FedViews, FRBSF (no permalink): Mark Spiegel of the Federal Reserve Bank of San Francisco gives his view of the outlook for the economy:
The advance estimate of real GDP growth for the fourth quarter of 2006 was 3.5%, contrary to market analysts’ expectations of 3.0%. Growth was driven by strong consumption expenditures, as well as increases in government services and exports.
However, subsequent data releases in January registered some weakness, suggesting the potential for downward revisions to this number. Going forward, we project modest growth in the first quarter of 2007, and then a pickup to a moderate pace for all of 2007.
There were some signs of weakness in the manufacturing sector. The ISM new orders index for January fell to 50.3, close to stagnation, while the overall index fell to 49.3, which indicates some contraction. The automotive sector in particular showed weakness, as inventories were high in January and auto manufacturers cut production levels sharply.
The high inventories in the automotive sector reflected the relatively weak January sales. Sales of autos and light trucks were essentially unchanged in January, although domestic sales weakened 0.2 million units, while imports increased 0.2 million units.
We are beginning to see some signs of stabilization in the housing market. Overall housing starts rose modestly in December to 1.64 million units, but single-family starts fell to 1.23 million units. Adjusted permit issues, which are generally considered a more accurate forecaster of future construction activity in single-family housing, rose in December after declining steadily for ten months. There has been some speculation that exceptionally warm weather in December increased the number of starts, but it appears unlikely that the weather would have much impact on permit issues.
Unemployment ticked up to 4.6% in January, which is still consistent with tightness in the labor market. The employment report for January was a little weaker than expected in January, with estimated growth at 111,000 jobs, while expectations were closer to 150,000 jobs. Still, the shortfall was largely offset by upward revisions to the December figure, from the initial report of 167,000 to 206,000. We project the unemployment rate to increase slightly by the end of 2007, but to remain at levels consistent with labor market strength.
The personal consumption expenditures (PCE) price index rose 0.4% in December. Increases in the core index were very modest, but there were marked increases in the price index for energy, including an 8.1% increase in the cost of motor fuel. For the year as a whole (12 months ending in December), the PCE price index grew 2.2%. PCE price inflation is expected to remain contained in 2007, and to fall below 2% by the end of 2008.
The FOMC kept the federal funds rate target unchanged at its meeting on January 31. The statement noted strengthening on the real side of the economy, as well as positive news on the inflation front, but retained the suggestion in its policy statement that the risks of future changes were primarily to the upside and would be based on incoming information.
The expected path of the federal funds rate is now basically flat, with the market not expecting a cut until December 2007.
Interest rates are up modestly since the beginning of the year, primarily on news concerning strength in the U.S. economy. There has been a modest flattening in the yield curve, with 3-month Treasuries up by 16 basis points at 5.18%, 2-year Treasuries up by 12 basis points at 4.94%, and 10-year Treasuries up by 9 basis points at 4.80%.
The U.S. trade deficit narrowed in November. The gains were primarily due to increases in exports, which included a jump in aircraft sales. However, aircraft sales often prove to be transitory and the market expects some reversals in these gains in the December figures that come out tomorrow.
The narrow nominal dollar has appreciated 1.5% since the beginning of the year. The dollar has appreciated 1.8% against the euro and 2.3% against the yen.