DON'T EXPECT ANY SUDDEN MOVES FROM THE FED
The fly on the wall at this meeting got an earful. When the Federal Reserve Board sat down behind closed doors on Nov. 17 to map out monetary policy for the coming weeks, the session was easily the most important in several months.
Two things have changed since the central bank's last meeting--big things. First, a new Democratic Administration with its own fiscal agenda and a White-House-friendly Congress raise new questions for the Fed. Until the election, it essentially had complete control over economic policy. Now, with fiscal gridlock gone, the Fed will no longer make its decisions in a vacuum.
The second development is the improving tone of some key economic indicators (page 32). Pickups in money growth (chart) and bank lending suggest that past rate cuts are finally creating new demand for credit. Consumers seem to feel a little better. And more tangible, jobless claims are down, and retail sales are up.
Of course, this is the third time in 112 years that the data have firmed up. And they softened on the two previous occasions. Once again, the Fed must decide if its job is done; that is, if the economy is finally able to move ahead under its own power.
The betting is that the central bank will give the economy the benefit of the doubt while waiting to see how fiscal policy unfolds. Consequently, the Fed probably decided to retain a bias toward further easing in coming weeks, but it is unlikely to carry through on any more interest-rate cuts, either this year or next. In fact, chances are increasing that the Fed's next move will be a tightening of policy, but that is still a long way off.
The rationale for further rate cuts is rapidly disappearing. In the past, the Fed's stated reasons for easing policy have been a sluggish economy, below-target money growth, and declining inflation. Although inflation remains the best part of the outlook, the recent spate of better-looking indicators is the main reason that monetary policy is probably on hold for now.
In particular, new bank loans jumped by $11 billion in September--the largest monthly increase in about two years. Weekly data suggest another, although smaller, advance in October, led by further gains in real estate lending and in commercial and industrial borrowing.
As a result, the broad money supply--measured by M2--is showing some new life. It rose strongly in both September and October, capped by an enormous $11.9 billion jump in the week ended Nov. 2. That was the biggest weekly gain in three years. The M2 measure has grown at a 2.4% annual rate from its yearend 1991 level, and chances are improving that M2 will finish the year within the Fed's target range of 2.5% to 6.5%.
But despite the latest encouraging numbers, there is still no sure sign that the economy is ready to perform significantly better than its 2.4% growth rate so far in 1992. Growth is not likely to break out of that humdrum pattern until the second half of 1993, when a dollop of expected fiscal stimulus and further inroads against the economy's structural barriers provide the push.
Still, the Fed probably would be happy with that result. It implies further gradual improvement that would keep pressure off inflation. Besides, after cutting short-term rates from 814% down to 3% in 212 years, another small slice would hardly alter the economy's momentum.
The missing ingredient in faster economic growth remains jobs. On that front, the recent drop in jobless claims provides hope--but not assurance. New claims fell in late October to the lowest weekly rate in two years. But while the decline may signal fewer layoffs, that doesn't necessarily mean a big pickup in hiring.
Restructuring and cost-cutting are an ongoing passion in Corporate America. Although fewer layoffs may allow net payroll gains in coming months, those gains are likely to be far below the 200,000 or so per month that are common during an economic expansion.
Indeed, manufacturers shed 56,000 employees in October--the second-largest payroll cut in 112 years. And industrial production is going nowhere (chart). Output of manufacturers, mines, and utilities rose 0.3% in October, but it had declined in three of the four previous months. Output at the beginning of the fourth quarter was flat with the third-quarter level.
Manufacturing output alone also rose 0.3% last month, but the gain was not broad. Increased production of cars and trucks accounted for 0.2 percentage point of the advance. Even with Detroit's contribution, though, factory output in October was no higher than it was in May.
Despite their current malaise, however, manufacturers are ready to lift output as quickly as new demand dictates. Factories quashed their summer inventory buildup with output cuts, and stock levels throughout the economy remain lean. Inventories in manufacturing and trade held steady in September, after rising during the three previous months. And the ratio of stock levels to sales fell back very close to a 312-year low.
Judging by the recent gains in retailing, factory orders might pick up a little in coming months. Retail sales rose a broad 0.9% in October, on top of a 0.5% gain in September. Sales of furniture and building materials were up strongly, probably reflecting post-hurricane rebuilding, mostly in Florida.
After adjusting for inflation, retail volume in October was the highest ever (chart). Real retail sales began the fourth quarter with a 4% jump, at an annual rate, above the third-quarter average.
The early November surge in the University of Michigan's index of consumer sentiment shows that consumers are more upbeat. But the experience since 1990 has proven that how consumers feel is not as important to spending as what's in their wallets. Indeed, in early November, car sales fell off, and the Johnson Redbook Service reports that department-store sales weakened.
However, the September surge in imports suggests that U.S. manufacturers may not be getting the full benefit of better retail buying. Although exports jumped 6.8% in September, to a record $38.2 billion, imports also hit a record. They rose 4%, to $46.5 billion. The trade deficit narrowed a bit, to $8.3 billion from $8.9 billion in August, but for the quarter, it widened substantially.
That widening trend should continue, exerting a drain on the economy. U.S. growth is uninspiring, but the rest of the industrialized world is doing even worse. That means the September pace of exports is not sustainable.
The October burst in retail sales was matched by a flare-up in consumer prices. But while sales gains were widespread, the price blip occurred in just a few items. That means inflation is still well under control.
The consumer price index jumped 0.4% in October, twice its September pace. Excluding food and energy, the core cpi was up by 0.5%, the largest gain in seven months (chart). But unusual leaps in the prices of tobacco products and airfare, along with a hurricane-related jump in housing costs, caused almost all of the increase. None of those jumps will be repeated in coming months.
Even with the October fluke, inflation remains one headache that isn't troubling the Fed. The yearly core-inflation rate stands at only 3.5%. And the weakness in both factory output and the labor markets indicates that two major price pressures--tight industrial capacity and faster wage growth--won't appear on the economic scene until late in 1993. And that will remain true even if the new Administration decides to do some pump-priming.
The new dynamics in Washington may change some of the Fed's policymaking strategy, but the object of the game remains the same: balancing faster growth with the need to hold down inflation. With that target now within striking distance, the Fed will put monetary policy on hold, while it waits for the new Administration to settle in and make its first move on fiscal policy.JAMES C. COOPER AND KATHLEEN MADIGAN