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Tuesday, August 31, 2010

2Q Results: Banking Industry Regaining Strength

The FDIC released its Q2 bank earnings report today, which shows that, even with significant economic headwinds, the banking industry continues to regain its strength. Capital increased, earnings were up and margins improved. Moreover, troubled loans were down, provisions fell and charge-offs declined.

Banks reported their highest earnings since the third quarter of 2007, with a second quarter profit of $21.6 billion.


Banks have increased their capital levels and set aside strong reserves to cover problem loans that typically result from high levels of unemployment and business failures. Problem loans are down, allowing banks to put losses behind them and look for new lending opportunities as the economy improves.

It was no surprise to learn that all major loan categories reduced balances during the quarter, given the still weak economy and the regulatory uncertainty that has been hovering over the industry for nearly two years. This will, unfortunately and incorrectly, be reported as banks not lending. As I’ve mentioned in several blog posts, banks have to first replace loan losses and repaid (and amortizing) loans just to stay even each quarter with loan volumes. Clearly,not an easy task – or a reasonable one – given the poor economic conditions facing many communities and the emphasis by regulators on higher levels of capital.

There was other good news surrounding problem loans: net charge-offs totaled $49 billion in the second quarter, a $214 million decline from a year earlier and the first year-over-year decline since the fourth quarter of 2006. Further, noncurrent loans declined by $19.6 billion during the second quarter, the first quarterly decline since the first quarter of 2006.

Banks overall are in a strong financial position. 95.6% of banks – holding over 98.8% of the industry’s assets – are classified as "well capitalized," which is the highest regulatory designation possible. These numbers reflect an increase in banks in the well-capitalized category from the first quarter. Banks added another $27 billion in equity capital in the second quarter and total industry capital is now just short of $1.5 trillion. When added to the more than $250 billion in reserves banks have set aside to cover losses, this makes for a total buffer of $1.74 trillion against losses.


The increase in the number of banks on the list of troubled institutions (from 775 to 829) is not surprising given some parts of the country are still mired in the recession. However, the total assets of troubled institutions declined to $403 billion (from $431 billion), signaling a decline in asset size of banks that are currently on the list (from $520 million to $486 million on average). The Deposit Insurance Fund reduced its deficit for the second consecutive quarter, resulting from the largest quarterly gain in FDIC’s history -- $5.47 billion. This was attributable to both higher assessments ($3.2 billion) and, importantly, $2.5 billion of recaptured loss provisions resulting from a downward revision in expected losses for this year. The FDIC did report the highest quarterly operating expenses of $382 million for the quarter.



The banking industry is committed to maintaining the strength of the deposit insurance fund. All costs of the FDIC are borne by the industry, not taxpayers. Each depositor is fully insured up to $250,000, and in the 75-year history of the FDIC no depositor has ever lost a penny of insured deposits.

Navigating the ups and downs of the economy is nothing new to banking. The vast majority of banks have been in business for more than 50 years, and one of every three banks has served its local community for more than a century. Through good times and bad, it is this philosophy of building long-term relationships with customers that has made banks successful.

Case-Shiller Index: Existing Home Prices Rise 1.0%, Up 4.2% From Prior Year

The twenty-city Case-Shiller Index for existing home prices in the three months ending June rose by 1.0% on a non-seasonally adjusted basis, following 1.3% growth in May. The ten-city metro area index reported 1.0% growth from May and registered 5.0% higher than one year ago. As the index is a three-month average of home prices, price appreciation over the quarter from the home buyer tax credit was likely responsible for the index’s increase. Prices are expected to be falling now, but the declines will not likely register on the index’s three-month rolling average until September. The Case-Shiller press release set these expectations saying, “recent housing indicators point to more ominous signals as tax incentives have ended and foreclosures continue.”

Seventeen of the twenty metro areas reported price appreciation from May to June. Las Vegas was down 0.6% and Phoenix and Seattle were both flat.



Conference Board Consumer Confidence Index Jumps 2.5 Points

According to the Conference Board Consumer Confidence Index, consumer confidence increased 2.5 points in August after falling 11.7 points in previous two months. The index increased from 51.0 in July to 53.5 in August. Future expectations, which were responsible for the declines in June and July, rebounded in August, driving the month’s increase.

Conditions of the labor market weakened significantly. The share of consumers reporting jobs being plentiful fell to its lowest level this year, while the share reporting jobs hard to get rose its highest level for the year.

The inflation expectations index, at 4.9, reported no change from July to August; however, the index has been trending downward since March’s 5.4 reading as fewer consumers expect higher interest rates over the next year.



10.08.31 (Source: Conference Board)

Monday, August 30, 2010

Personal Income, Consumption Up; Savings Rate Falls 0.3 Points, Remains Historically High

Personal income grew 0.2% in July, following no growth in June. The increase was driven by greater wage and salary income, which grew 0.3% in July following a 0.1% decline in June. The reduction in Census workers subtracted $1.4 billion at an annual rate from July payrolls, improvement from the $3.4 billion that was subtracted in June. From a year-prior, incomes were 3.0% higher.

Personal consumption rebounded a modest 0.4% in July after flat or negative growth since April. Consumers grew more cautious in the spring, with April’s 0.1% contraction ending seven consecutive months of increases. Spending on both durables and nondurables rose in July, following three months of declines.

The increase in consumption came at the expense of the savings rate which declined to 5.9% in July, following over 6.0% readings in May and June. Despite the decline, the savings rate is trending near a high level not seen since the early 1990s. Consumers continue to bolster their balance sheets as the transition from government-supported income growth to growth driven by the private sector proves to be slow but present.

As measured by the PCE deflator, prices increased 0.2% after three months of negative or flat growth. Readings suggest inflation remains well-contained. From a year prior, the PCE deflator was 1.5% higher, the second consecutive month below 2.0%. The core PCE deflator, which excludes energy and food prices, was up 0.1% over the month and was 1.4% higher from the year prior.



10.08.30 (Source: Bureau of Economic Analysis)

Friday, August 27, 2010

Bernanke: Fed Ready to Act If Economy Deteriorates Further

Today in Jackson Hole, Wyoming, Federal Reserve Chairman Ben Bernanke outlined numerous strategies the Fed could implement to provide additional stimulus to the economy, but considering the unknowns and costs associated with each option, stressed that they would only be implemented if the economy weakens further. Bernanke focused on three main tools: (1) additional purchases of longer-term securities, (2) modifying the FOMC’s communications, and (3) reducing the interest on excess reserves.

Bernanke asserted, “additional purchases of longer-term securities, should the FOMC choose to undertake them, would be effective in further easing financial conditions.” However, he warned that with little experience using this option, precise knowledge of its impact is unknown. He also warned that continued expansion of the Fed’s balance sheet could reduce the public’s confidence in the Fed’s ability to unwind much of the stimulus and simultaneously control inflation.

A second strategy would be alter the FOMC’s communications regarding inflation expectations. The FOMC could “modify the language in the statement to communicate to investors that it anticipates keeping the target for the federal funds rate low for a longer period than is currently priced in markets. Such a change would presumably lower longer-term rates by an amount related to the revision in policy expectations.”

“A third option for further monetary policy easing is to lower the rate of interest that the Fed pays banks on the reserves they hold with the Federal Reserve System… On the margin, a reduction in the IOER rate [interest on excess reserves] would provide banks with an incentive to increase their lending to nonfinancial borrowers or to participants in short-term money markets, reducing short-term interest rates further and possibly leading to some expansion in money and credit aggregates.” Currently, the Fed pays 25 basis points on excess reserves. Bernanke said the rate could be reduced to ten or even zero basis points. However, given current circumstances, the impact of reducing the rate would likely be “relatively small.”

Bernanke dismissed the idea that the FOMC should increase its inflation goals, saying “I see no support for this option on the FOMC.” Recently several economists have proposed increasing the Fed’s medium-term inflation goals beyond levels consistent with price stability.

Bernanke stressed that these plans would only be implemented if the economy showed further signs of weakness, as all of the options carry costs and consequences. The economy continued to expand, albeit at a slower pace than initially hoped. Bernanke affirmed that “falling into deflation is not a significant risk for the United States at this time, but that is true in part because the public understands that the Federal Reserve will be vigilant and proactive in addressing significant further disinflation.”

2Q GDP Revised Down From 2.4% to 1.6%

Second quarter real GDP growth was revised down from an annualized 2.4% to an annualized 1.6%. The adjustment was driven by downward revisions to both private inventories and net exports. Consumer spending was revised upward; however, GDP’s downward revision marks a weakening recovery. On a year-ago basis, real GDP grew 3.0%.

Weaker exports and higher imports detracted 3.4 points from GDP, compared to the 2.8 point reduction initially reported. This is much weaker than the first quarter, where net exports removed 0.3 points from GDP. Inventory investment decelerated faster than initially expected, adding 0.6 points to GDP, down from the previously reported 1.1 points. This was the weakest inventory report in past three quarters.

An upward revision to consumer spending was a small offset to the downward pressures. Consumption added 1.4 points to GDP, up from the initially reported 1.3 points. Consumer spending has improved for two consecutive quarters.

Corporate profits increased $73 billion from the first quarter to an annualized $1.64 trillion. This was the sixth consecutive quarterly increase in profits as companies benefitted from stronger consumer demand. Profits were 11.2% of GDP in the second quarter, up from the 7% cyclical low at the end of 2007.


No Loan Demand From Small Businesses; Weak Sales Top Problem

William Dunkleberg from NFIB on CNBC Squawk Box says there is no demand for loans from small businesses. The percent that say they don’t want a loan has risen by 10 points since the beginning of the recession to a record high. Most “good” borrowers are on the sidelines, still waiting for a reason to seek a loan and expand their businesses. What businesses need are customers, giving them a reason to hire and make capital expenditures and borrow to support those activities. Twenty-nine percent cite weak sales as their top business problem.

See the full NFIB (National Federation of Independent Business) report here.












Video via CNBC.com

Sluggish Increase in Consumer Sentiment; Index Up 1.6 Points

In August, the University of Michigan Consumer Sentiment Index rose 1.6 points to 68.9. The index rose more than many forecasters had expected. Despite the increase, consumers continue to be concerned about income growth and job prospects. According to the survey, a quarter of households had seen their finances improve during August survey period, which was due to individuals paying down debts and building up savings.

The measurement of future expectations dropped a year-over-year 3.2 points to 62.9. The relatively flat economic outlook in the expectations index is attributed to roughly 80% of consumers not expecting a decline in unemployment. Despite the pessimism about jobs, consumers were twice as optimistic about the labor market as they were two years ago.


Thursday, August 26, 2010

Thrifts Report $1.49 Billion Net Income in 2Q

The thrift industry reported a net income of $1.49 billion in the second quarter, the fourth consecutive profitable quarter for the industry. Despite lower loan loss provisions in the second quarter, net income declined from $1.72 billion in the first quarter. High unemployment, unrelenting housing market weakness, and instability in the commercial real estate sector continued to depress earnings. Despite the economic conditions, the foundation of the industry remained solid, as a majority of thrifts, 93.4 percent, were considered “well-capitalized” by regulatory standards.

See ABA's full summary of 2Q results here.



Wednesday, August 25, 2010

New Home Sales Fall 12.4% – Median Sales Price Down 7.6%

New home sales fell 12.4% in July to an annualized pace of 276,000 units. This follows a downwardly revised sales pace of 315,000 units in June (previously reported to be 330,000). Sales have been very volatile in recent months primarily due to the effects of the homebuyer tax credit which expired in April. Sales rose sharply in March and April as buyers rushed to take advantage of the credit. Following this rush, sales fell back to much lower levels. Housing activity has clearly slowed down over the past few months.



The median sales price has likewise been volatile. Prices fell 13.6% in April as homebuilders likely discounted prices in order to clear inventory before the credit ended. In May, prices jumped back up 16.2%. Since then, prices have continued to fall, dropping 7.6% in July. The median sales price was $201,600 in July, down 4.9% from a year earlier.

With the drop in sales, the months supply of inventory of homes for sale rose to 9.1 from 8.0. The historical norm is about 4.5 to 5 months. Before it can be certain the prices have stabilized, this ratio will likely have to find its way back to this area.



10.08.25 (Source: Census Bureau)

Q2 Personal Bankruptcies Rise as Pace Continues to Slow

Personal Bankruptcies up as Total Q2 Filings Rise 9%
Data on the second quarter filings shows that the lack of employment opportunities has contributed to a higher number of bankruptcy filings. During the quarter, there were roughly 422,000 in total bankruptcy filings, up 9% from a quarter earlier and 11% from a year before, based on data from the U.S. Bankruptcy Courts. Additionally, analysis showed that personal bankruptcy filings rose 9%, the second consecutive quarterly increase. This rise in personal filings comes as business bankruptcies have fallen for the last three quarters.



Pace of Bankruptcies Continues to Slow Despite Volume Increasing
The graph below illustrates that the rate of bankruptcy filings has slowed since 2007 and seems to be following a downward trend. The year-over-year percentage change in filings has fallen significantly to a pace of 7% through June, compared to a rate of 40% a year ago. But it is important to remember that the recent historical numbers are coming off of an extremely low level due to the 2005 Bankruptcy Reform. In addition to the pace of filings slowing, the emergence of a post-Bankruptcy Bill seasonal pattern is becoming more pronounced.


Along with the quarterly data, a heat map was included in the press release illustrating the counties with the highest bankruptcies per capita (click here).

Full analysis is available here or in the "Documents of Interest" column to the right.

Tuesday, August 24, 2010

Existing Home Sales Plunge 27.2%; Single-Family Home Sales - Slowest Pace Since 1995

Existing home sales fell by 27.2% in July to an annualized sales pace of 3.83 million units. This sets a new cyclical low sales pace and is the slowest since the data series began in 1999. Single-family homes, which account for the bulk of the series, were at the slowest pace since 1995. July’s decline was the third consecutive monthly drop following the expiration of the homebuyer tax credit. From a year-prior, sales were down 27.5%.

With the decrease in sales over the month, the months supply of inventory rose to 12.5 from 8.9. The historical normal is around 5 months of inventory. Ratios well above this level are historically correlated with short term price declines. Until the sales pace increases and/or the supply of inventory gets further worked off, price stability is unlikely. In July however, prices were relatively stable. The median sales price declined 0.2% to $182,600, ending a four month trend of price appreciation. From a year earlier, prices were up 0.7%.


Source: National Association of Realtors

Wednesday, August 18, 2010

Minneapolis Fed: Breakdown in Job Openings & Unemployment Relationship Tells of Structural Unemployment that the Fed Can't Fix

In a speech yesterday, Federal Reserve Bank of Minneapolis President Narayana Kocherlakota described a breakdown in the relationship between the job opening rate and the unemployment rate. Historically, the two rates held a close inverse relationship: as the job opening rate increased, more could find work and the unemployment rate decreased.

However, in mid 2008, the relationship began to break down. Kocherlakota stated, “The job openings rate has risen by about 20% between July 2009 and June 2010. Under this scenario, we would expect unemployment to fall because people find it easier to get jobs. However, the unemployment rate actually went up slightly over this period.”


The breakdown signals firms having job openings, and adding new jobs, but being unable to find the appropriate people to fill them. This situation, referred to as structural unemployment, occurs when those seeking work cannot fill the current job openings, typically because applicants do not possess the required skills. However, in this cycle, many seeking work may also be unable to relocate to potential job opportunities because they are underwater on their mortgage or have completed a mortgage modification, many of which require the borrower to stay in the house for a specified period of time. Additionally, some in the labor force have job opportunities which they are reluctant to accept, as the salary is below their previous pay and they are unwilling to permanently reduce their standard of living.

The breakdown in this relationship between job openings and unemployment has serious implications for our economy. Kocherlakota explained, “Were that stable relationship still in place today, and given the current job opening rate of 2.2%, we would have an unemployment rate of closer to 6.5%, not 9.5%.”

Addressing this situation is even more troubling. The Fed continues to provide an accommodative monetary policy, providing conditions for plants to hire new workers, but as Kocherlakota explained:

“..the Fed does not have a means to transform construction workers into manufacturing workers… How much of the current unemployment rate is really due to mismatch, as opposed to conditions that the Fed can readily ameliorate? The answer seems to be a lot. Most of the existing unemployment represents mismatch that is not readily amenable to monetary policy.

Read all of Kocherlakota speech here.

Tuesday, August 17, 2010

CSPAN Appearance to Discuss the Dodd-Frank Act & Answer Callers' Questions

This morning I appeared on CSPAN’s Washington Journal to discuss the impact of the Dodd-Frank Act and other new regulations on the banking industry. I stressed the need for a balanced approach in implementing new rules, keeping in mind many of the problems originated in the non-bank sector. Traditional banks, which had nothing to do with the crisis, will be burdened by as much as 5,000 pages of new regulation, a burden that will result in higher prices and lower availablitity of loans. The bill does provide the tools for addressing systemically significant institutions, which further secures our financial system – a provision that ABA supported.

I responded to callers’ questions on TARP, stressing the fact that the bank investments have provided $20 billion in profit to the taxpayers, while all of the losses have resulted from AIG, auto companies, and the government’s mortgage programs. I also reminded listeners of the expanded FDIC deposit coverage, now at $250,000.

See the full video on CSPAN’s site by clicking on the picture below.

Housing Starts Rise 1.7%, Single Family Starts Down 4.2%

In July, housing starts rose 1.7% to an annualized pace of 546,000 units. July’s increase follows a large downwardly revised drop in June of 8.7% (previously reported as a 5.0% drop). Since the expiration of the homebuyer tax credit, housing construction has fallen considerably and remained at a low level not seen since October 2009.

The increase over the month was entirely due to the volatile multifamily starts component, which rose 32.6% after dropping 33.3% in June. Single family starts continued to fall, declining 4.2%. Single family starts are now at their slowest pace since May 2009. From a year prior, total starts were down 7.0%, while single family starts were down 14.6%.

New building permits, which tend to lead future starts, fell 3.1%, Single family permits declined by 1.2%.


Source: Census Bureau

Banks More Willing to Make Consumer Loans, Demand Remains Weak

The July Federal Reserve Senior Loan Officer Survey reported that banks increased their willingness to make consumer installment loans for the third consecutive quarter, reaching a decade high. A small net fraction of banks reported easing standards on both credit card and other consumer loans.


Terms on consumer loans other than credit card loans were reported to have been roughly unchanged during the three month survey period. Demand for all types of consumer loans weakened.



Indicators of changes in standards and terms for approving applications for credit card loans were mixed. A few banks eased standards, but small net fractions of domestic banks indicated that they had tightened terms and conditions on credit card
accounts. Moreover, a small fraction of banks reported having reduced the size of credit card lines for existing customers, though that fraction has decreased noticeably over the past few surveys.

As for residential real estate lending, a small fraction of domestic banks eased standards on prime residential mortgage loans. The increase in demand over the past few months for prime residential mortgage loans reported by several respondents to the current survey represents a reversal of the net weakening of demand for such loans reported in the April survey.

Industrial Production Up 1.0%, Manufacturing Up 1.1%

In July, industrial production had a strong showing, rising 1.0% over the month. This follows a slight decline of 0.1% in June. The increase was primarily due to a 1.1% rise in manufacturing output. This area has been somewhat volatile in recent months. July’s rise follows a drop of 0.5% in June.

The increase was primarily driven by a 9.9% jump in auto production, which was in part due to GM not engaging in its usually seasonal plant retooling. Still, even without autos included, manufacturing output grew 0.6%, boosted by another month of strong growth in business equipment production. Non-durable goods manufacturing grew by a much small 0.1%.

Mining output rose 0.9%, while utilities output rose 0.1%. The latter category rose heavily in the prior two months and remained at a high level in July. This was in large part due to high seasonal temperatures driving up air-conditioning related electricity demand.

The capacity utilization rate rose 0.7 points to 74.8%. There still remains heavy productive slack; however, the utilization rate is considerably higher than its lows of last year. It will have to continue to increase in order to drive significant capital expenditures and payroll expansion.


Source: Federal Reserve

PPI: Headline Up 0.2%; Core Prices Up 0.3%

In July, the Producer Price Index for finished goods rose 0.2%. This reversed a three month trend of declines. The prior declines were primarily driven by lower energy prices. In July, energy prices rose somewhat. However, the increase was primarily driven by non-energy products, particularly pharmaceutical inputs and light trucks. The core index, which does not include energy or food product prices, rose by 0.3%. This was the fastest clip thus far this year. From a year prior, the core index was up 1.5%. Though this is still quite modest producer price inflation, it is the highest year-over-year increase since September 2009. The top line index was 4.1% higher from a year prior.


Source: Bureau of Economic Analysis

Monday, August 16, 2010

C&I Loan Terms & Standards Ease, Demand Unchanged in Fed's July Survey

According to the July Federal Reserve Senior Loan Officer Opinion Survey, domestic banks reported easing standards and most terms on C&I loans to firms of all sizes, a move that continues a modest unwinding of the widespread tightening that occurred over the past few years.

A modest net fraction of domestic banks eased standards for lending to large and middle-market firms over the previous three months—the second consecutive survey showing such an easing. Moreover, this is the first survey that has shown an easing of standards on C&I loans to small firms since late 2006.


Many banks eased terms on C&I loans, as they had reduced spreads of loan rates over their bank’s cost of funds and trimmed the costs of credit lines. Domestic banks also reported that they had stopped reducing the size of existing credit lines for commercial and industrial firms, on net—the first time that banks had not reported cutting such lines since these questions were added to the survey in January 2009.

Nearly all banks that reported easing standards or terms on C&I loans cited more aggressive competition from other banks or nonbank lenders (other financial intermediaries or the capital markets) as an important reason for doing so, and about one-half of the respondents that eased pointed to a more favorable or less uncertain economic outlook.

On balance, demand for C&I loans from large and middle-market firms and from small firms changed little in the July survey. In comparison, the April survey reported weaker demand from firms of all sizes.


Banks that experienced higher C&I loan demand attributed the improvement to customers shifting funding needs from other credit sources to banks and customers’ increasing need to finance inventory and receivables. Also, loan demand for investments in plant or equipment increased in July relative to the April survey.

About 20 percent of respondents, on net, said inquiries on the availability and terms of new C&I credit lines increased over the last three months.

Friday, August 13, 2010

Retail Sales Up 0.4% – Led By Auto and Gasoline Sales

In July, retail sales grew 0.4% after two months of declines. The volatility over the past few months has been due, in part, to fluctuations in auto sales and gas prices. Sales excluding autos and gas sales fell slightly by 0.1% over the month, following a 0.2% rise in June. Most retail subcategories saw modest declining sales outside of gasoline and autos.

From a year prior, sales were up 5.5%, down from 8.7% in April, but up from 5.2% in June. Core sales, were up 4.0% from a year earlier, down from 5.0 percent in April and unchanged from June.



10.08.13 (Source: Census Bureau)

CPI Up 0.3%; Core Prices Rise 0.1%

In July, the Consumer Price Index rose 0.3%, following three months of declines. The index had been dragged down by declining energy prices over the prior three months, but in July energy prices rose 2.6%. The core index, which excludes prices of energy and food products, rose 0.1% following a 0.2% rise in June.

From a year prior, the CPI was 1.3% higher. This is up from the 1.1% change in June, but still the second lowest measure of this cycle. The core CPI was up by a lesser 1.0% from a year prior, tying the cyclical low of the past three months. The growth in core prices has continued to be very modest, indicating that at least currently, little inflationary pressure exists.



10.08.13 (Source: Bureau of Labor Statistics)

University of Michigan Consumer Sentiment Index Up 1.8 Points

In August, the University of Michigan Consumer Sentiment Index rose 1.8 points to 69.6. This moderate improvement follows a large decline in July of 8.2 points. Confidence levels seem to have stabilized for the moment, but still remain very low. The improvement in July was evenly due to both of the major components of the index. Both the current conditions component and the future expectations component rose 1.8 points.

Changes in inflationary expectations were mixed. The one-year outlook rose to 2.8 percent from 2.7 percent in June. The five-year outlook fell to 2.7 percent from 2.9 percent.



10.08.13 (Source: University of Michigan)

Tuesday, August 10, 2010

Fed Funds Rate Kept Constant; View Of Economy Less Upbeat – Will Roll Over MBS Holdings

The Federal Open Market Committee voted to keep the Federal Funds Target in a range between 0 and 25 basis points. In addition, the Fed indicated that in order to “support the economic recovery,” it will keep constant the current level of securities on its balance sheet by reinvesting the principal payments of agency and agency mortgage-backed securities in longer-term Treasury securities. This is looser monetary policy relative to the previous plan of allowing the balance sheet to contract as securities mature, yet is a step to shift the composition of the Fed's balance sheet closer to its traditional holdings of mainly Treasury securities.

The general mood of the committee regarding the economy was more pessimistic this time around:
Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months. … the pace of economic recovery is likely to be more modest in the near term than had been anticipated.

As of the sending of this e-letter, the stock market reacted bullishly, with the DOW Jones Industrial Average rising 50 points. The bond market also rallied, with the ten-year treasury falling about 25 basis points to 2.80 percent.

There was one vote against the policy statement coming from Thomas M. Hoenig. He judged that the economy is recovering modestly, as projected. Accordingly, he believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted and limits the Committee's ability to adjust policy when needed. In addition, he objected to the Fed keeping its balance sheet constant.

Key statements new to current release in RED. Key statements removed relative to prior release in BLUE.
















































August 10th Meeting




June 23rd Meeting


Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Bank lending has continued to contract. Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be more modest in the near term than had been anticipated.
Information received since the Federal Open Market Committee met in April suggests that the economic recovery is proceeding and that the labor market is improving gradually. Household spending is increasing but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad. Bank lending has continued to contract in recent months. Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be moderate for a time.



























Measures of underlying inflation have trended lower in recent quarters and, with substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.
Prices of energy and other commodities have declined somewhat in recent months, and underlying inflation has trended lower. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.



























The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.



























To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities.1 The Committee will continue to roll over the Federal Reserve's holdings of Treasury securities as they mature.


































The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.
The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.



10.04.28 (Source: Federal Reserve)

Labor Productivity Down 0.9%; Unit Labor Costs Rise 0.2%

Labor productivity growth came to a halt in the second quarter, declining 0.9% on a seasonally adjusted, annualized basis. This decline follows five quarters of very strong growth. The growth rate has been decelerating for three quarters now, and this change represents a transition into the next period of economic recovery. In early stages of expansion, as has been the case the past year, productivity surges as firms find new ways to get more out of their existing labor forces. Therefore, GDP growth occurs without a lot of new hiring. Productivity growth is required in the long run if incomes are to grow, but in the short run it reduces the demand for new hires. However, at some point, firms existing labor forces cannot continue to produce more and new hiring is required. Assuming that the economic recovery continues, this step is likely now beginning and an upturn in new employment will begin.

Over the month, output per hour of labor fell by 0.9% annualized, while compensation per hour fell 0.7%. At least part of the compensation decline was likely due to the mix of workers as firms have begun to hire new entrants that tend to have lower starting wages. Unit labor costs, the measure of cost of a unit of output per hour, rose 0.2%, the first increase since Q2 of 2009. Even with the increase, inflationary pressure from the labor market will remain minimal as heavy slack still persists.



10.08.10 (Source: Bureau of Labor Statistics)

Friday, August 6, 2010

June Housing and Mortgage Market Trends

Big uncertainties remain for the housing market as the home purchase tax credit program expired and doubt lingers about the strength of the U.S. economic recovery. As I sat in the dark following an extended power-outage in a Maryland suburb of Washington DC, I noticed a similar feeling between the lack of electricity and the uncertain state of the housing market. Comments regarding the two situations could have been interchangeable –

“the storm was bigger than we first thought and it’s taking longer to work through the problems”
“we’re not sure when normality will be restored”
“we’ve revised the timeline and it will be longer than expected”

Meanwhile everyone is cursing the darkness and looking desperately for signs of improvement. My electricity is back after nearly a week, but the same can’t be said for the housing market.

As a result of the shaky situation, homebuilders have discounted sales to unload excess inventories. After the mad scramble to fulfill purchases before the expiration of the tax credit, potential home buyers are once again back to sitting on the sidelines. The low interest rate environment and falling home prices continue to sweeten deals, but not enough to overcome the softness of the labor market and the slide in consumer confidence.

Below are the highlights from the June numbers:

  • Existing home sales fell for the second straight month, declining 5.1% to an annualized pace of 5.37 million units. Sales have since fallen off in the wake of credit program ending. From a year prior, sales were up 9.9%. With the decrease in sales over the month, the months supply of inventory rose to 8.9 from 8.3. The supply of inventory will have to continue to decline before prices can be certain to have bottomed out. The historical normal is around 5 months of inventory.
  • New home sales shot up 23.6% in June to an annualized pace of 330,000 units. However, this followed a large decline in May, so the percentage increase is only giving an appearance of strength without much underlying support. The cumulative rise of sales off of the prior trend in March and April was about the same magnitude as the decline in sales in May and June. This suggests that the vast majority of sales that were driven by the tax credit where not newly induced buyers. Instead, it is likely that many buyers who would have purchased a home in later months simply moved their purchase forward by a couple months to take advantage of the credit. [See the blog posting on this subject.]
  • Housing starts fell again to an annualized level of 549,000 units, the second consecutive monthly decline. The number of starts fell to level last seen in November 2009. Meanwhile, permits rose 2.1% from the previous month to 586,000 units in June. The fact that starts (at 549,000 units), are still much greater than sales of new homes (at 330,000 units) shows the pressure on the homebuilding sector will continue for some time. It is a bit shocking that there is little demand to clear the near-record-low levels of new homes being built.
  • Mortgage rates continue to set new record lows – reaching a monthly average 4.38% in June. Rates have been pushed down by the Greek sovereign debt crisis this past Spring. The market uncertainty boosted investor appetite for US Treasuries due to the “flight to safety.” This, coupled with a general sentiment that the US economic recovery will be slower than previously anticipated, and the recent news that inflation remains in check, has had the effect of driving down long term interest rates.
  • The NAR Housing Affordability Index (at 170) still remains high and shows that the typical household has more than enough financial resources to buy the median priced home. However, the index has been declining in recent months, which reflects rising home prices supported in part by the tax credits. With the conclusion of the tax credit program, home demand has fallen back. Moreover, mortgage rates continue to find new record lows. Thus, we expect this index to rise over the next several months.
The Housing and Mortgage Market Trend Sheet, located in the "OCE Documents of Interest" column at the right, is now updated with June figures. The trend sheet includes sales, pricing, construction, underwriting and delinquency data.

Payroll Employment Down 131,000 Due to Census Workers – Private Sector Payrolls Up 71,000

In July, payroll employment fell by 131,000. This followed a downwardly revised decline of 225,000 in June (previously reported to be a drop of 125,000). In both months, the declines were driven by the laying off of temporary Census workers. In July Federal government employment fell by 154,000.

Private sector payrolls continued to grow over the month, but at a meager pace of 71,000. This follows a downwardly revised number of 31,000 in June (previously reported to be a gain of 83,000). In March and April, private sector job growth occurred at a solid pace, averaging about 200,000 per month. Even since, payroll growth has been modest. About 100,000 to 150,000 jobs must be crated each month in order to start to drive down the unemployment rate.

Despite the decrease in payrolls, the unemployment rate, which is measured by a different survey, stayed steady at 9.5%. The constant rate was in part due to a decline in the labor force participation rate, which fell by 0.1 point to 64.6%. The rate has been dropping steadily since April as more workers have likely become discouraged. July’s rate is the lowest since January tying the lowest rate since the economic downturn began. About 1.2 million people left the workforce over the past three months. These people will likely reenter the workforce once sentiment over the labor market improves and this will make it more difficult to drive the unemployment rate down.



10.08.06 (Source: Bureau of Labor Statistics)

Wednesday, August 4, 2010

ADP Employment Report: Private Payrolls Up 42,000

In July, according to the ADP Employment Report, private sector payrolls rose by 42,000. This followed an upwardly revised increase of 19,000 over the month of May (previously an increase of 13,000). July was the sixth consecutive month of private payroll expansion. Though this is vast improvement from a year ago when the labor market was still shedding jobs at a brisk pace, the speed of labor market recovery thus far has been very modest. Payrolls need to expand at about 100,000 to 150,000 per month in order to begin to drive down the unemployment rate. Considering that temporary census workers were continuing to be let go in July, there will be an additional drag on the Labor Department’s payroll number due out this Friday.

The increase over the month was driven by growth of service sector jobs, which increased by 63,000, putting the job growth rate on track with the past 6 months or so. Manufacturing lost 6,000 jobs; the first decline in six months. Goods producing jobs as a whole shed 21,000 payrolls.



10.08.04 (Source: Automatic Data Processing)

Tuesday, August 3, 2010

Personal Income, Consumption Unchanged; Savings Rate Numbers Revised Much Higher

In June, personal income growth was flat flowing three months of strong growth. The month’s lackluster performance was in part due to the ending of temporary census workers employment. This helped to drive down wages and salaries, which fell 0.1%. From a year-prior, however, incomes were 2.6% higher.

Personal consumption growth was also flat. Following a couple of months of strong growth in the late winter and early spring, the consumer has become more cautious. April ended a period of seven consecutive monthly increases. Still, due to the increases in consumption earlier in the year, from a year prior, personal consumption was up 3.1%.

The recent slowdown of consumption relative to income has been due to consumers moving to increase their rate of savings. This is even more evident with recent revisions that were made showing that consumption trends over the past year were lower that had been previously reported. As a result, the personal savings rate numbers were adjusted higher. The savings rate came in at 6.4% in June, up slightly from May. The rate has now has been at least 5.4% since the beginning of the year. It had been previously reported that the rate in recent months was around 3.0 to 3.5%. It is now trending near a high level not seen since the early 1990s.

As measured by the PCE deflator, prices fell slightly over the month by 0.1%. Therefore, real incomes and real consumption both rose by 0.1%. From a year prior, the PCE deflator was 1.4% higher, a new cyclical low growth rate. Therefore, on a year-ago basis, real income was up 1.2% while real consumption was 1.7% higher. The core PCE deflator, which excludes energy and food prices, was unchanged over the month and was 1.4% higher than a year prior.



10.08.03 (Source: Bureau of Economic Analysis)

Monday, August 2, 2010

Construction Spending Rises 0.1%; Entirely Due to Public Sector Spending

In June, new construction spending rose 0.1% following a 1.0% decline in May. The month’s increase was entirely due to a rise in public sector construction, which rose 1.5%. Housing construction continued to decline in the wake of the expired homebuyer tax credit. Residential spending fell 0.8%. Private non-residential spending continued to fall as well, declining 0.5%.

On a year ago basis, total construction spending was 7.9% lower. Private residential spending was up 11.8%, but private non-residential spending was down 24.1%. Public sector spending was down 4.1% from a year earlier.


Source: Census Bureau

ISM Manufacturing Index Falls 0.7 Points to 55.5; New Orders Down but Employment Up

In July, the Institute for Supply Management's Manufacturing Index fell back for a third straight month, declining 0.7 points to 55.5. Despite the drop, the index remains well above the expansionary threshold of 50. However, this is the lowest level since last December. Manufacturing activity is continuing to expand; however, it is becoming evident that the recovery in this sector is decelerating. If the index continues on this trajectory in future months, it would be a cause for concern about the broader economic recovery.

The production component fell 4.4 points to 57.0. As a forward looking indicator of future production, the new orders component fell heavily for a second straight month. It declined by 5.0 points to 53.5, the lowest level since June 2009. In contrast, the employment component rebounded after June’s decline, increasing by 0.8 point to 58.6.