in the jobless rate.
That's one reason the Fed, though it expects core inflation to ease this
year, isn't relaxing. With unemployment currently 4.6%, at or below the
Fed's view of its natural rate, inflation may edge up after the temporary
impacts of energy and rent subside. That could require the Fed to
raise interest rates enough to push unemployment up sharply and
bring inflation down.
Unemployment
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The number of workers filing new claims for unemployment
benefits fell sharply last week as the effect of recent winter
storms appeared to dissipate, but claims levels nonetheless
remained above levels seen late last year, suggesting some
slackening in labor markets.
New claims for unemployment insurance fell by 27,000 to a
seasonally adjusted 332,000 in the week ended Feb. 17, the
Labor Department said Thursday. The previous week's figure
was revised to 359,000 from 357,000.
Despite last week's drop, claims still came in above Wall Street
expectations. The median estimate of economists surveyed by
Dow Jones Newswires was for claims to fall by 35,000 to
322,000. The four-week moving average, which economists
gauge for the underlying trend, rose by 1,250 to 328,000.
Housing
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Existing home prices are as high as they were this time last
year
Sales have receded only to 2003 levels
The only extreme decline is in construction; builders are trying
to get rid of the houses they’ve already built before they put up
more
The overhang of unsold homes could be back to normal by
around midyear
Houses are affordable even though prices rose more than 50%
in the past 5 years (may be due to low interest rates)
The decline in the housing market may be a much-needed
correction to the inflated housing market
Interest Rates
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Globalization and financial innovation are 2 key
factors in keeping rates low
Investors know more about the loans they’re buying,
so they will pay more for them
Credit default swaps have also improved
transparency (if investors bet heavily against an
issuer’s securities, its lending costs are driven up)
Creates a healthier market and ultimately lower rates
CPI
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The core CPI, which strips out food and energy
prices and is more closely watched by the Fed,
jumped 0.3% versus expectations of a 0.2%
increase. The rise broke a three-month string of
0.1% monthly gains and pushed the year-on-year
rate up 0.1 percentage point to 2.7%
Fed officials were broadly upbeat about economic
growth prospects, noting that they expected "solid
growth" in consumer spending to be maintained and
that strong financial conditions and high profits
should support "a firming of investment spending."
ISM Non-Manufacturing Index
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Steady growth in the service sector, which makes up roughly
80% of the U.S. economy, is particularly important now
because the manufacturing sector is struggling with high
inventories and soft demand for houses and cars
The Institute for Supply Management, an Arizona-based group
of corporate purchasing managers, said its index of
nonmanufacturing business activity in the U.S. rose to 59 in
January from 56.7 in December. Readings over 50 indicate
expansion, and January's surge marked the 46th consecutive
month that the service sector, which includes everything from
massage therapists to financial planners, has grown.