While it seems we’ve come a long way from the depths of the summer when expectations for the US economy had caused markets to price in a stronger chance of a double dip recession, the jury is still out on whether the pace of the US recovery is strong enough.
This is important as it has implications on what the Federal Reserve will do in regards to its monetary policy – whether to further loosen monetary policy through another round of quantitative easing – or if the pick up in activity can sustain on its own.
The main concern currently is that the euro-zone sovereign debt situation seeps into the real global economy thereby weakening the prospects for global growth. However, if we examine the recent fundamental data from the US on its own we’ve actually seen a string of better-than-expected releases which bolsters the case for the Federal Reserve to remain on the sidelines in terms of further monetary easing.
We have further confirmation of that this week as he sought retail sales Empire manufacturing index, industrial production all improving.
This Week’s Reports (Retail Sales, Industrial Production, Empire Manufacturing Index) Beat Expectations
We began the week with a better-than-expected retail sales report which showed sales climbing 0.5% in the month of October following a 1.1% gain in September. Expectations had sales rising 0.3%. We notice that most of the gain were led by core retail sales which were up 0.6% compared to a 0.2% forecast. That matched the figure we had for core sales in September.
It’s very important to monitor consumer spending as it makes up a majority of the US economy and therefore it helps us to determine how confident consumers are, and how willing they are to go out and spend despite high unemployment rate and still weak economic prospects (not to mention turmoil from Europe, though the average consumer probably isn’t thinking about Italy when buying a new TV).
The retail sales report for October is supportive of consumers showing a willingness to spend. However the questions now is will this pick up in spending be sustainable considering the pace of sales is out-matching the gains in US wages, and as a result households and consumers are running down their savings in order to do that spending. Looking at it from that angle, the recent stronger spending certainly seems unsustainable.
Turning from consumer spending to manufacturing, on Tuesday the New York Fed’s manufacturing index turned back into positive territory for November at 0.6. That following a -8.5 reading in October, and beat expectations of an improvement but for the index to still remaining negative (-2.0).
In a second report released Wednesday, industrial production for October rose by 0.7%, which beat forecasts of a 0.4% increase. While the reading for September was revised downward (to -0.1% from 0.2% previously reported) overall the report showed that the manufacturing sector is attempting to rebound from what has been a soft rest of the year. The capacity utilization rate – the number of factories in use – rose to 77.8% from 77.2%.
Even home builders are feeling more confident as the NAHB housing market index rose to a reading of 20 in November, which beat forecasts of the index remaining at its October level of 18. We will get more data on the construction sector on Thursday with the latest release of building permits and housing starts.
Last Week’s Data Was Also Supportive of Improvement
If we look at the data from last week, we saw better-than-expected reports as on trade, jobs, and consumer confidence adding to the perception that growth may be picking up.
The trade balance narrowed when expectations had it widening.
Jobless claims fell below the 400K level, hitting a 7-month low. If claims can remain below the 400K it would be a positive for the labor market as that lower level of claims has historically been consistent with around 150K+ in non-farm payroll gains.
And, the University of Michigan consumer sentiment index – the preliminary reading for November – rose to 64.2 from October’s 60.9.
Impact on the Fed and USD
Putting all of that data over the last 2 weeks together we see improvement in consumer spending and confidence, positive development in the labor market, stronger manufacturing, better trade, and an uptick in home-builders’ expectations.
The important indicator to look out for next from the point of view of what the Fed may do next is the November non-farm payroll report. If the labor market shows improvement the need for the Fed to do more easing lessens. There are divergent views currently within the FOMC on whether the economy needs more stimulus, and we have seen the battle-lines between the FOMC’s doves and hawks play out over the last couple of months.
Inflation data this week showed that the Fed has some scope to consider more easing if needed as headline CPI fell in monthly and annual terms, though the core annual CPI did move above the 2% level – the target of the Fed. If core inflation continues to move higher, and the data (granted some of this is second tier) suggests the economy is picking up some pace of late it would suggest that the hawks have a better case for their argument when the FOMC meets next.
If the chance of more QE lessens that would be a positive for the USD as that monetary tool indirectly debases the currency. However, in addition to the latest reading on employment from the US, we have to be aware of the role of outside shocks on the US economy that can tilt the scales back in favor of the FOMC doves.
As Bernanke put it, the US recovery has had some “tough luck” this year. Whenever it looked like things were improving some shock came along; Libya war and rise in oil prices, Japan’s earthquake/tsunami that disrupted supply chains and manufacturing, the debt ceiling debate and the downgrade of the US credit rating which hampered business and consumer confidence and now the most recent flare-up of the Euro-zone sovereign debt crisis threatens to yet again undermine US growth.
So, while the better than expected US data-stream the last 2 weeks is encouraging, we need to see the NFP, manufacturing and services data during the first week of December, and monitor developments in Europe before we can say that the Fed is considering not adding to the punch bowl.
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