Economy In A Holding Pattern
The Federal Reserve Board’s decision to hold interest rate steady at 2% mirrors the current state of the economy, which is a holding pattern. The Fed is torn between placing emphasis on slowing economic growth or rising inflationary pressure from the commodities market.
Economic data released today reaffirms this situation, according to the Labor Department jobless claims stayed the same from a week ago at 384,000. The Bureau of Economic Analysis released it’s final revision for Gross Domestic Product for the first quarter raising it to 1% up from 0.9% from an earlier revision made last month.
While these aren’t great numbers, the economy is faring slightly better than what most economists were predicting. Although it does appear we are entering a period of stagflation, it is no where near the scale of which the economy faced in the 1970’s.
The Commerce Department released figures showing that sales of existing homes climbed slightly last month to an annual rate of 4.99 million homes up from a record low of 4.85 million homes in April. Although declining prices have spurred some buyers back into the market, the housing slump is expected to continue for the foreseeable future as the inventory of unsold homes accumulates with mortgage rates climbing in recent months.
Consumer spending numbers have received a recent boost from economic stimulus payments but much of the increase can be attributed to rising energy and food prices. However, falling consumer confidence levels and a weak outlook on job growth is expected to have a negative impact on spending once those payments run out.
More writedowns are expected to hit the financial services sector as firms will need to revalue bond portfolios with some of the major bond insurers being downgraded to little higher than junk bond status. Still we need to keep in mind that most of these writedowns will not actually become realized losses and that while much of the municipal bond market has been devalued, it still has a strong history of low default rates unlike collaterized debt obligations from the residential mortgage market.
As ratings agencies slowly adjust municipal credit ratings to more closely match the standards of the corporate bond market we should see some of these writedowns disappear. However, rising defaults and foreclosures in the housing market will still affect those with the greatest subprime exposure.
Until the economy signals to the Fed which direction to go to, rates will most likely remain steady though out the summer.
