Consumer spending, incomes up in March

Recovery not stalling

A rise in consumer spending and higher personal income last month is helping to alleviate some of the worries that economic activity is slowing too quickly.

The government reported this morning that consumer spending increased 0.6% in March, while personal income gained 0.5%.  That follows an upward revision to February’s numbers, including a robust 0.9% rise in spending in February.

Inflation continued its upward March, as higher oil and food prices pushed up the PCE Price Index by 0.4%, matching February’s rise.  The core rate of inflation, however, slowed, increasing just 0.1% last month and held at 0.9% year-over-year.

Given the overall rise in inflation, real spending, which takes into account the change in prices, was up a modest 0.2% after moving ahead a respectable 0.5% in the prior month.

The savings rate held steady at 5.5%.

The improvement in income is being aided by increased employment, which in turn is helping to support consumer outlays and taking some of the sting out of higher gasoline prices.

Further, the upward revision to February seems likely to provide modest support to GDP when the figure is revised next month.

But weekly jobless claims have turned higher.  Assuming the disquieting upward shift in claims is not coming from statistical noise that seasonal adjustments are failing to capture, it does seem appear the economy is slowing somewhat.

We’ll get more when the ISM service and manufacturing reports are released next week.

Still, March’s rise in spending suggests the recovery is not stalling out.

Consumer sentiment stabilizing

The University of Michigan’s survey of consumer sentiment tumbled in March amid the uncertainty generated by events in Libya, surging gasoline prices and the earthquake in Japan.

But the closely-followed Consumer Sentiment Index managed a small rise this month, increasing from 67.5 in March to 69.8 in April, suggesting some stability in consumer confidence.

Inflation continues to be a concern but longer-term fears appear to be easing.

Reuters said the one-year inflation expectation was unchanged at 4.6%, the highest level since 2008. No doubt that gasoline prices are heavily influencing the short-term outlook.

But the 5-to-10-year inflation outlook fell to 2.9% from 3.2% the month before, which reveals that consumers and bond holders alike still believe the Fed has not lost its ability to keep price hikes under control (see chart from WSJ below).

That bodes well  for the economy since consumers have been squeezed by the pain at the pump, and it has to come as a relief to policymakers at the Federal Reserve who have been wrestling with a sluggish economy, surging commodity prices and a modest bump in core inflation.

Weaker GDP growth based on a number of factors

GDP advanced at a respectable 3.1% annualized pace in Q4 but slowed considerably according to advanced data provided by the U.S. Commerce Department, growing just 1.8% in Q1.

Real final sales, which measures GDP less changes in private inventories, increased a scant 0.8%, versus a robust 6.7% in the final three months of 2010.

The table below looks at key components of GDP and how they contributed to or detracted from the economy last quarter and in Q4 per government data.

As an example, consumer spending contributed 2.8 percentage points to the 3.1% rise in GDP in Q4 and 1.9 percentage points in Q1. Weakness in other components translated into growth of just 1.8%.

	Q4’10	Q1’11
GDP	3.1	1.8
Consumer Spending	2.8	1.9
Change in Inventories	-3.42	0.93
Exports	1.06	0.64
Imports	2.21	-0.72
Govt. Spending	-0.34	-1.09
Residential construction	0.07	-0.09

The huge swing in inventories lent support to GDP in Q1, as companies lifted output following a big drawdown in Q4, but a large rise in imports detracted from overall economic performance.

Diminished consumer confidence and rising gasoline prices also appeared to pressure consumer spending despite the payroll tax cut that was enacted by Congress late last year.

Housing’s diminished role in the economy had very little impact (see Housing – losing its importance as economic driver).

Today’s report is not the final say on growth last quarter, as we have two more revisions that will incorporate updated information on trade, inventories and spending.

If there is a silver lining to today’s report, the outsized jump in imports played a key part in the feeble GDP number, but one can’t discount the anxiety consumers are feeling.

Needless to say, Q1 was a disappointment and is a stark reminder that a recovery that follows a recession caused by a financial crisis is typically slow and uneven.

Unfortunately, the uptick in weekly jobless claims and recent modest gains in the bond market suggest the slowdown is continuing into Q2.  Strength in the stock market, however, suggests the weakness we are seeing is temporary.

Weekly jobless claims at three-month high

Weekly jobless claims unexpectedly jumped from 404,000 in the prior week to 429,000, the third consecutive week above 400,000 and the highest level in three months.

The 4-week moving average increased by 9,250 to 408,500, and continuing claims fell 68,000 to 3.64 million.

GDP in Q1 expanded by 1.8% according to preliminary data, and given the unexpected rise in jobless claims over the past three weeks, it appears that the slowdown in economic activity is continuing into Q2.

Oil has risen by about $20-25 per barrel in recent months to just over $110 per barrel but remains well below the all-time high of $145.  Gasoline prices, however, have surged by about a $1 per gallon in the last year and are hovering near the high hit in 2008.

Whether the slowdown is directly related to the spike in gasoline prices or the glitches in the supply chain caused by the earthquake in Japan, the unexpectedly large rise in jobless claims over the past three weeks is disconcerting.

It not only points a further slowing in the recovery, but it may also be signaling fewer gains on the employment front.

Fed still transitory on spike in inflation

The Fed was pretty clear where it stands on the recent spike in inflation from extremely low levels.

In its statement, the FOMC said: “Commodity prices have risen significantly since last summer, and concerns about global supplies of crude oil have contributed to a further increase in oil prices since the Committee met in March.  Inflation has picked up in recent months (a new addition to the statement), but longer-term inflation expectations have remained stable and measures of underlying inflation are still subdued.

The Fed added, “Increases in the prices of energy and other commodities have pushed up inflation in recent months.  The Committee expects these effects to be transitory.”

It’s the publicly stated belief that higher gasoline and other commodity prices won’t stoke a new round of unwanted inflation which pushed the dollar down and gold and silver prices higher in late afternoon action.

Traders believe that Bernanke is not taking a hard enough line on surging commodity prices.

But wage gains remain stable and there’s still some slack in the economy, and that does give the Fed some leeway.

Moreover, Bernanke’s focus is on the tepid pace of the economic recovery, and a hawkish shift in the Fed’s stance is unlikely as long as unemployment remains high and job creation does not substantially accelerate.

Given a ten-year Treasury yield that is below 3.40%, the bond market is more in sync with the Fed, even if gold and the dollar are not.

Still, there are always risks to the outlook, and Bernanke is willing to gamble on an uptick in the core rate of inflation if it means a more robust recovery.

Fed boosts inflation forecast, cuts GDP

Bernanke points to end of QE

The first take on the Fed’s rate decision and economic outlook is available in my piece, Fed holds steady, tweaks outlook on economy. But in conjunction with Ben Bernanke’s first press conference, the Fed released its outlook on the economy, lifting its view on inflation and cutting the outlook on GDP growth.

Below is a look at economic projections released today by the Federal Reserve for GDP, unemployment, headline inflation and core inflation.


 (click to enlarge)

Despite its latest take on inflation, the Fed still believes the impact on inflation will be “transitory,” as wages, the biggest input cost to most businesses, have been stable, and there is still some slack in the economy.

Q&A
QE2 - no tapering off; the Fed will just let the program end in June, and he doesn’t expect much of a disruption in the financial markets since the central bank’s intentions have been well telegraphed.

Because inflation has picked up somewhat and inflation expectations are a little higher, trade-offs for a third round of quantitative easing are less attractive at this point. Translation: QE3 looks unlikely amid the spike in gasoline prices.

Other sound bites from Bernanke in his press conference:

His interpretation of “extended period” in the statement goes out two meetings, but it is also used simply because uncertainty is a part of every economic equation.

The Fed cut its GDP forecast based on an expected weak Q1 GDP number, which it also believes will be transitory.

The Fed is carefully watching gasoline prices, but rising oil demand has been mostly confined to emerging markets and U.S. demand is down. Consequently, the Fed has little control over the price of oil.

Bernanke supports a stable dollar, and the recent decline is mostly due to an unwinding of safe-haven buys. Still, he didn't talk much on the importance of a strong dollar, suggesting that a stable and strong dollar is not high on the Fed's list of priorities.

Looking ahead, the Fed plans to maintain the level of securities on its balance sheet and re-invest maturing securities, something I alluded to yesterday when I previewed today’s report.

Bernanke said that not re-investing the proceeds of maturing securities would shrink the Fed’s balance sheet and would be correctly construed as tightening.

Asked whether the Fed's monetary policy might provide the future tinder for inflation, Bernanke believes the Fed will tighten at the right time and not stoke unwanted inflationary pressures by easing for too long a period.

On the deficit, Bernanke said addressing the spending and revenue gap must be a top priority.

Asked if the public is expecting too much from the Fed given that recessions sparked by a financial crisis are slow, Bernanke looked at past policy mistakes, including a slow recapitalization of banks. And he focused on factors that are specific to this recovery, including housing and high gasoline prices.

He sympathized with the public's impatience but does expect growth to gradually accelerate though he did not provide specific remedies for accomplishing his goals in the short term.

New home sales rebound from record low

New home sales totaled a seasonally adjusted annual rate of 300,000, representing an 11.1% rise from an upwardly revised 270,000 in February, suggesting that calmer weather may have provided a mild tailwind for home builders, as sales rebounded from their lowest level since records began back in 1963.



Based on current sales, the supply of homes for sales fell from 8.2 months in February to 7.3 months in March.

The actual number of new homes for sale slipped by 2,000 to 183,000, the lowest number since August 1967 when a record low of 181,000 homes were available, according to government data.



Of course, the U.S. population is much greater than it was over 40 years ago, and the lack of available supply may lend support to the market when sales eventually rebound.

Builders are not where they would like to be but they have been able to reduce the supply of homes on the market that are based on current sales from a peak of over 12 months in early 2009 to a more sustainable range.

Still, the lack of actual supply, which might normally be a plus for the market, is being offset by a number of factors at the current time.

Builders continue to compete with distressed sales and a shadow inventory of late model homes that are being held in foreclosure.

Traffic is a key driver for housing starts, and visitors at model homes are down sharply from the levels seen when the market was much stronger.

Many who have been forced from their houses are finding shelter in rentals and have little desire, or the financial resources, to purchase another home at this time. And the general lack of confidence potential buyers have in the housing market is also a headwind to sales.

The rebound in March shouldn’t be dismissed as it suggests the new home market is not headed to new lows, but sales continue to meander along the bottom without any concrete signs of a new burst in activity (see Home builder sentiment languishes).

Weekly jobless claims hold above 400,000

Weekly jobless claims held above the psychologically important level of 400,000 for the second-consecutive week, according to data provided this morning by the Department of Labor.

Weekly initial jobless claims fell from an upwardly revised 416,000 in the prior week to 403,000. The 4-week moving average edged up 2,250 to 399,000, and continuing claims slipped by 7,000 to 3.70 million.



After settling below 400,000 in much of February and March, the progress in claims appears to be stalling out.  A kink in the supply chain caused by the earthquake in Japan may be responsible for much of the recent uptick, and if that's the case, growth may moderate some in the coming months.

Economic growth could also be plateauing amid lackluster consumer confidence and a general uncertainty that still prevails following the steep recession and generally slow pace of job creation.

An unexpectedly sharp drop in the sometimes volatile Philly Fed Business Activity Index (see chart below) released today may also be foreshadowing a modest deceleration in activity, and I suspect some of the supply-chain issues connected with Japan could temporarily cool the red-hot manufacturing sector.



But I’m cautiously optimistic that the economic recovery is intact, especially given the recent uptick in job creation and confidence investors have been displaying in stocks.

Despite a surge in gasoline prices, uncertainty in the Middle East and the earthquake in Japan, shares have blown past economic headwinds and are flirting with multiyear highs, suggesting that investors are confident that revenues and profits will continue to improve at the nation’s largest companies in the coming months.

Existing home sales rise

Trend less than encouraging

Existing home sales rebounded following February’s big drop, climbing a modest 3.7% to a seasonally adjusted annual rate of 5.10 million in March, besting the forecast offered by Bloomberg of 5.0 million units.

The total inventory of houses remains bloated, rising 1.5% to 3.55 million existing homes available for sale, which represents an 8.4-month supply at the current sales pace, versus 8.5-months in February.



Lawrence Yun, NAR chief economist, said, “Existing-home sales have risen in six of the past eight months, so we’re clearly on a recovery path.

“With rising jobs and excellent affordability conditions, we project moderate improvements into 2012, but not every month will show a gain – primarily because some buyers are finding it too difficult to obtain a mortgage.”



He added that sales would be “notably stronger if mortgage lending would return to the normal, safe standards that were in place a decade ago – before the loose lending practices that created the unprecedented boom and bust cycle.”

His remarks have merit but I take some issue with his comment that we are "clearly on a recovery path," as stiff headwinds that are still in place following the housing market bust continue to hamper the market, including lackluster consumer confidence in the recovery and still high unemployment.

Despite the modest rise in March, home sales have not moved beyond depressed levels, an overhang of excess supply is still holding down prices, and the monthly increases in sales that Yun referred to are coming off extremely depressed levels that followed the expiration of the housing tax credit.



More realistic lending standards would likely aid the market, but potential buyers will probably remain on the sidelines until they are convinced the slide in housing prices is past and hiring accelerates.

Spring gives rise to hope for housing

Housing starts and permits took a dive during the cold and snowy winter months, but numbers provided by the government this morning revealed that milder weather in March provided a much-needed shot in the arm for home builders.

Sentiment is holding at depressed levels in the industry based on yesterday’s release of home builder sentiment, but housing starts jumped a better-than-expected 7.2% in March to a seasonally adjusted annual rate of 549,000 units, while February was revised upward.

Single-family starts also increased by a similar amount.

Building permits, which are more forward looking, increased an impressive 11.2% to 594,000, also topping expectations. And the more closely-followed single-family permits figure, which removes the volatile multifamily sector and gives us a better read on the new home market, rose a respectable 4.5% to 405,000.

No doubt about it, the current level of permits and starts remains at depressed levels, but last month’s rise is suggesting that the industry is not headed to new lows.

Mortgage rates remain near historical lows and pricing is favorable, resulting in a near record level of affordability. And that suggests this is a great time for potential buyers to snag a great deal.

Still, there’s plenty of uncertainty.  A downward drift in prices remains a headwind, and job creation, which has picked up in recent months, is not at levels that are needed to boost consumer confidence and provide a much needed boost to housing.

Home builder sentiment languishes

The National Association of Home Builders/Wells Fargo Housing Market Index fell one point in April to 16, suggesting that the moribund new home market has yet to awaken from its slumber.



“The spring home buying season is getting off to a slow start due to persistent concerns about home values as more foreclosures seem to be hitting the market, increasingly restrictive lending requirements for home buyers and builders, and the slow pace of economic recovery,” acknowledged NAHB Chief Economist David Crowe.

“While pockets of improving activity are appearing in some markets, the best sales activity appears to be happening in the lower price ranges, where first-time buyers have greater flexibility than repeat buyers who must sell their current home,” he added.

The housing market has stumbled badly heading into 2011. Nasty weather in parts of the country may have played a role, but it appears that potential buyers are holding off amid worries that the drop in prices may not be over.

In addition, the economic recovery thus far has failed to produce a significant number of new jobs, which has also dampened enthusiasm for new and existing homes.

Traffic has been improving in recent months and that may eventually translate into a firmer new home market, but sales continue to languish and lackluster builder sentiment is a good reflection of the tough environment.

S&P’s shot across the bow

Standard & Poor’s announcement today that it lowered its outlook to negative from stable for the country’s triple-A credit rating really shouldn’t come as a surprise given that U.S. debt will soon surpass 100% of GDP.

Both sides in Congress have advanced sharply different proposals and have dug in their heels.  And with an election less than two years away, progress seems unlikely.

One can only hope that the big drop in stocks today, compliments of the S&P announcement, will spur serious negotiations and produce a credible debt reduction plan.

More on today’s S&P release at Examiner.

Core inflation muted–for now

Yesterday’s release of the Consumer Price Index for March revealed to almost no one’s surprise that headline inflation continues to heat up amid the seemingly relentless rise in gasoline and crude oil prices.

But there was some good news, as core inflation, which eliminates the volatility caused by food and energy prices, was muted – details at Examiner.



After watching the core rate of inflation rise 0.2% in both January and February – the first such back-to-back increases in over a year- it was a relief to see the core rate return to a more subdued rise of just 0.1%.

A drop in apparel prices played a role and shelter, which accounts for almost one-third of the CPI, barely moved and is up just 0.9% from one year ago.

Still, commodity prices have been soaring and the extra slack in the economy that’s helped to rein in pricing pressures is slowly dissipating as the manufacturing sector continues to excel.

Looking ahead, core inflation seems likely to slowly push higher since businesses are beginning to tap into their new-found pricing power, but don’t expect any outsized jumps in prices amid fears they would alienate customers.

Additionally, labor costs, which make up the bulk of expenses for most business, remain contained. In other words, we’re probably OK on the pricing front in the short term.

What concerns me are the obstacles we don’t see that are beyond the horizon, especially since commodity prices are in the stratosphere.

Unlike the last decade when the Fed was gradually raising interest rates against the backdrop of rising raw material prices, monetary policy remains extremely accommodative this time around.

Fed officials have repeatedly said they are willing and able to implement an exit strategy, preventing inflation from heating up. But they are constrained by the current economic environment, which seems likely to prevent anything more than a subtle shift in policy in the near term.

Empire Manufacturing, prices push higher

The Empire Manufacturing Survey released by the New York Fed indicates that manufacturing conditions in New York state improved for the fifth consecutive month. But pricing pressures also intensified.

The index, which provides an early look at manufacturing conditions in April, increased from 17.5 in March to 21.7 in the current month. Moreover, new orders, which are a good proxy for future business conditions, shot up 17 points to 22.3. A reading above zero suggests production is expanding.



It’s safe to say that we still aren’t seeing much of an impact from the surge in gasoline prices, at least on a small portion of the economy.

Price pressures, however, have yet to abate, as both prices paid and prices received continued to accelerate.



Since the recovery began in June 2009, manufacturers have had little leeway in passing along higher prices, as the expansion has been anything but robust; however, as the second chart above shows, prices received has moved above zero, indicating the growing economy is allowing firms to shift some of the pricing burden to customers.

Separately, a look at today's release of the Consumer Price Index for March is available at Examiner.

Weekly jobless claims back above 400,000

Weekly initial jobless claims increased 27,000 in the latest week to 412,000, well above most economists’ estimates.

The 4-week moving average rose 5,500 to 395,750, and continuing claims dipped by 58,000 to 3.68 million.



Because of its timeliness and its reflection of business confidence, jobless claims are an excellent leading indicator of future economic activity.

The decline below 400,000 has been encouraging as economic activity has picked up in recent months, and the sudden reversal would be a bit concerning.

Bloomberg News did report this morning that factors tied to the start of the quarter may be responsible for the unexpected jump in claims. It did not make mention of the earthquake in Japan, which has caused a kink in the global supply chain.

Due to the volatility of the weekly numbers, we’ll need confirmation over the next couple of weeks as to whether we’re seeing a slowdown in the recovery or just a temporary blip in weekly claims tied to the difficulty in making seasonal adjustments.

Producer price inflation on the rise

The Producer Price Index rose 0.7% in March, which comes on top of a 1.6% increase in February and a 0.8% rise in January.

April’s smaller-than-expected gain cane be traced back to a 0.2% dip in the price of food following February’s outsized gain of 3.9%. The rise in energy prices slowed from February’s 3.3% to a still uncomfortable 2.6%.



The Federal Reserve, however, remains focused on core inflation, or inflation that excludes food and energy.

The core rate last month edged up 0.3%, suggesting that higher energy and raw material prices may be starting to impact the broader prices level.

Year-over-year, producer prices, though still at heightened levels, did ease from 5.8% to 5.7%, but the core rate continued to creep higher, rising from 1.9% to 2.0%.



About the only piece of relatively good news is that the increase in prices at the earlier stages of production are relatively stable (see chart above and below).

Most members of the Fed have argued that the jump in commodity prices will have only a transitory effect on inflation, and a continued moderation in increases may bolster their case.

That may be the case, even as the Fed's aggressive policy has helped to feed commodity inflation.

Still, I’m a bit skeptical.  Though we are not seeing an ever-increasing rate of price increases, prices at this level can be very volatile and pressures have yet to abate.  And the Fed's own anecdotal data suggest that businesses are beginning to experience a degree of pricing power.



Nonetheless, it’s important to look at the other side of the equation, and powerful forces remain in place that are helping to keep retail inflation from getting out of hand.

Wages, which are the biggest cost to most businesses, are rising very slowly, and there is still plenty of slack in the economy. Moreover, a ten-year Treasury yield that has been hovering near 3.50% is not signaling an imminent outbreak in inflation.

Tomorrow, we’ll get the latest on consumer prices when the Consumer Price Index is released. A survey by Bloomberg reveals that analysts expect a 0.5% rise in the headline rate and a 0.2% increase in the core rate.

Fed policy remains extremely accommodative, but rising prices at the wholesale level are beginning to complicate matters for policymakers.

Higher gasoline prices fail to dent retail sales

Retail sales grew at a fairly healthy pace last month despite the jump in gasoline prices.

The U.S. Commerce Department reported this morning that retail sales in March increased 0.4% amid soft auto sales; however, February was revised higher.

Ex-autos, sales were up a healthy 0.8%, and excluding autos and gasoline station sales (+2.6%), which helps to eliminate the distortion in the data caused by the spike in gas prices, so-called “core sales” increased a respectable 0.6%.



As I’ve argued in the past, $100 per barrel crude is not enough to derail the economic recovery, and March’s retail numbers bear this out.

Also, same-store sales posted by individual retailers for March were solid despite a much later Easter holiday this year, indicating that modest job growth is lending support to spending.

But job growth, though improving, is not a the level where it would provide a significant boost to consumer confidence. And as the chart above shows, the rate of acceleration in sales ex-autos and gas stations is gradually trending lower.



Gasoline’s impact
Gasoline prices that are approaching $4 per gallon are unquestionably a psychological blow, and crude briefly passed $110. According to the latest EIA data, prices now average $3.79 per gallon, or $0.93 above one year ago. And for every penny the price rises, consumers spend an extra $1 billion each year per economists estimates.

Still, let’s not forget that the U.S. economy towers over $14 trillion, and stocks, which initially sold off on tensions in the Middle East and higher crude prices, have recovered, suggesting the economic recovery is intact.

I suspect that the Easter holiday will give individual retailers a lift in April.   But the summer months will provide us with a greater degree of clarity, as headwinds increase from higher gasoline prices.

Economic impact of QE2 looks limited

QE2, or the second round of the Fed’s program of quantitative easing as it is popularly called, was launched with plenty of fanfare and controversy last November, but was crafted as an insurance policy against deflation as well as a way to jump-start a sluggish recovery that had failed to create a significant number of new jobs.

Since its plan to buy an additional $600 billion in longer-term Treasuries, stocks have rallied, the economy has side-stepped a double-dip recession but inflation worries have surfaced amid soaring commodity prices.

Not surprisingly, the Fed has been content to take credit for the rally in stocks and the reinvigorated economy but not the surge in commodity prices.

Looking more closely at the data, the Fed’s actions, at best, may be having only a very limited impact on the economy as I’ll explain below.

First, let’s define quantitative easing before analyzing its effect on the economy.  Quantitative easing is a tool that a central bank uses in order to provide more liquidity, or cash, than is needed to keep short term rates at zero.

In other words, a central bank, such as the Federal Reserve or the Bank of Japan, resorts to unconventional means when conventional policies that drive short-term rates to zero fail to stimulate economic growth.



In early 2009, the Fed, in its efforts to clear the logjam in the credit markets, clarified its planned asset buys by announcing it would purchase $1.25 trillion of agency mortgage-backed securities, up to $200 billion of agency debt and $300 billion in Treasury securities by the end of the year.

How does the Fed do it? What is essentially happening is that the Fed creates cash and buys government bonds from a bond dealer.  When the Fed receives its newly purchased bond, the bond dealer receives cash, which it deposits into its bank account.

The bank now has new deposits which it can lend to businesses and consumers, after holding a small percentage in reserve.  Anything above that minimum-required reserve is called “excess reserves.”

Normally, banks minimize excess reserves because they earn nothing sitting in the vault, and a bank is in business to make a profit by paying you and I a certain return on our deposit before lending it out at a higher rate.

When late 2008 rolled around, there was absolutely nothing normal happening in the credit markets, and risk-averse banks tightened credit standards and used the extra cash to shore up balance sheets. 

As you can see from the chart above, much of the Fed’s actions in late 2008 and most of 2009 simply ended up back at the Fed in the form of these excess reserves.

A quick note: Unlike in past years the Fed began paying a very small amount, 0.25%, on excess reserves held at the Fed. That’s better than what banks can get for overnight loans on the fed funds market and better than holding it the vault. Remember, the Fed is targeting a fed funds rate at between 0 – 0.25%.

The second round of QE, or QE2, has had a similar impact, as excess reserves are up nearly $400 billion since the program was initiated (see chart above). Excess reserves now stand at almost $1.4 trillion.

What is this suggesting? Simply that banks are not lending out the extra cash to businesses or consumers and instead are holding them at the Fed in the form of excess reserves, which earn a paltry 0.25%.

 

A quick look at the second and third charts seems to confirm the newly minted Federal Reserve dollars aren’t finding their way into the real economy because lending standards remain tight and consumers, who are still reeling from the worst recession in 70 years, continue to shore up savings accounts and focus on debt.



At this point in the cycle, the Fed’s extraordinarily accommodative monetary policy does not appear to be responsible for the improvement in economic activity in recent months.

Think “liquidity trap,” where monetary policy becomes largely ineffective.

Still, the very modest uptick in consumer lending and the stabilization in commercial and industrial loans are encouraging, but we’re going to need to see a greater willingness among banks to lend before the recovery kicks into high gear.

Weekly jobless claims drift lower

Weekly jobless claims fell by 10,000 in the latest week to 382,000, which marks the sixth week in seven that jobless claims have come in under the psychologically important level of 400,000.

The 4-week moving average fell 5,750 to 389,500 and continuing claims were down 9,000 to 3.7 million.



Despite the spike in gasoline prices, the downward drift in jobless claims does suggest that the economic recovery and the modest progress we've been seeing in the labor market are continuing.

Otherwise, there’s not a whole lot to say about this week’s data.

ISM services survey shows economy expanding but pace slowed in March

The ISM survey of the br0ad-based service sector revealed that the lion’s share of the economy continues to expand, but the pace moderated from the first two months of the year.

The ISM Non-Manufacturing Index released by the Institute for Supply Management slowed from 59.7 in February to a still healthy 57.3 in March. A reading above 50 suggests the service sector is expanding.



The Business Activity/Production subcomponent took the biggest drop, falling from 66.9 in February to 59.7, but new orders, which are a good indication of future activity slipped just 0.3 points to a still strong 64.1.

It appears that some of the uncertainty earlier in the month caused by the spike in oil prices and possibly what’s going on in Japan may have played a role, however, the exports component of the survey did improve.

We're also seeing a bit of divergence from manufacturing, which continues to lead the expansion.



Next month should provide us with more clarity on the situation in Japan and how that might be impacting the U.S., but it is unlikely that the jump in crude and the situation overseas will threaten the U.S. recovery in my view.

Growth in nonfarm payrolls encouraging

But more is needed

Nonfarm payrolls jumped by 216,000 in March, including a rise of 230,000 in private-sector payrolls. Further, we saw modest upward revisions to the private sector in both January and February.

March’s 230,000 increase in private-sector jobs generated by an improving economy is the second consecutive rise north of 200,000, which is the first such back-to-back increase in five years.

Given various surveys of the employment landscape, coupled with the modest drop in weekly jobless claims, it’s safe to say that the labor market is on the mend.

Still, millions of jobs were lost in the recession and more is needed to get the labor market back on track.

Most economists believe that the economy must create at least 150,000 net new jobs each month jus to absorb new entrants into the labor force.

Of course, the recession has blunted growth in the labor force, which has contributed to the decline in the unemployment rate.

Nonetheless, the expanding and broadening economic recovery is lifting job growth and I’m cautiously optimistic that a further acceleration is on tap.

ISM manufacturing remains at healthy level but prices are a rising concern

The ISM Manufacturing Index, which is a closely-followed survey of national manufacturers, slipped from a cyclical high of 61.4 in February to a still healthy 61.2 in March, roughly in line with most analysts’ forecasts.  But the cost of raw materials remains a concern.

A reading of 50 suggests that goods producers are neither expanding nor contracting.

" The component indexes of the PMI remain at very positive levels and signal strong sector performance in the first quarter. While manufacturers are benefiting from strength in new orders and production, there is significant concern with regard to commodity prices,” Norbert Ore, chair of the Institute for Supply Management said.

“Many manufacturers indicate the prices they have to pay for inputs are rising, and there is concern about the impact of higher prices on their margins."

He states his case well. 

Prices paid jumped from an already high 82.0 in February to 85.0, signaling that manufacturers continue to grapple with the high costs of materials.   And regional surveys of the manufacturing landscape suggest firms are starting to have some success passing along higher prices.

Nonetheless, wages gains have been muted and excess slack still exists in the economy, which should limit shortages and bottlenecks and help keep core inflation under control, at least in the short term.

Meanwhile, manufacturers continue to enjoy a very robust recovery.

Production rose 2.7 points to a very strong 69.0, while a modest slowdown in new orders to a still solid 63.3 suggests that the rapid ascent in the recovery is peaking, and we may be settling into a strong but sustainable recovery in the goods-producing sector.

Overall, the manufacturing sector, which helped to pull the U.S. economy out of the worst recession in 70 years, continues to lead the expansion.