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Review of Economy, Fed Reserve Statement, and Market

Posted by Larry Doyle on April 29, 2009 2:57 PM |

The Federal Reserve released its regular statement on the economy at 2:15pm. The statement includes:

1. no change in the Fed’s interest rate policy with the Fed Funds rate remaining between 0-.25%.

2. no change in the Fed’s asset purchase program of government and mortgage-backed securities. 

3. overall economic activity remains weak but the pace of decline is slowing.

4. inflation remains below the Fed’s long term target.

5. the Fed will employ all available tools at its disposal to help the economy recover.

The equity markets are having a strong upward move today based not on the Fed’s statement but reaction to the DRAMATIC decline in inventories reflected in this morning’s VERY weak GDP report. If an equity market rallying after a VERY weak GDP report seems counterintuitive it is due to the fact that if and when consumer demand picks up it will drive production.

In my opinion, banking on a pickup in consumer demand is a big if. With credit tight and likely to remain tight, I believe our economy needs to and will adjust to lessened demand. 

The WSJ comments on this economic activity, U.S. Economy Shrank At 6.1% In First Quarter:

Weaker investment in housing combined with the enormous inventory adjustment to pull the economy downward. But the aggressive drawdown of stockpiles of goods, while hurting the economy in the short run, is beneficial because it is an important step toward bringing inventories under control and ending a production freefall. U.S. industrial production retreated a fifth straight month in March, recent data show. Over the past 12 months, output was down nearly 13%. Capacity use by industries receded to 69.3%, a historical low since records began in 1967.

One area of concern for me is the uptick in prices. Although economists and analysts are panning the near term inflation risks, in my opinion, this risk should not be underestimated. The increase in prices in today’s GDP report has received little coverage, but 

Price indicators within Wednesday’s report suggested inflationary pressures rose in first-quarter 2009, easing fears of deflation. For instance, the price index for personal consumption expenditures fell by 1.0%, a decline much smaller than the fall of 4.9% in the fourth-quarter 2008. The PCE price gauge excluding food and energy rose 1.5%, after increasing 0.9% in the fourth quarter.

Free money in the form of a 0-.25% Fed Funds rate will continue to help banks recover but government deficits as far as the eye can see must be addressed. If the economy stabilizes, look for interest rates to ratchet higher. 

In fact, in today’s trading government bonds are down and rates are back to the highs seen last November. 


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