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The Fed preaches positivity, patience

02 Aug

The U.S. economy seems to be behaving as well as it has at any point since enduring a near-meltdown almost six years ago. That’s the overall assessment when considering input from the Federal Reserve, the labor market, consumers, and a recent flurry of other data.

In the short term, of course, stocks frequently don’t follow the economy’s path. The week’s positive economic news may have even contributed to a difficult week for the stock market as investors considered the possibility of the Fed raising interest rates earlier than anticipated.

For the week ended August 1, 2014, the S&P 500 Index was down 2.7% to 1,925 (for a year-to-date total return—including price change plus dividends—of about 5%). The yield on the 10-year U.S. Treasury note was up 4 basis points for the week to 2.52%, for a year-to-date decrease of 52 basis points.

Fed officials appear cautiously upbeat

Fed policymakers this week acknowledged the economy’s progress but noted that patience is crucial as it decides when to start raising short-term interest rates. In a statement released after the July 29–30 meeting of its Federal Open Market Committee, the central bank said economic activity rebounded in the second quarter, with labor market conditions improving. That led the Fed to further reduce its stimulative monthly bond purchases as of this month, from $35 billion to $25 billion. It has previously said it would end the program in October, if the economy progresses as expected.

As expected, the Fed maintained its guidance on interest rates, which it has held between 0% and 0.25% since late 2008. The Fed said it was likely to wait “a considerable time” after the end of its bond-purchase program before raising rates as it analyzes the labor market, inflation, and other economic developments. Although the Fed said the risks of excessively low inflation were fading, it expressed caution over the “significant underutilization of labor resources” and the housing sector’s slow recovery.

“The Fed continues to anticipate that the federal funds rate will remain at the current level for a considerable time,” said Vanguard economic analyst Vytas Maciulis. “However, the Fed’s statement had a tweak in its assessment of inflation, reflecting that inflation appears to be accelerating from a low rate. This doesn’t mean an inflationary spike is a concern, especially if long-term inflation expectations are well-anchored. The Fed will continue to closely monitor inflation-pressure indicators such as wages and inflation expectations in the near term, as well as a broad array of labor market indicators, to gauge when it will be appropriate to lift the policy rate from zero.”

Mixed news for the labor market

The U.S. economy added 209,000 jobs in July, below economists’ expectations and the strong pace of the previous three months. Slower growth in service-sector hiring was a factor in the lower-than-anticipated figure. Still, the Labor Department’s report had a positive tone as May and June employment numbers were both revised higher for a combined total of 15,000 additional jobs.

Also, the three-month average of 245,000 new jobs is considered healthy, and job totals increased 200,000 or more for the sixth straight month. The unemployment rate edged to 6.2% from 6.1%, and the labor participation rate to 62.9% from 62.8%. Improvement was notable compared with a year earlier, when unemployment stood at 7.3%. About 1.7 million more people joined the nation’s payrolls over the 12 months.

U.S. employment

The nation’s economy bounces back

The U.S. economy rebounded strongly in the second quarter, more than offsetting the first quarter’s retreat. Real gross domestic product (GDP), the value of all goods and services when adjusted for inflation, grew 4.0%, according to the Commerce Department’s advance estimate for April through June. The growth exceeded economists’ forecasts and made up for the first-quarter decline, which was revised from –2.9% to a less steep –2.1%.

Inventory-building by businesses and a rise in consumer and government spending fueled much of the growth and overcame the detraction caused by imports growing faster than exports. Economists have largely attributed the first quarter’s contraction to the severe winter weather that affected much of the nation. Although the recent figures point to an upswing in the economy, the advance GOP estimate often undergoes major revision as the latest data become available.

GDP: Under the hood
1Q final estimate 2Q initial estimate
Real GDP growth estimates (annualized)
–2.1% +4.0%
Components: Contributions/subtractions (percentage points)
Consumer spending +0.8 +1.7
Housing-sector investment* –0.2 +0.2
Business spending and inventories –0.9 +2.3
Trade (exports minus imports) –1.7 –0.6
Federal, state, and local government spending –0.2 +0.3

*Together with business spending and inventories, the combined amount equals the “investment” category of GDP.
Percentages may not add up to 100 because of rounding.

Get a closer look at GDP and its components.

Consumer confidence jumps

Consumers gave the economy a round of applause. The Conference Board’s Consumer Confidence Index surged to 90.9 in July, above economists’ expectations. Also, June’s figures were revised upward. July’s improvement marks the index’s third-straight monthly increase and its highest reading since October 2007. Consumers polled in this household survey, which tends to correlate strongly with consumer spending patterns, were optimistic about the present situation as well as the future. The improving labor market lifted consumers’ appraisal of current conditions, while better short-term assessments of the economy and the job market led to the gain in expectations.

Compensation costs increase

The Employment Cost Index, the broadest measure of the price of civilian U.S. labor, rose 0.7% in the second quarter, exceeding economists’ forecasts and the first quarter’s 0.3% advance. A 1% increase in retirement and health-care benefits contributed significantly to the gain, along with a 0.6% growth in wages, which make up about 70% of compensation costs. For the 12 months ended June 30, total employment costs were up 2.0%, wages were up 1.8%, and benefits were up 2.5%. Overall, analysts said that the report offered reasons for optimism, and that the rise in wages may translate to greater consumer spending.

The economic week ahead

Economic reports scheduled for release include factory orders and the ISM Non-Manufacturing Index on Tuesday, international trade on Wednesday, consumer credit on Thursday, and productivity and costs on Friday.

Summary of major economic reports
Date Report Actual
value
Consensus
expected value
10-year note yield S&P 500 Index
July 28 +2 bp 0.0%
July 29 Consumer Confidence (July)
Source: The Conference Board
90.9 85.3 –3 bp –0.5%
July 30 Real Gross Domestic Product (2Q, annual rate)
Source: Commerce Department
+4.0% +3.0% +10 bp +0.0%
FOMC Monetary Policy
Source: Federal Reserve Board
July 31 Initial Jobless Claims (week ended July 26)
Source: Labor Department
302,000 300,000 +1 bp –2.0%
Employment Cost Index (2Q)
Source: Labor Department
+0.7% +0.5%
August 1 Unemployment Rate (July)
Source: Commerce Department
6.2% 6.1% –6 bp –0.6%
Nonfarm Payrolls (July)
Source: Commerce Department
209,000 235,000
Personal Income (June)
Source: Commerce Department
+0.4% +0.4%
Personal Spending (June)
Source: Commerce Department
+0.4% +0.4%
Construction Spending (June)
Source: Commerce Department
–1.8% +0.5%
ISM Manufacturing Index (July)
Source: Institute for Supply Management
57.1 56.1
Weekly change +4 bp –2.7%

bp=basis points. 100 basis points equal 1%. For example, if a bond’s yield rises from 5.0% to 5.5%, the increase is 50 basis points.

Notes

  • The economic statistics presented in this report are subject to revision by the agencies that issue them. For more information on the reports mentioned in this article, read our Guide to major U.S. economic reports.
  • All investing is subject to risk, including the possible loss of the money you invest.

 

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