The Federal Reserve released the minutes to the December 14th meeting. Below is the Staff outlook for the economy, along with a bit of my commentary/translation interspersed.
"…[E]conomic activity was increasing at a moderate rate, but...the unemployment rate remained elevated. The pace of consumer spending picked up in October and November, exports rose rapidly in October, and the recovery in business spending on equipment and software (E&S) appeared to be continuing.
"In contrast, residential and nonresidential construction activity was still depressed. Manufacturing production registered solid gains in October. Nonfarm businesses continued to add workers in October and November, and the average workweek moved up. Longer-run inflation expectations were stable, but core inflation continued to trend lower."
A reasonably solid performance and more upbeat than after the previous meeting. Without a doubt construction remains depressed, but it is the change that counts for economic growth, not the level.
Construction will probably stop declining in 2011, with perhaps a bit of a rebound (to still extremely depressed levels) in the second half of 2011. Just not being a drag on growth will be a big improvement to the overall growth picture.
"Labor demand rose further in recent months, but unemployment stayed at a high level. The average increase in private nonfarm payroll employment in October and November was close to the pace over the preceding six months, while the average workweek for all employees edged higher.
"The bulk of the private-sector job gains continued to be in the services industries; employment in manufacturing, construction, and retail trade declined, on average, in October and November. Employment at state and local governments rose slightly over the two-month period. A number of indicators of job openings and hiring plans improved in October and November, and initial claims for unemployment insurance trended steadily lower through November and early December.
"However, the unemployment rate, which remained at 9.6 percent during the preceding three months, increased to 9.8 percent in November, while the labor force participation rate and the employment-population ratio remained depressed."
Employment growth and a falling unemployment rate are not one and the same. They come from different surveys, to start with. But more importantly, changes in the labor force participation rate have a big influence on the unemployment rate.
The participation rate has been falling for the past three years (although was stable last month) which has understated the deterioration in the unemployment rate. As the economy improves, it is likely to move back up, which means that a decline in the unemployment rate could seriously lag employment growth on the way back up.
"Industrial production in the manufacturing sector increased at a solid pace in October, with advances widespread across industries; total industrial production was unchanged due to an offsetting weather-related drop in the output of utilities.
"The manufacturing capacity utilization rate continued to move up in October, although it remained significantly below its 1972-2009 average. Most indicators of near-term industrial activity, such as the new orders diffusion indexes in the national and regional manufacturing surveys, were at levels consistent with moderate gains in industrial production in the near term.
"Motor vehicle assemblies, which rose in October, fell back in November but were scheduled to move up again in coming months."
The improvement in Industrial Production and Capacity Utilization has been impressive, but the depths to which they fell were unprecedented. They rightly point out that the total production and utilization figures can be greatly influenced by weather affecting utilities. It is thus better to just look at the manufacturing numbers. Saying that they are significantly below the 1972-2009 average is a bit of an understatement.
Even with the impressive rebound, the level of capacity utilization, both total and manufacturing, is only near the lows of previous recessions. Still, things are moving in the right direction.
"The pace of consumer spending picked up in recent months from the modest rate that prevailed earlier in the year. Nominal retail sales, excluding purchases at motor vehicles and parts outlets, posted a strong gain in November, and revised estimates showed larger increases in September and October than previously reported.
"In addition, sales of new light motor vehicles stepped up in October and remained at that higher level in November. A number of factors supporting consumer spending also improved. Revised data on personal income indicated that it was stronger last spring and summer than previously reported. Household net worth rose further in the third quarter, as an increase in equity values more than offset the effect of a drop in house prices.
"Consumer sentiment turned more positive in November and early December, retracing most of the decline that occurred during the summer. However, while consumer credit outstanding showed signs of stabilizing after two years of runoffs, credit terms were still noticeably less favorable than in the past, and demand for credit appeared to remain weak."
The consumer is doing much better than a year ago. While there is more work to be done, consumers have greatly improved their personal balance sheets, and debt service is falling as a percentage of disposable income.
The savings rate is well off the pre-recession unsustainable lows. It will probably continue to increase, but not at the same rate as we have seen. A high savings rate is good for the long term, but an increasing savings rate slows down the recovery. All things considered, it is likely that personal consumption should be a positive for economic growth in 2011.
"Activity in the housing market was still quite depressed. In October, starts of new single-family homes remained at the very low level that had prevailed since August. Moreover, the level of permit issuance, which is typically a near-term indicator of new homebuilding, continued to run below starts.
"The persistence of a large excess supply of existing homes on the market and tight credit conditions for construction appeared to constitute a significant restraint on new homebuilding. Demand for housing also remained very weak: Sales of new homes in October were at the lowest level in the 48-year history of the series. Purchases of existing homes edged lower in October; in part, the still-low level of sales likely reflected the payback from the earlier surge in sales associated with the homebuyer tax credit and also the moratoriums on sales of bank-owned properties.
"Measures of house prices declined recently, and households' concerns that home values might continue to fall, their pessimism about the outlook for employment and income, and the tight standards faced by many mortgage borrowers appeared to be weighing on demand."
Housing has been a huge fly in the ointment of this economic recovery. Normally it is the sector that helps lead the economy out of recessions. Higher employment growth should lead to higher household formation and thus higher demand for housing, but it is going to be a slow process.
Given how depressed things are in the sector, it will not take very high levels relative to history to generate some very impressive percentage gains. That is probably more of a second half of 2011 or 2012 story than a first half of 2011 story, but when it happens it should generate some fairly impressive growth.
Real business investment in equipment and software appeared to be increasing, although the pace of spending seemed to have moderated from the rapid rate of the first half of the year. The rise in E&S spending during the third quarter, while somewhat slower than earlier in the year, remained solid and broad based, but the available data for the fourth quarter were mixed.
Nominal orders and shipments of nondefense capital goods excluding aircraft declined in October, and business purchases of new vehicles in October and November were down a bit from their third-quarter level. In contrast, sales in software still appeared to be on a solid uptrend, and deliveries of completed aircraft picked up in November.
Surveys of purchasing managers reported plans to step up capital spending in 2011; however, reports from small businesses on their planned expenditures remained downbeat. Business outlays on nonresidential structures appeared to be declining further, with a drop in spending on building construction offset only slightly by increased investment in drilling and mining structures.
Overall borrowing by nonfinancial corporations was robust again in November, indicators of credit quality continued to improve, and small businesses noted some easing in credit availability. However, financing conditions for commercial real estate remained tight.
Business investment in equipment and software has been leading the recovery this time around. I consider this the highest possible quality growth, as it lays the foundation for future growth.
Non-residential construction is likely to be weak in 2011, but at least the vacancy rates have stopped increasing. The turn in non-residential construction will happen after the turn in residential construction, so much more likely in 2012 than in 2011.
"Real inventory investment rose sharply in the third quarter, but book-value data for October suggested that the pace of accumulation was slowing. Although inventory-sales ratios rose during the third quarter, survey data implied that few businesses perceived inventory stocks as being too high."
Inventory investment was a big contributor to GDP growth in 2010. This is not likely to continue, but inventory investment is very low-quality growth.
"Consumer price inflation trended lower in October. The 12-month change in the total personal consumption expenditures (PCE) price index reached its lowest level of the past year; the 12-month change in the PCE price index for core goods and services also moved down.
"In October, core PCE prices were unchanged for a second month, as goods prices declined and prices of non-energy services posted a small increase. The broad-based deceleration in underlying inflation was also apparent in other measures, such as the trimmed-mean PCE price index and a diffusion index of PCE price changes.
"Despite the rise in agricultural commodity prices, the increase in retail food prices was modest. In contrast, consumer energy prices continued to rise rapidly in October, and spot prices of imported crude oil moved higher, on net, during November and early December.
"The rise in prices of nonfuel industrial commodities moderated over the intermeeting period as spot prices of metals declined, but the producer price index for domestically manufactured intermediate goods accelerated in October and November. In November and early December, survey measures of households' short- and long-term inflation expectations remained in the ranges that have prevailed since the spring of 2009."
Inflation is not a problem, and it is not likely to be one in 2011. The danger was more the other way, of outright deflation occurring. QE2 should take that risk off the table.
"Available measures of labor compensation showed that labor cost pressures were still restrained. The 12-month change in average hourly earnings for all employees remained low in November. In the third quarter, the modest rise in hourly compensation in the nonfarm business sector was matched by a similar increase in productivity."
With unemployment at 9.8%, this is not a good time to go and ask your boss for a raise. The benefit of increased productivity has mostly been going to corporations through higher profits, not to labor through higher wages.
"The U.S. international trade deficit narrowed considerably in October, shrinking to its lowest level since the beginning of the year, as exports surged and imports edged down. The strength in exports was relatively broad based. Exports of industrial supplies and agricultural goods registered the largest increases, although rising prices accounted for some of those gains. Exports of machinery and automotive products also rose strongly.
"The decrease in imports was concentrated in petroleum products, reflecting lower volumes, and in computers. In contrast, imports of consumer goods posted a noticeable increase."
Very good news on the trade front, but we need a lot more of it. A weaker dollar will help. The trade deficit is, in my opinion, a much more serious problem than is the budget deficit, particularly over the short term. Keep in mind that half of the trade deficit is due to out oil addiction, and that part will not be helped by a falling dollar.
I simply do no see how we can solve the trade deficit problem, though, without a weaker dollar. "King Dollar" is a tyrant and needs to be beheaded. Reducing oil imports is an economic imperative.
"Recent data releases confirmed that, in the aggregate, the rise in foreign real gross domestic product (GDP) slowed sharply in the third quarter from the very rapid pace earlier in the year. The slowdown was most pronounced in the emerging market economies (EMEs), where economic activity was restrained by the abatement of inventory rebuilding and the associated waning of the rebound in global trade, the unwinding of fiscal stimulus measures, and a continued tightening of monetary policies in several countries.
"More recent indicators for the EMEs -- including purchasing managers indexes (PMIs) -- pointed to a rebound in economic activity in the fourth quarter. The advanced foreign economies (AFEs) also saw a slower rise in real economic activity in the third quarter than occurred earlier in the year.
"In the euro area, economic performance continued to diverge across countries. The increase in German economic activity in the third quarter was nearly twice the euro-area average rate, and recent indicators, including PMIs and consumer and business sentiment, showed further solid performance.
"In contrast, Spanish economic activity stagnated in the third quarter, Greek GDP extended its decline, and more-recent indicators point to continued weakness in peripheral European economies. Headline inflation rates generally picked up in the foreign economies, driven largely by food and energy prices; measures of inflation excluding food and energy prices were relatively steady."
I would expect that economic growth in 2011 will still be much stronger in the emerging markets of Asia and Latin America than in the developed economies of Europe and Japan. Europe still has serious problems. Austerity there is not going to help growth.
Overall, the outlook is pretty good: solid economic growth and low inflation are likely in 2011. However, we are still in a very deep hole, and the pace of growth is not going to restore the 8 million jobs lost in the recession anytime soon. If we gain back a third of those jobs in 2011 it would be a success.
Construction is still a major drag to the economy but will eventually turn around, however the timing of that is uncertain, and it is unlikely early in 2011. However, if it just stops acting like a brake on growth in 2011, the overall economy could do much better.
Zacks Investment Research
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"In contrast, residential and nonresidential construction activity was still depressed. Manufacturing production registered solid gains in October. Nonfarm businesses continued to add workers in October and November, and the average workweek moved up. Longer-run inflation expectations were stable, but core inflation continued to trend lower."
A reasonably solid performance and more upbeat than after the previous meeting. Without a doubt construction remains depressed, but it is the change that counts for economic growth, not the level.
Construction will probably stop declining in 2011, with perhaps a bit of a rebound (to still extremely depressed levels) in the second half of 2011. Just not being a drag on growth will be a big improvement to the overall growth picture.
"Labor demand rose further in recent months, but unemployment stayed at a high level. The average increase in private nonfarm payroll employment in October and November was close to the pace over the preceding six months, while the average workweek for all employees edged higher.
"The bulk of the private-sector job gains continued to be in the services industries; employment in manufacturing, construction, and retail trade declined, on average, in October and November. Employment at state and local governments rose slightly over the two-month period. A number of indicators of job openings and hiring plans improved in October and November, and initial claims for unemployment insurance trended steadily lower through November and early December.
"However, the unemployment rate, which remained at 9.6 percent during the preceding three months, increased to 9.8 percent in November, while the labor force participation rate and the employment-population ratio remained depressed."
Employment growth and a falling unemployment rate are not one and the same. They come from different surveys, to start with. But more importantly, changes in the labor force participation rate have a big influence on the unemployment rate.
The participation rate has been falling for the past three years (although was stable last month) which has understated the deterioration in the unemployment rate. As the economy improves, it is likely to move back up, which means that a decline in the unemployment rate could seriously lag employment growth on the way back up.
"Industrial production in the manufacturing sector increased at a solid pace in October, with advances widespread across industries; total industrial production was unchanged due to an offsetting weather-related drop in the output of utilities.
"The manufacturing capacity utilization rate continued to move up in October, although it remained significantly below its 1972-2009 average. Most indicators of near-term industrial activity, such as the new orders diffusion indexes in the national and regional manufacturing surveys, were at levels consistent with moderate gains in industrial production in the near term.
"Motor vehicle assemblies, which rose in October, fell back in November but were scheduled to move up again in coming months."
The improvement in Industrial Production and Capacity Utilization has been impressive, but the depths to which they fell were unprecedented. They rightly point out that the total production and utilization figures can be greatly influenced by weather affecting utilities. It is thus better to just look at the manufacturing numbers. Saying that they are significantly below the 1972-2009 average is a bit of an understatement.
Even with the impressive rebound, the level of capacity utilization, both total and manufacturing, is only near the lows of previous recessions. Still, things are moving in the right direction.
"The pace of consumer spending picked up in recent months from the modest rate that prevailed earlier in the year. Nominal retail sales, excluding purchases at motor vehicles and parts outlets, posted a strong gain in November, and revised estimates showed larger increases in September and October than previously reported.
"In addition, sales of new light motor vehicles stepped up in October and remained at that higher level in November. A number of factors supporting consumer spending also improved. Revised data on personal income indicated that it was stronger last spring and summer than previously reported. Household net worth rose further in the third quarter, as an increase in equity values more than offset the effect of a drop in house prices.
"Consumer sentiment turned more positive in November and early December, retracing most of the decline that occurred during the summer. However, while consumer credit outstanding showed signs of stabilizing after two years of runoffs, credit terms were still noticeably less favorable than in the past, and demand for credit appeared to remain weak."
The consumer is doing much better than a year ago. While there is more work to be done, consumers have greatly improved their personal balance sheets, and debt service is falling as a percentage of disposable income.
The savings rate is well off the pre-recession unsustainable lows. It will probably continue to increase, but not at the same rate as we have seen. A high savings rate is good for the long term, but an increasing savings rate slows down the recovery. All things considered, it is likely that personal consumption should be a positive for economic growth in 2011.
"Activity in the housing market was still quite depressed. In October, starts of new single-family homes remained at the very low level that had prevailed since August. Moreover, the level of permit issuance, which is typically a near-term indicator of new homebuilding, continued to run below starts.
"The persistence of a large excess supply of existing homes on the market and tight credit conditions for construction appeared to constitute a significant restraint on new homebuilding. Demand for housing also remained very weak: Sales of new homes in October were at the lowest level in the 48-year history of the series. Purchases of existing homes edged lower in October; in part, the still-low level of sales likely reflected the payback from the earlier surge in sales associated with the homebuyer tax credit and also the moratoriums on sales of bank-owned properties.
"Measures of house prices declined recently, and households' concerns that home values might continue to fall, their pessimism about the outlook for employment and income, and the tight standards faced by many mortgage borrowers appeared to be weighing on demand."
Housing has been a huge fly in the ointment of this economic recovery. Normally it is the sector that helps lead the economy out of recessions. Higher employment growth should lead to higher household formation and thus higher demand for housing, but it is going to be a slow process.
Given how depressed things are in the sector, it will not take very high levels relative to history to generate some very impressive percentage gains. That is probably more of a second half of 2011 or 2012 story than a first half of 2011 story, but when it happens it should generate some fairly impressive growth.
Real business investment in equipment and software appeared to be increasing, although the pace of spending seemed to have moderated from the rapid rate of the first half of the year. The rise in E&S spending during the third quarter, while somewhat slower than earlier in the year, remained solid and broad based, but the available data for the fourth quarter were mixed.
Nominal orders and shipments of nondefense capital goods excluding aircraft declined in October, and business purchases of new vehicles in October and November were down a bit from their third-quarter level. In contrast, sales in software still appeared to be on a solid uptrend, and deliveries of completed aircraft picked up in November.
Surveys of purchasing managers reported plans to step up capital spending in 2011; however, reports from small businesses on their planned expenditures remained downbeat. Business outlays on nonresidential structures appeared to be declining further, with a drop in spending on building construction offset only slightly by increased investment in drilling and mining structures.
Overall borrowing by nonfinancial corporations was robust again in November, indicators of credit quality continued to improve, and small businesses noted some easing in credit availability. However, financing conditions for commercial real estate remained tight.
Business investment in equipment and software has been leading the recovery this time around. I consider this the highest possible quality growth, as it lays the foundation for future growth.
Non-residential construction is likely to be weak in 2011, but at least the vacancy rates have stopped increasing. The turn in non-residential construction will happen after the turn in residential construction, so much more likely in 2012 than in 2011.
"Real inventory investment rose sharply in the third quarter, but book-value data for October suggested that the pace of accumulation was slowing. Although inventory-sales ratios rose during the third quarter, survey data implied that few businesses perceived inventory stocks as being too high."
Inventory investment was a big contributor to GDP growth in 2010. This is not likely to continue, but inventory investment is very low-quality growth.
"Consumer price inflation trended lower in October. The 12-month change in the total personal consumption expenditures (PCE) price index reached its lowest level of the past year; the 12-month change in the PCE price index for core goods and services also moved down.
"In October, core PCE prices were unchanged for a second month, as goods prices declined and prices of non-energy services posted a small increase. The broad-based deceleration in underlying inflation was also apparent in other measures, such as the trimmed-mean PCE price index and a diffusion index of PCE price changes.
"Despite the rise in agricultural commodity prices, the increase in retail food prices was modest. In contrast, consumer energy prices continued to rise rapidly in October, and spot prices of imported crude oil moved higher, on net, during November and early December.
"The rise in prices of nonfuel industrial commodities moderated over the intermeeting period as spot prices of metals declined, but the producer price index for domestically manufactured intermediate goods accelerated in October and November. In November and early December, survey measures of households' short- and long-term inflation expectations remained in the ranges that have prevailed since the spring of 2009."
Inflation is not a problem, and it is not likely to be one in 2011. The danger was more the other way, of outright deflation occurring. QE2 should take that risk off the table.
"Available measures of labor compensation showed that labor cost pressures were still restrained. The 12-month change in average hourly earnings for all employees remained low in November. In the third quarter, the modest rise in hourly compensation in the nonfarm business sector was matched by a similar increase in productivity."
With unemployment at 9.8%, this is not a good time to go and ask your boss for a raise. The benefit of increased productivity has mostly been going to corporations through higher profits, not to labor through higher wages.
"The U.S. international trade deficit narrowed considerably in October, shrinking to its lowest level since the beginning of the year, as exports surged and imports edged down. The strength in exports was relatively broad based. Exports of industrial supplies and agricultural goods registered the largest increases, although rising prices accounted for some of those gains. Exports of machinery and automotive products also rose strongly.
"The decrease in imports was concentrated in petroleum products, reflecting lower volumes, and in computers. In contrast, imports of consumer goods posted a noticeable increase."
Very good news on the trade front, but we need a lot more of it. A weaker dollar will help. The trade deficit is, in my opinion, a much more serious problem than is the budget deficit, particularly over the short term. Keep in mind that half of the trade deficit is due to out oil addiction, and that part will not be helped by a falling dollar.
I simply do no see how we can solve the trade deficit problem, though, without a weaker dollar. "King Dollar" is a tyrant and needs to be beheaded. Reducing oil imports is an economic imperative.
"Recent data releases confirmed that, in the aggregate, the rise in foreign real gross domestic product (GDP) slowed sharply in the third quarter from the very rapid pace earlier in the year. The slowdown was most pronounced in the emerging market economies (EMEs), where economic activity was restrained by the abatement of inventory rebuilding and the associated waning of the rebound in global trade, the unwinding of fiscal stimulus measures, and a continued tightening of monetary policies in several countries.
"More recent indicators for the EMEs -- including purchasing managers indexes (PMIs) -- pointed to a rebound in economic activity in the fourth quarter. The advanced foreign economies (AFEs) also saw a slower rise in real economic activity in the third quarter than occurred earlier in the year.
"In the euro area, economic performance continued to diverge across countries. The increase in German economic activity in the third quarter was nearly twice the euro-area average rate, and recent indicators, including PMIs and consumer and business sentiment, showed further solid performance.
"In contrast, Spanish economic activity stagnated in the third quarter, Greek GDP extended its decline, and more-recent indicators point to continued weakness in peripheral European economies. Headline inflation rates generally picked up in the foreign economies, driven largely by food and energy prices; measures of inflation excluding food and energy prices were relatively steady."
I would expect that economic growth in 2011 will still be much stronger in the emerging markets of Asia and Latin America than in the developed economies of Europe and Japan. Europe still has serious problems. Austerity there is not going to help growth.
Overall, the outlook is pretty good: solid economic growth and low inflation are likely in 2011. However, we are still in a very deep hole, and the pace of growth is not going to restore the 8 million jobs lost in the recession anytime soon. If we gain back a third of those jobs in 2011 it would be a success.
Construction is still a major drag to the economy but will eventually turn around, however the timing of that is uncertain, and it is unlikely early in 2011. However, if it just stops acting like a brake on growth in 2011, the overall economy could do much better.
Zacks Investment Research
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