Market News
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	Economic Outlook The U.S. economy, to date, appears to have shrugged off the ill effects of the crisis in Europe. Growth in the fourth quarter was 2.8 percent, a solid improvement over the 1.2 percent pace of growth in the first three quarters of 2011. Some parts of the economy appear to be on the mend, including the housing market and the labor market. Although unseasonably warm weather during the winter months helped the housing sector numbers to some extent, recent data on homebuilder sentiment, housing affordability and sales have been encouraging. Forward-looking indicators for labor conditions are also perking up. Initial unemployment claims, job vacancies and various surveys of hiring intentions have all been moving in the right direction and are reasonably upbeat on hiring in the coming months. Offsetting these positive developments, a number of headwinds may be getting ready to intensify. Disposable income growth in the U.S. has been tepid and data indicate that increases in spending have come at the expense of savings, an unsustainable situation given the precariousness of consumers’ home values and retirement nest eggs. With the labor market improving only gradually, and growth in higher income jobs nearly non-existent, income growth will likely remain anemic and, if fiscal policy contracts next year, may even narrow going forward. Fragile income growth and consumer spending against a backdrop of struggling financial markets is not a recipe for a strengthening economy. In sum, the U.S. economy is progressing at neither a boom nor bust rate, but the tail risks seem to be skewed toward another soft patch, if not bust. Events in the rest of the world, and in particular Europe, pose the biggest threat to U.S. growth in 2012. The Fed’s assessment is in a similar vein. The FOMC policy statement released following the January 25^th meeting was slightly more upbeat about recent data with the economy “expanding moderately, not withstanding some slowing in global growth” but remains very cautious about the outlook. Excerpts can be found below: “Information received since the Federal Open Market Committee met in December suggests that the economy has been expanding moderately, notwithstanding some slowing in global growth. While indicators point to some further improvement in overall labor market conditions, the unemployment rate remains elevated. Household spending has continued to advance, but growth in business fixed investment has slowed, and the housing sector remains depressed. Inflation has been subdued in recent months, and longer-term inflation expectations have remained stable. “Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects economic growth over coming quarters to be modest and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that over coming quarters, inflation will run at levels at or below those consistent with the Committee’s dual mandate.” There were several significant changes in the wording of the remaining statement, quoted below. The changes may have been driven by a frustration that things haven’t improved at a rate the Fed had wanted and/or by concerns that the economy could be hit by higher taxes and more fiscal austerity measures, as well as repercussions from Europe’s debt crisis or an exogenous shock emanating from somewhere else in the world. With the language regarding the outlook for inflation softer than what was laid out previously, the Fed indicated an intention to keep rates at “exceptionally low levels…at least through late 2014,” about a year-and-a-half later than the previous language of “mid-2013.” To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1 / 4 percent and currently anticipates that economic conditions – including low rates of resource utilization and a subdued outlook for inflation over the medium run – are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014. Fed Chairman Bernanke, in his post-FOMC meeting press conference, cautioned against taking too literally the new projections on the timing and firming of policy. He noted, “Our ability to forecast three or four years out is very limited.” The main takeaway is interest rates are on hold for an extraordinarily long time but there is no consensus as to when or how aggressively rates will need to rise. In fact three of seventeen members think the appropriate timing of firming policy is this year, while two believe it is not until 2016. The statement says, “… the Committee expects to maintain a highly accommodative stance for monetary policy” in order to support a stronger economic recovery. That most likely means the Fed has lowered the bar for additional quantitative easing through large-scale asset purchases. After three years of a roller coaster ride for the economy, going from green shoots to brown-out and back to green shoots, this Fed, with its more dovish voting core, will err on the side of caution, risking doing too much rather than not enough. The lowered bar for additional quantitative easing now seems to reflect the failure of economic growth to accelerate, rather than a deceleration in growth or fears of an outright recession, and could be expected in the second or third quarter of this year. For without more robust growth, the unemployment rate will remain elevated and income growth will remain tepid, keeping the economy at risk to external shocks.