Experts Talk FOMC Minutes, Housing Starts, Fannie and Freddie

Bloomberg BusinessWeek compiles comments from Wall Street economists and strategists on the key economic and market topics of Feb. 17.

Action Economics

The [Fed Open Market Committee] minutes showed quite the debate over an exit strategy at the Jan. 26-27 policy meeting. Policymakers were unanimous in the view that the Fed's balance sheet should be reduced "substantially over time," although [views on] how that should be done varied. Most [board members] believed a gradual asset sale program would be helpful in shrinking the balance sheet and [shifting] the composition toward Treasuries, although many thought that could be disruptive. Several believed it was important to begin an asset-sale program in the near term so that the balance sheet [would shrink] more quickly and more predictably than via what could be accomplished solely by redeeming maturing securities. A few suggested the pace of sales, and potentially purchases, could be adjusted over time in response to developments in the economy.

As we already knew, the committee made no decisions over asset sales at the January meeting. We'll look for a further update on these matters from [Fed Chairman Ben] Bernanke next week when [he] presents his Humphrey-Hawkins testimony to Congress [on Feb. 24].

Michelle Meyer, Barclays Capital

Industrial production jumped 0.9% in January, while the data were revised to show a stronger 0.7% increase in December (previous: 0.6%). January was above consensus expectations of a 0.7% gain, but in line with our forecast of a 1.0% rise. The pick-up in production pushed the capacity utilization rate up to 72.6%, from 71.9%, showing some reduction of the excess slack in the economy. The capacity utilization rate is up notably from the record low of 68.2% reached last June but is still below the historical average of 81%. As expected, the improvement in industrial production was broad-based, as manufacturing output increased 1.0%, reflecting a 4.9% pop in motor vehicles and a 0.8% gain elsewhere.

Every major market group ticked higher, including a 0.9% rise in consumer goods, a 0.9% gain in business equipment, and even a 1.0% bounce in construction supplies. The widespread improvement is an encouraging sign for the sustainability of the economic recovery. Outside of manufacturing, utilities and mining output increased 0.7%.

David Wyss and Beth Ann Bovino, Standard & Poor's

Prices of imported goods jumped 1.4% in January, led by a 5.3% rise in fuel prices. The consensus was for a 0.9% rise. Export prices rose 0.6%, led by a 1.7% rise in agricultural prices, reflecting recent bad weather in the South. {Non-agricultural] export prices rose 0.5%, while non-fuel import prices were up 0.4%. Import prices are up 11.5% from January 2009, led by a 78.6% jump in fuel costs, while non-fuel prices are up a modest 1.3%. Export prices have risen 3.4% over the 12 months.

The data suggest a worsening of the trade gap in January. However, inflationary pressure remains confined to energy.

David Greenlaw, Morgan Stanley

Housing starts [were] mildly stronger than expected. Relative to our own expectation, the bulk of the upside surprise was in the volatile multifamily category. The key single-family component edged up 1.5% in January but has basically been drifting sideways since mid-2009. The low level of starts is contributing to a rapid fall-off in housing completions. In fact, single-family completions plummeted 13% in January, following on the heels of a 12.5% drop in December. The inventory of new homes available for sale is already at its lowest level since 1971. At the current pace of homebuilding activity, it should continue to drift lower. Multifamily starts have recovered in recent months after hitting a 50-year low in October. However, the fundamentals suggest condo and apartment construction probably have limited upside from here over the near term.

The report did not have any meaningful impact on our expectation for gross domestic product over the next couple of quarters. The number of homes under construction continued to edge lower (-2.3% in January), so we are not inclined to alter our estimates for residential construction spending. We look for the residential investment component of GDP to be little changed in the first quarter, following a +19% recovery in the [2009] third quarter and a more modest 5% advance in the fourth quarter.

Alec Phillips, Goldman Sachs

Fannie Mae and Freddie Mac announced last week that they would purchase delinquent loans out of agency mortgage-backed securities, which is likely to result in $340 billion in unexpected prepayments over the coming year. This policy could result in a change in federal foreclosure mitigation strategies. First, it could marginally increase the motivation to foreclose on these loans (some of them are already in foreclosure) in order to avoid a Treasury-imposed cap on GSE mortgage portfolios. Second, and particularly if the first point bears out, it could increase pressure on the GSEs to develop new strategies to creatively deal with property they have acquired as loan collateral. Third, it could also increase interest in developing new modification programs, though it seems unlikely that the GSEs will be able to go so far as broadly applied principal reductions.

While the buyouts will provide investors with cash to reinvest in the MBS market, they are hardly an offset to the end of Fed purchases. Most important, they will be funded largely through agency debt issuance rather than the creation of bank reserves. In addition, while they will put new money in the hands of investors who may purchase newly issued MBS, they will reduce the capacity of the GSEs to make purchases in their own portfolios to reduce volatility, particularly around the end of the Fed's purchases.

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