Data and the Fed

The WSJ has a good summary of the latest economic data here. For the rare few without a subscription, here is what the article is saying.

The latest readings on the U.S. economy show continuing signs of weakness: Sales of newly built homes over the summer were weaker than previously estimated, September manufacturing was subdued, business inventories are mounting and the job market is displaying worrying signs of erosion.

How do we read this

1) Declining sales of newly built home suggest that construction of further new homes is unlikely to occur. This hurts GDP directly via a decline in residential investment within the GDP formula (C + I + G + NX). Further, since sales are slowing and inventory levels are high, prices are likely to come down and this can hurt GDP via consumption if people are no longer able to tap home equity to fund consumption

2) Rising business inventories suggest that businesses are not selling as many goods as they had anticipated. This points to a slowdown because they are unlikely to continue producing at current levels until inventories levels are back to where they want them

3) Although the latest NFP report suggests a decent labor market, data on "initial claims" has been rising as of late. Initial claims are initial unemployment claims people make when they lose their job so they can continue collecting unemployment.

How bad does this data look? Well, it certainly does not point to robust growth but the text of the article is not as bad as the first paragraph seems.

1) Sep new home sales rose a bit this month, with inventories declining modestly and pricing rising (editorial: although this is probably an illusion since the data is flawed in that it doesn't include cancelled contracts)

2) Business inventories were previously falling, so it may be the case that businesses are rebuilding their inventories back to the levels they want them at. Granted, this doesn't point to further build ups (which means no boost to GDP), but it "may" not mean a slowdown is in order. The strength in business investment suggests this is a possibility

3) Initial claims, while they are rising, are still not that high historically speaking and may be adversely impacted by the recent auto strikes, which temporarily boosted the claims.

How does the Fed respond to this? As you can see, the Fed has their work cut out for them since you can argue the imperfect data either way. However, it does look the downside risks to growth are real and potentially bad. Therefore, the current data is "bad enough" that another rate cut is likely as a hedge against a potential recession. As you will soon learn, monetary policy operates with a lag (between 6-18 months), before the full force of the rate cut can take place. If the recession risks are real, the Fed is going to want to get the rate cuts in the pipeline now because if they wait too long they will miss the recession (then again, on the other side of the coin, if no recession is coming the Fed can stoke inflation).

Now you know why they appoint these guys to 14 year terms.