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Commentary
Without “Measure”
As expected, on January 31, the Fed raised rates for the fourteenth consecutive time. However, for the first time in two and a half years, FOMC minutes did not include any mention of increasing rates at a “measured” pace. Still, the Fed mentioned that further rate increases “may” be needed. In contrast, December’s minutes indicated that rate increases were “likely” to be needed.
The forward markets and short-end of the yield curve appear to be discounting a 90%+ chance of a Fed tightening to 4.75% at the March 28 FOMC meeting, and a 35%+ chance of a similar 25-basis-point move at the May 10 meeting.
It is unclear whether the FOMC will continue sending transparent signals regarding rate changes under the Bernanke regime. For now, it appears that the release of current economic data may take on more meaning than in the recent past. Of specific concern will be data that demonstrates shrinking manufacturing capacity and the possibility that higher energy prices are being passed through to the finished goods level. Indeed, capacity utilization, at 79.6%, is now at its highest level since 2000.
Consumer Confidence: Will the upbeat mood carry into the future?
The Conference Board’s index of consumer confidence for the month of January rose to a four-year high of 106.2, from December’s 103.8. The Conference Board ascribed the strong reading “solely [to] consumers’ assessment of current economic conditions, especially their more positive view of the job market.” The board made this strong observation in spite of a Labor Department report showing wage and benefits growth of only 3.1% for 2005―the slowest gain in over nine years. The U.S. economy produced 1.98 million jobs last year―not a far cry from 2004’s 2.10 million jobs.
Tightening Labor Markets?
During January, the U.S. economy generated 193,000 new jobs―pushing the unemployment rate down to 4.7%, the lowest level since mid-2001. Moreover, the economy produced 81,000 more jobs in November and December than had originally been reported. Employment was especially strong in the health services and educational sectors. In the Fed’s “Beige Book” release, the Philadelphia Federal Reserve Bank commented that salaries have risen for some hard-to-fill occupational categories such as, “trucking, construction, financial services, and skilled manufacturing.”
As the Fed focuses on a robust job market, it is likely to view hourly earnings and declining labor productivity with a modicum of caution. During January, average hourly earnings increased at an annualized rate of 4.8%. Labor costs increased during 2005 by 2.4%―he highest rate increase since 2000. Productivity (having increased by 2.7% during 2005) grew at its slowest pace since 2001.
Withering GDP?
During the fourth quarter, GDP rose at an unexpectedly low rate of 1.1%, after having grown by 3.8% during the third quarter. Nonetheless, our survey of select economists reveals an expectation of rebounding first-quarter performance, similar to that of the third quarter of last year. While the consumer may be able to extract less disposable spending power from a decelerating housing market, the fallback could be mitigated, at least in the short-term, by resilient job growth and lower-than-expected energy costs due to what has, heretofore, been a mild winter. Indeed, natural gas prices are now trading at roughly 40% below their peak levels.
As of this writing, the spread (inverted) between three-month and 10-year treasuries was seven basis points. Interestingly, the Federal Reserve Bank of New York, which maintains a predictive model that examines the relationship between these two points on the yield curve notes that, since 1960, recessions have always followed sustained periods in which yields on three-month treasuries exceeded 10-year maturities by more than 12 basis points. (See http://www.ny.frb.org/research/capital_markets/ycfaq.html).
Some Action Steps
With the Fed having raised rates on 14 successive occasions, and the forward markets suggesting a continued flat yield curve, it may be prudent for asset-sensitive institutions to consider capped floating-rate advances as a part of their funding mix. With option volatility near historic lows, this wholesale funding structure may be a viable means of profiting from declining rates, while gaining some protection from rising rates. Additionally, as investment portfolios shrink and the supply of pledgeable securities dwindles, it may be worthwhile to seek the assistance of the Seattle Bank as a potential source of letters of credit.
Things Are Seldom What They Seem: Rainy Days, Squeaky Shoes
Finally, we’re compelled to share a real-life example of the consequences of failing to think outside-the-box. Upon returning home during the twenty-eighth consecutive night of rain in Seattle, the author swore that he had heard the squeals of voracious rodents. At first, the noises emanated from the furnace closet. Next, the noises grew louder in the laundry room. The following night, convinced that the services of a professional exterminator would be required, the author ventured into the garage. The sounds grew louder. The author then shared his concern with his wife, who handed him a flashlight to search for visible clues. No evidence was found. Finally, the author was urged to take five steps forward. Sure enough, that loathsome cacophony was coming from nowhere other than the author’s shoes!
The lessons learned: 1. Seek the advice of others. 2. Catastrophic thinking will get you nowhere. 3. The answers to life’s persistent questions are often right at your feet!
John Biestman is Director of Business Development at the Federal Home Loan Bank of Seattle.
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