Sunday, 5 September 2010

What might make the Fed flinch?

WASHINGTON (Reuters) – The U.S. economy appears to be trudging along, neither booming nor busting, growing steadily enough to diminish double-dip recession fears but not quickly enough to bring down unemployment.

That puts the Federal Reserve in a bit of a policy pickle. If the economy were clearly backsliding, Fed Chairman Ben Bernanke has made it clear he would not hesitate to provide further support. But what about an economy that is moving forward, albeit painfully slowly?

Minutes of the central bank's August 10 policy meeting said several officials felt the outlook would have to deteriorate "appreciably" to trigger more action, which might include additional purchases of government debt or a promise to keep interest rates near zero for an even longer stretch.

The latest batch of data -- particularly the employment report on Friday that showed stronger-than-expected private hiring in August -- doesn't seem to fit that description.

"Is there enough here to prompt the Fed to pull the trigger as early as at the September 21 meeting? Probably not," said Lena Komileva, an economist with Tullett Prebon in London.

So what might make the Fed flinch?
Neil Dutta, an economist with Bank of America-Merrill Lynch in New York, thinks the slow-but-steady economic slog will eventually prod the Fed into action, perhaps early next year.

His firm predicts a "growth recession," which may sound like an oxymoron but essentially sums up what is happening now. The economy keeps growing, yet unemployment rises.

Dutta said if monthly employment figures continue to show only modest hiring and rising unemployment, "the Fed is not going to sit idle."

Indeed, many economists think the Fed will feel compelled to step in if unemployment surpasses the recession high of 10.1 percent notched in October 2009. The rate rose to 9.6 percent in August, and is likely to inch higher in the coming months.

The White House is searching for new ideas that might help reduce the stubbornly high unemployment rate, and President Barack Obama said he would outline plans to boost the economy this week. Tax cuts to encourage hiring are expected to be among the proposals, but they would require support from Republicans in Congress.

Dutta pointed out that there are "good" and "bad" reasons for unemployment to rise. The "good" kind, like now, is caused by more people feeling confident enough about job prospects to venture back into the labor force. The "bad" kind is driven by increased job cuts. The first type might not spur the Fed into action; the "bad" kind almost certainly would.

On Wednesday, the Fed will release its "Beige Book" report of anecdotal economic evidence gathered from its 12 regional banks, which will provide insight into what is and isn't working well.

The report drills down to details as specific as Broadway show ticket sales, rural crop conditions and vacation resort bookings, and Fed officials routinely cite the findings when they discuss their views on the economy.

The last report, released in late July, added to double-dip fears because some Fed districts reported the economy was slowing. An upbeat report would support the idea the economy regained some momentum after a sluggish second quarter and encourage a wait-and-see approach from the Fed.

Trade was by far the biggest drag on second-quarter U.S. growth, which registered a lackluster 1.6 percent annual pace. A surge in imports subtracted nearly 4.5 percentage points from gross domestic product. Because GDP measures domestic growth, imports count as a negative.

Thursday's July trade report is expected to show the gap narrowed slightly, which would ease pressure on third-quarter economic growth.

Michael Gapen, an economist with Barclays Capital in New York, said the third quarter appeared to be off to a "respectable start" and growth will likely be modestly stronger than in the second quarter.

The Fed's Bernanke would seem to agree. He pointed out in late August that the spike in imports was probably due to fleeting factors, and economic growth should pick up.

If growth doesn't accelerate, however, that would be one more plausible trigger for renewed Fed action.

China may offer a big clue about whether U.S. imports really are subsiding. It is scheduled to release trade figures for August on Friday, and those are likely to show another month of explosive gains in exports. Economists polled by Reuters think China's exports rose 35 percent, while imports increased a relatively modest 26.1 percent.
(Editing by Dan Grebler)

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