Unavoidable work obligations took priority over blogging during the past week. Of course, blogging or not, the data flow continues uninterrupted. And the tenor of that data has been generally positive. In the near-term, the upbeat news will have limited impact on monetary policy. The Fed will remain committed to the path laid out at the last FOMC meeting. That said, I have to imagine some of the moderates on the FOMC - those pulled into Federal Reserve Chairman Ben Bernanke's gravity with the softening of data this summer - will be starting to feel a little bit of buyer's remorse, thinking that maybe, just maybe, they pulled the trigger a little too soon. The doves, of course, should be ecstatic that the FOMC locked in an easier policy at beginning of an upswing. Rather than threatening to withdraw stimulus at the slightest sign of recovery, now we have a commitment to keep monetary momentum until the economy is clearly on firmer ground. This will be supportive of the upswing in activity.
The death of the consumer continues to be more myth than reality. The retail sales report revealed that households have shaken off the summer doldrums:
While the year over year trend is not particularly strong:
the last three months have packed a bit of a punch:
While industrial production was up somewhat, the trend over the past year is basically flat:
The underlying story, I think, remains two-fold. First, some investment was likely pulled forward into 2011 by now-expired tax credits. Second, the global slowdown is also weighing on manufacturing growth. That said, note that the current scenario continues to look more like 1998 than 2008:
To be sure, core new orders have been a little unnerving of late, and certainly something to watch. But this would not be the first time that an external shock failed to deliver a US recession. For now, I expect that to continue to be the case.
And one reason to believe that the US will escape recession is the obviously improving housing market. Starts exceeded expectations in September:
Can we attribute September's strength to QE3? I think it is somewhat of a stretch to believe that builders were sitting around waiting for the go-ahead from the Fed; this is especially true of multi-family housing, a category that requires a bit of lead time before shovels break earth. Still, I think that you can argue that the build-up to QE3 supported expectations that monetary policy would tend toward easier rather than tighter, reducing uncertainty that the Fed would pull the plug just as new projects were taking off.
What else can we say about housing? The Wall Street Journal offered up three views of the data. First:
This move forward from the bottom was inevitable, says Patrick Newport of IHS Global Insight. “Housing has a self-correcting mechanism — it’s called population growth. Every year, the U.S. population increases by about 3 million, and the number of households increases by 1.1-1.3 million. New homes have to be built to meet demand from this segment. In recent years, housing construction has been depressed, first because of overbuilding during the boom years, then, because the Great Recession forced many Americans to move in with friends and family,” he said.
I agree; the long period of bouncing along the bottom was starting to look excessive. It couldn't last forever. Second:
But that correction doesn’t mean that housing is going to lead a broader recovery. “The sector is much less important than it used to be,” said economist Jim O’Sullivan atHigh Frequency Economics, Ltd. “Total residential investment directly accounts for 2.4% of GDP now, down from a 6.3% peak in 2005. Within that, new home construction, the part tracked by housing starts, accounts for 0.9% of GDP now, vs. a peak of 3.9% in 2005.”
True, housing is a relatively small part of the economy. And I can argue that the emphasis on multi-family units will be yield less of an economic boost compared to single-family housing. Moreover, I have yet to be convinced that we are on the verge of another price bubble that will swell net worth and trigger a jump in mortgage equity withdrawal. But, even an additional 0.5 percentage point contribution from residential housing is meaningful when the economy is bouncing along at 2% growth. I am not expecting miracles, but a recovering housing sector is certainly a step in the right direction. Finally, we have this:
The housing recovery has materialized, but the strength of that recovery is an open question. “How far can the rebound go with unemployment where it is? From our perspective, not much farther,” said economist Steve Blitz at ITG Investment Research, Inc. “The notion housing will now lead rather than reflect the overall economy is a bit too optimistic. The demographics lean against a national boom in home construction as does the limited availability of mortgage credit.”
Traditionally, housing has led the economy. I wouldn't bet against it. Moreover, this analysis appears to assume that unemployment rates stay constant, which seems like something of a heroic assumption given the steady decline in the unemployment rate experienced over the last three years:
Moreover, mortgage credit will loosen up as the housing recovery broadens and deepens. Lender confidence will improve as prices stabilize. Ultimately, they want to lend money; it's how they make more money.
I am not sure that the FOMC would have moved on QE3 if the data then was what we are seeing now. If this data flow continuous - a big "if" considering the propensity of the data to swing from optimistic to pessimistic throughout the course of the year - some moderates will likely question their decision. But the die has been cast, and will not be shattered easily. New York Federal Reserve President William Dudley reminds us:
Even over the next few years, while there are significant downside risks relating to the fiscal cliff and the eurozone, it is possible that the recovery could turn out stronger than expected. The underlying process of balance sheet repair is considerably advanced, housing is recovering and, as that occurs, our newly recalibrated monetary policy could gain additional traction. Thus, if uncertainties about the U.S. fiscal path and the future of the eurozone were resolved in a constructive manner, growth could pick up more vigorously than anticipated.
This would be a wonderful outcome. The September FOMC statement noted: the Committee expects "that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the recovery strengthens". Consistent with this, if we were to see some good news on growth I would not expect us to respond in a hasty manner. Only as we became confident that the recovery was securely established, would I expect our monetary policy stance to evolve to ensure that it remained appropriate to achievement of our objective: maximum sustainable employment in the context of price stability.
For now, price stability is on the side of the Federal Reserve, allowing for policymakers to keep pressure on the gas pedal despite improving data. While the headline CPI jumped 0.6%, core gained just 0.1% in September, suggesting that the headline gains remain a transitory artifact of higher gas prices. The year-over-year trends are not worrisome:
Remember that CPI inflation tends to run a bit above the Fed's PCE target. Moreover, note that wage growth remains constrained, limiting the ability of inflationary pressures to spread. The recovery has room to run before we see sufficient pressure on wage growth to raise the specter of tighter policy. Note that the Fed's commitment to supportive policy stands in stark contrast to their almost eager desire to shift to tighter policy after previous upswings in activity. In short, Fed policy is ramping up in line with the housing market and the broader economy, hopefully providing the boost that is capable of breaking the economy free of the zero bound. This bodes well for growth in 2013.
That is, unless Congress lets the economy fall off the fiscal cliff. No, nothing is written in stone at the moment. Plenty of things can go wrong with fiscal policy, Europe, war in the Middle East, etc. The usual suspects. But for now these are risks, not reality. I think the reality is that the economy looks a little brighter than just three months ago.
Bottom Line: I fear becoming too optimistic. During the recovery, excessive optimism has tend to result in disappointment. A month of data, after all, is just a month of data. At the same time, however, the pessimistic story is fading further into the distance. So far that some monetary policymakers might be having second thoughts about QE3. But even if they have such thoughts, and even if the hawks start chirping louder, the Fed is now committed to this path. Assuming inflation remains contained, at this point I suspect that we would need to see sustainable growth well above 3 percent in 2013 (the Fed's central forecast is 2.5-3%) before policymakers are willing to consider pulling their foot off the gas anytime soon.