Friday 25 May 2007

Signs of economic strength, more tightening ahead?

It looks like those who expect a rebound in the US economy soon may be right. Reuters reports a strong recovery in new home sales:

Sales of new U.S. homes rose 16.2 percent in April, the sharpest climb in 14 years as builders slashed prices a record 11 percent, a government report showed on Thursday, signalling stabilization in the housing sector...

The number of new homes for sale fell to 538,000 in April from 546,000 in March. It would take 6.5 months to clear that inventory at the current sales pace, a sharp drop from the 8.1 months recorded a month earlier.

...continued growth in durable goods orders:

Another report showed April orders for durable goods rose a weaker-than-expected 0.6 percent, but key gauges of business investment and inventories signaled strength...

The rise in orders followed a strong 5 percent March gain, while orders for non-defense capital goods excluding aircraft, seen by economists as a proxy for business investment, rose 1.2 percent in April after a 4.4 percent increase in March.

...and a resilient job market.

In a third report, the Labor Department said new claims for jobless benefits rose 15,000 to 311,000 last week.

But a four-week moving average of claims, which irons out weekly variations to give a clearer picture of underlying labor-market trends, fell for a fourth successive week. The average hit 302,750, the lowest level since February 2006.

Markets appear to be waking up to the fact that rate cuts by the Fed are unlikely in the near future. Again from Reuters:

U.S. government bond yields climbed neared four-month highs on Thursday after a surge in new home sales reduced chances of an interest-rate cut, while the dollar hit a six-week high against the euro.

But rate-sensitive utility stocks and losses in the technology sector led U.S. stock indexes lower, as did a round of profit-taking ahead of a three-day holiday weekend...

"People are coming to grips with the idea that not only are there not going to be rate cuts any time soon, but if the 10-year Treasury (yield) goes much higher, then people are going to start talking about the Fed lifting rates again," said Jim Paulsen, chief investment officer at Wells Capital Management in Minneapolis.

However, Calculated Risk reminds us that possible revisions mean that we should take the just-reported data with "a grain of salt". Barry Ritholtz at the Big Picture says that "whenever New Home Sales jump double digits, it usually reflects a mean reversion from the prior (or subsequent) month's reportage". The Bonddad Blog points out that the positive tone in the news does not reflect the difficulties that companies in the industry are experiencing.

In any case, rate cuts appear unlikely because the Fed remains wary of inflation, and Harvey Rosenblum, head of research at the Federal Reserve Bank of Dallas, explains why the subdued core inflation rate may not be telling the full story.

"In the United States over the last 20 years, core measures excluding food and energy did take out a lot of noise. But in the last three years it has been extracting quite a bit of signal," said Harvey Rosenblum, head of research at the Federal Reserve Bank of Dallas...

"In the last three years, energy has moved in one direction for the most part, and food over the last two years has moved primarily up. And it is becoming annoying to people to see the central bank exclude those," he said...

On the other hand, Rosenblum said that because the Fed relies on a number of different measures of price pressure, there was not much risk the flaws in core inflation would translate into a policy mistake.

What other measures of price pressure could the Fed be relying on? Spare capacity for one. This Reuters article has more on it.

Inflation's not gone, it's gone global -- that's the conclusion of a growing number of economists who say global capacity pressures now have more influence on a country's inflation than factors closer to home.

Five years of the fastest world growth since the 1960s mean a dwindling amount of spare capacity is left at a global level, so central banks must look more beyond their own borders if they want to keep one step ahead of inflation, researchers say.

The OECD also thinks that strong global economic growth means that inflation should be a concern for central banks.

The global economy is doing better than for years as red-hot Chinese growth combines with comebacks by Europe and Japan to offset a U.S. slowdown, the Organisation for Economic Co-operation and Development said on Thursday.

Unemployment is falling and central banks need to remain on guard as inflation risks mount due to increases in the cost of food, commodities and shipping, the Paris-based OECD said in a twice-yearly report on international economic prospects.

"The current economic situation is in many ways better than what we have experienced in years," chief economic Jean-Philippe Cotis said.

Interest rate policy needed to remain tightish.

Indeed, the European economy has made a comeback, thanks to a large extent on German growth, which looks likely to continue. After the ZEW Center reported that German investor confidence rose to an 11-month high in May earlier this week, yesterday we got the following news from Bloomberg:

The Ifo institute's sentiment index, based on responses from 7,000 executives, was unchanged at 108.6, the Munich-based research institute said today. Economists expected an increase to 108.8, according to the median of 37 forecasts in a Bloomberg News survey. The index reached 108.7 in December, the highest since records for a reunified Germany began in 1991...

The biggest jump in company spending on equipment in seven years and rising inventories drove economic growth in the first quarter, the Federal Statistics Office said today. The economy expanded 0.5 percent from the fourth quarter, exceeding economists' 0.3 percent median estimate.

There have been other signs of strength in the European economy. On Wednesday. Eurostat reported that industrial new orders in the euro area rose 2.7 percent in March. Yesterday, Reuters reported that British manufacturers are looking to put up prices at their fastest pace in 12 years as order books improved for the fourth month, according to the Confederation of British Industry's industrial trends survey.

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