Suitably Flip

The Fed Poops The Party

The Federal Reserve released the minutes of the December FOMC meeting this afternoon, quickly deflating the big rally that was underway on Wall Street.

The two concerns the Fed's comments upon which are lately most closely regarded are inflation and the housing slowdown.  Of particular significance is the Fed's read on whether the slumping housing market is having or will have a broader negative effect on economic activity.  The stock market's reaction to the minutes suggests investors are increasingly convinced that it will.

I don't see it.

In the policy statement that followed the December meeting, the Fed added the word "substantial" to its discussion of the cooling housing market, so we already knew they'd upped their estimate of the size of the slowdown.  And the Commerce Department's revised third quarter report released in December also adjusted upward the estimate of the negative GDP impact of the housing decline (from 1.0% to 1.2%).

So it's not news today that housing has slumped more significantly than earlier estimated, nor that the Fed's mindset in December recognized that fact.  So if this market move is rational, it must be based on a shift in investors' opinions (or a perceived shift in the Fed's opinion) of whether the cooldown would bleed into other areas of economic activity, leading to a broader-based slowdown.

If that's the case, it isn't shown in the data, either in the 3rd quarter GDP report, which showed normalized (adjusting for housing) annualized growth remaining at 3.2%, nor in the December ISM manufacturing report just released this morning, which also suggested real GDP growth of 3.2%.  In other words, the slowdown in housing has thus far appeared to reduce economic growth only on a direct basis - for every percentage point of housing related contraction, there's just one percentage point of lost economic growth.

As for whether we can count on the non-contagion of housing contraction to continue, the very Fed minutes that sent the markets into such a funk seem to offer encouragement that sustainable economic growth will indeed not be impaired.

The rate of increase in real GDP was expected to pick up gradually as the drag from the contraction in residential construction diminished, returning towards the end of 2007 to a rate close to the staff's estimate of potential output growth.

What's more, the minutes gave a few happy hints about the Fed's inflation outlook.  Having made a point not to holster its rate-hiking weapon, even as it paused such hikes in recent months, the Fed has reminded us time and again that "some inflation risks remain" and that "additional firming... may be needed to address these risks..."  Today's minutes seem to indicate the FOMC expects prices to stabilize further, increasing the likelihood that the next shift in rate policy could be a dovish one.

Core inflation was anticipated to edge down in 2007 and 2008 in response to a waning of the effects of higher energy and import prices, a step-down in rent increases, and the emergence of a small amount of slack in the economy.

Nonetheless, Wall Street has turned decidedly sour on the release, even more so as I composed this post, with the major indices now all down for the session.

Comments

The Fed Poops The Party

The Federal Reserve released the minutes of the December FOMC meeting this afternoon, quickly deflating the big rally that was underway on Wall Street.

The two concerns the Fed's comments upon which are lately most closely regarded are inflation and the housing slowdown.  Of particular significance is the Fed's read on whether the slumping housing market is having or will have a broader negative effect on economic activity.  The stock market's reaction to the minutes suggests investors are increasingly convinced that it will.

I don't see it.

In the policy statement that followed the December meeting, the Fed added the word "substantial" to its discussion of the cooling housing market, so we already knew they'd upped their estimate of the size of the slowdown.  And the Commerce Department's revised third quarter report released in December also adjusted upward the estimate of the negative GDP impact of the housing decline (from 1.0% to 1.2%).

So it's not news today that housing has slumped more significantly than earlier estimated, nor that the Fed's mindset in December recognized that fact.  So if this market move is rational, it must be based on a shift in investors' opinions (or a perceived shift in the Fed's opinion) of whether the cooldown would bleed into other areas of economic activity, leading to a broader-based slowdown.

If that's the case, it isn't shown in the data, either in the 3rd quarter GDP report, which showed normalized (adjusting for housing) annualized growth remaining at 3.2%, nor in the December ISM manufacturing report just released this morning, which also suggested real GDP growth of 3.2%.  In other words, the slowdown in housing has thus far appeared to reduce economic growth only on a direct basis - for every percentage point of housing related contraction, there's just one percentage point of lost economic growth.

As for whether we can count on the non-contagion of housing contraction to continue, the very Fed minutes that sent the markets into such a funk seem to offer encouragement that sustainable economic growth will indeed not be impaired.

The rate of increase in real GDP was expected to pick up gradually as the drag from the contraction in residential construction diminished, returning towards the end of 2007 to a rate close to the staff's estimate of potential output growth.

What's more, the minutes gave a few happy hints about the Fed's inflation outlook.  Having made a point not to holster its rate-hiking weapon, even as it paused such hikes in recent months, the Fed has reminded us time and again that "some inflation risks remain" and that "additional firming... may be needed to address these risks..."  Today's minutes seem to indicate the FOMC expects prices to stabilize further, increasing the likelihood that the next shift in rate policy could be a dovish one.

Core inflation was anticipated to edge down in 2007 and 2008 in response to a waning of the effects of higher energy and import prices, a step-down in rent increases, and the emergence of a small amount of slack in the economy.

Nonetheless, Wall Street has turned decidedly sour on the release, even more so as I composed this post, with the major indices now all down for the session.