As Fed’s confidence rises, cracks in consumer sentiment appear

It may seem counterintuitive that the Federal Reserve raised interest rates on the day last week when inflation was shown to have declined in May for the second time in three months.
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It may seem counterintuitive that the Federal Reserve raised interest rates on the day last week when inflation was shown to have declined in May for the second time in three months.

The central bank was being forward-looking, though, as is its duty, and it was trying to keep the economy growing while fending off the price increases it foresees “over the medium term.” Unemployment continues to fall — it dipped to a 16-year low of 4.3 percent in May — but inflation, for now, remains low, as well.

Hours before the Fed announced its rate move last Wednesday, the Labor Department said the Consumer Price Index fell by 0.1 percent in May. Core inflation, which excludes the volatile food and energy categories, rose 0.1 percent for the month.

The Personal Consumption Expenditures price index, the Fed’s preferred inflation gauge, has risen only 1.5 percent for the 12-month period that ended in April. The Fed’s target is 2 percent. The PCE index measures the price changes of consumer goods and services.

“Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term, but to stabilize around the committee’s 2 percent objective over the medium term,” said the statement that the Federal Open Market Committee, the central bank’s policymaking panel, issued after its meeting last week.

The committee also said it is “monitoring inflation developments closely.”

"We want to keep the expansion on a sustainable path and avoid the risk where we find ourselves in a situation where we've done nothing, and we need to raise the funds rate so rapidly that we risk a recession," Fed chairman Janet Yellen said at a press conference after the statement was released. "But we are attentive to the fact that inflation is running below our 2 percent objective."

The rate increase — a quarter-point —"reflects the progress the economy has made and is expected to make toward maximum employment and price stability," Yellen said.

"What I can tell you is that we anticipate reducing reserve balances and our overall balance sheet to levels appreciably below those seen in recent years, but larger than before the financial crisis," she added.

Analysts saw the Fed’s moves as a vote of confidence that the economy will weather the rising rates of inflation that the central bank is expecting.

“The rate hike signals that the Fed believes the economy is improving and is going to be resilient to those hikes,” Tara Sinclair, a professor at George Washington University and a senior fellow at the jobs website Indeed, told the Washington Post.

So what signals did the economy give in the days after the meeting? On Thursday two indexes suggested that the manufacturing industry remains relatively strong, but the housing market and consumer confidence took hits.

The Philadelphia Federal Reserve said its manufacturing index for the region that covers eastern Pennsylvania, southern Delaware and New Jersey declined, though less than expected. Its reading of 27.6 in June followed a 38.8 performance in May, and MarketWatch said that was the index’s second-highest reading in 30 years.

The Federal Reserve Bank of New York said its Empire State index, which had fallen below zero in April, at -1, recovered to a level of 19.8.

Any reading above zero in either index is an indicator of growth.

Gauging the housing industry, the National Association of Home Builders/Wells Fargo Housing Market Index fell two points, to 67, in June, although any reading above 50 on the index is considered positive.

“Builder confidence levels have remained consistently sound this year, reflecting the ongoing gradual recovery of the housing market,” NAHB chairman Granger MacDonald, a home builder and developer from Kerrville, Texas, said in a statement.

“As the housing market strengthens and more buyers enter the market, builders continue to express their frustration over an ongoing shortage of skilled labor and buildable lots that is impeding stronger growth in the single-family sector,” said Robert Dietz, the association’s chief economist.

Housing starts declined 5.5 percent in May, to a seasonally adjusted annualized rate of 1.09 million, the weakest performance since last September, the Census Bureau reported. It was the third monthly decline in a row.

Building permits fell 4.9 percent in May to an annualized rate of 1.17 million.

"It's too soon to say that the homebuilding recovery from the Great Recession has peaked, but the data so far this year on residential construction has worrisome implications for economic growth," Gus Faucher, chief economist at the PNC Financial Services Group, said in a research note that U.S. News & World Report cited in a story about May starts. "Residential building has contributed to economic growth over the past few years, and if it is slowing, that would weigh on the expansion."

Consumer confidence, which climbed after Donald Trump was elected president, showed a decline in the early June reading of the University of Michigan’s Consumer Sentiment Index.

The index fell to 94.5 from 97.1 at the end of May, but Richard Curtin, chief economist of the university’s Surveys of Consumers, said the drop since June 8, when former FBI director James Comey testified before Congress and was critical of Trump, had been an even larger 11 points, from 97.7 to 86.7.

Curtin did note that that only a few consumers spontaneously referred to Comey or his testimony when they were asked to explain their views.

“Importantly, the decline was observed across all political parties, but the loss in confidence among self-identified Republicans since June 8th was larger than among Democrats (9.2 vs. 6.8 index points), with independents showing the greatest falloff (11.5 index points),” Curtin said in a statement.

“The recent erosion of confidence was due to more negative perceptions of the proposed economic policies among Democrats and the reduced likelihood of passage of these policies among Republicans,” Curtin added.

“Fortunately, a strong job market, improved household income and wealth have provided a financial buffer against rising uncertainties. Nonetheless, consumers have become less optimistic about the future course of the domestic economy.”

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