The Economy's Split Personality
By Kim Rupert
Dichotomies in the recent run of economic data remain striking and will continue to pose an interesting dilemma to Fed policy makers. And they will leave U.S. asset markets on a roller-coaster in the near term.
Case in point: The February employment report largely highlighted the wide mix of numbers seen so far this year that have shown a manufacturing sector clearly on the skids -- while much of the rest of the economy is still showing surprising strength. So far the Fed has responded to the weakness in manufacturing by aggressively cutting rates, and another 50 casis point easing is widely expected on Mar. 20.
But the key question is: What happens to the economy through the second quarter -- and how much more will the Fed cut rates? A survey of Fed watchers by S&P MMS suggests more of this "puzzling" mix of data (as Fed Governor Ferguson termed it) is in store, while the Fed may be tempted to ease off the gas.
The newest data on the economy added to the data conundrum, and heightened the question as to whether the broader economy will remain immune to the debacle in manufacturing, or whether it and the accompanying weakness in equities and related impact on confidence will drag GDP into negative territory.
Recent comments by Fed officials are playing up the former scenario as they argue for an improved growth outlook in the second half of the year. Though the Fed still appears well on track to cut rates another 50 basis points at the March 20 FOMC meeting, the extent of further action is being questioned, albeit only by a minority currently. But that is a big change from only a month ago, when there were widespread expectations of more intermeeting rate cuts and the potential for a sub-4.0% federal funds rate target during the summer.
This week's S&P MMS Survey results show no change for the near term Fed outlook, with a 50 basis point easing still widely expected. However, forecasts beyond the March meeting showed a moderate tempering in Fed expectations. These results are consistent with what has been seen in the fed funds futures market, which has fully priced out the possibility of a rate cut before the upcoming meeting, and is showing little risk for 75 basis points in cuts this month.
Survey results show a solid 93% of the estimates projecting another 50 basis point rate cut this month. Two Fed watchers expect only a 25 basis point easing, as was the case last week. While the median estimate for the fed funds rate target after the May 15 FOMC held at 4.75%, the number of our survey participants expecting another 50 basis point easing diminished (they shifted to a 25 basis point cut). And in terms of the June 27 FOMC, the median again showed a 4.50% target, but there were fewer Fed watchers forecasting a sub 4.5% funds rate target.
Upcoming data will again be interesting for the bond market in terms of refining Fed expectations in the months to come, though not too useful at this point. Retail sales on Tuesday are expected to show a decent gain, with a median of +0.4% overall, and +0.2% ex-autos. Some forecasts were as high as 0.7% for the total (largely an auto story).
Housing starts for February will be out Friday and are expected to fall after a strong gain in January, though this sector has been well supported by lower mortgage rates. On the other hand, data on the Philadelphia Fed survey, industrial production, and consumer confidence are expected to reflect continued weakness, though off recent lows. Clear as mud.
Rupert is a Senior Economist for Standard & Poor's