Fed to Congress…Your Turn
- The Leading Economic Index for May increased by 0.3 percent as housing permits surged.
- Existing Home Sales fell slightly by 1.5 percent in May to a 4.55 million unit annual rate.
- Initial Claims for Unemployment Insurance declined by 2,000 for the week ending June 16.
- The Federal Open Market Committee voted to extend “Operation Twist” through the end of 2012.
The Leading Economic Index for May turned up again, after falling in April. The LEI gained 0.3 percent partially in response to the strong housing permits data for May. The LEI fell by 0.1 percent in April, its first decline since September 2011. The Coincident Index gained 0.2 percent for May and the Lagging index increased by 0.3 percent. When all three indexes are going up that is usually interpreted as a solid signal of economic growth. The housing story is crucial to that usual interpretation. The strong housing permits numbers for May, up by 7.9 percent, MUST be converted into starts in order to have a positive impact on the economy due to increased incomes of construction workers, increased demand for construction materials and increased GDP due to residential investment. Furthermore, with housing still weak, compared with the last up-cycle, the positive contribution from new residential construction is still somewhat small. Without the boost from housing permits, the LEI could have registered its second monthly decline, and that would send a strong cautionary signal.
Indeed, existing home sales declined in May, down 1.5 percent, increasing the expectation for a weak new homes number too, and that would dampen builders’ enthusiasm. The new home sales numbers for May will be released on Monday, June 25. While existing home sales fell slightly in May, the median sales price of an existing home continued to improve, now up 7.9 percent from a year ago according to the National Association of Realtors. Initial claims for unemployment insurance ticked down by 2,000 for the week ending June 9, to hit 387,000. The recent trend has been up and so the early June improvement is welcomed, but we need to see more improvement before we can say that labor markets are back on track. The Philadelphia Fed’s manufacturing survey for June shows that current manufacturing conditions have deteriorated in eastern Pennsylvania and southern New Jersey. The six-month outlook survey remains in positive territory.
Yesterday, the Federal Open Market Committee voted to extend the Fed’s “Operation Twist” through the end of this year. Operation Twist is the program of rebalancing the Fed’s assets by selling short-term securities and purchasing longer-term securities with the goal of driving down interest rates at the long end of the yield curve. The program was begun last September and was previously slated to end this June. The FOMC announcement included a statement that the Fed was prepared to undertake additional steps to promote a stronger economic recovery. However, as we inch closer to Election Day this fall, the likelihood of additional Fed action, in the form of QE3, diminishes, as the Fed is typically reluctant to undertake actions that may be viewed as partisan in nature. The extension of Operation Twist represents no new additional monetary stimulus to the economy. The bar appears to be set high for additional quantitative easing, which would be new stimulus. A rapid deterioration in Europe, or ongoing increases to the U.S. unemployment rate would clear that bar. Most likely, the next significant policy action will not come from the Fed, but rather from Congress in the form of easing the impact of the impending Fiscal Cliff.
Just as the interaction of economic cycles with political cycles is adding to uncertainty in Europe, it is also adding to uncertainty here. We may start calling this underperforming post-recession period “The Age of Uncertainty, Part II.” (For more about that see John Galbraith’s The Age of Uncertainty and Milton Friedman’s Free to Choose.)
Market Reaction: Equity markets are down. Treasury yields are also down. Oil is below $80 at $79.77/barrel. The dollar is up against the yen and the euro as the prospects for QE3 fade, for now.