BUSINESSWEEK ONLINE : JULY 10, 2000 ISSUE
BUSINESS OUTLOOK U.S.: The Fed Is Watching Consumers and Waiting for August If spending rebounds, a summer rate hike could still happen The Federal Reserve took a pass on another interest-rate hike at its June meeting, but don't get too comfy in your lounge chair this summer. Fed policymakers still don't seem convinced that their work is finished. To be sure, consumer spending--and the overall economy--slowed in the second quarter from its blistering pace of the past three quarters. Consumer spending, in fact, may have struggled to grow 3%, half its 6.1% clip over that prior nine-month period. Against the many recent signs of cooling, the Fed would have had little justification in lifting rates yet again, especially after the aggressive half-point increase on May 16, the first such sizable hike in more than five years. But it's not what the Fed did or didn't do on June 28, it's what it said. Although policymakers kept the federal funds rate at 6.5%, the central bank issued a hawkish-sounding statement, similar to others this year, that the risks in the outlook remain weighted toward conditions that could ''generate heightened inflation pressures in the foreseeable future.'' That's Fedspeak meaning: If growth rebounds this summer, we'll hike some more. Indeed, the Fed said signs of a slowdown ''are still tentative and preliminary.'' For instance, in June consumer confidence fell, though it was down from a very high May level (chart), and initial claims for jobless benefits turned up--but not by much. Weekly surveys of retail buying look a bit firmer than in May, but nothing exciting. Also, while existing-home sales rose in May, they are clearly off their peak of last year. MANY FED POLICYMAKERS are uneasy about the economy's consistent resilience in recent years. For the past two years, economic growth has slowed in the second quarter--to 2.2% in 1998, and to 1.9% in 1999--only to rebound strongly. To some extent, those slowdowns reflected mild winter weather and ever-earlier tax refunds, which boosted first-quarter activity at the expense of that in the second quarter. Those influences were at work this year, too. The Fed's six rate hikes in the past year, totaling 1 3/4 percentage points, have not shaken household fundamentals very hard. Consumer spending remains bolstered by strong job markets, falling mortgage rates, high home values, and a partial restoration of stock wealth. Plus, the outlook for capital spending remains good, especially given the rebound in stock prices and declines in borrowing costs. And that's not to mention the ongoing acceleration in exports, as growth outside the U.S. continues to pick up. In fact, $2-a-gallon gasoline may well have a greater impact on consumers than the Fed's rate hikes. It is clearly taking a bite out of household buying power this summer, a drain that could extend into the fall. Because of already low inventories and stronger world demand, the Organization for Petroleum Exporting Countries' (OPEC) recent agreement to boost output is unlikely to push oil and gas prices significantly lower anytime soon. EXPENSIVE GAS seems to be affecting household psychology. The Conference Board's index of consumer confidence fell six points in June, to 138.8, from 144.7 in May. That was the biggest drop since the financial markets' turmoil in the fall of 1998. However, keep in mind that the May level of confidence matched the record high reached in January. Moreover, households noted that job-market conditions remained extremely favorable. Some 54% of households described jobs as ''plentiful,'' up from May. And only 11.3% said jobs were ''hard to get.'' Both readings were very close to the record levels hit earlier this year. Those survey findings suggest that the upturn in initial unemployment claims in recent weeks may be just statistical noise. Besides, trends over the past decade suggest that weekly claims would have to reach 350,000 to be consistent with any significant slowing in job growth. The four-week average of claims is currently running just above 300,000 through mid-June. Housing fundamentals have not eroded very much, either. Thirty-year fixed mortgage rates in June are actually down some 50 basis points from their May peak (chart), and June mortgage applications to buy a home are trending higher. Sales of existing homes rose 4.3% in May, to an annual rate of 5.09 million. Through May, resales in the second quarter are running above their first-quarter level. WHILE THE FED is watching consumers closely for signs of a slowdown, policymakers are likely more sanguine about the continued strength in capital spending. That's because the deepening of the stock of capital goods increases productivity, which, the Fed statement said, has ''been containing costs and holding down underlying price pressures.'' Business investment in equipment has been growing at double-digit rates throughout most of this expansion. Spending on high tech alone has been soaring at rates of 20% or more over the past three years. The 6% jump in durable goods orders in May suggests that these uptrends will not end anytime soon. Unfilled orders for capital goods, excluding aircraft, remain at a record high level (chart). Why the continued boom? Credit the payoff possibilities of the cyberworld. The structural changes in the economy toward technological innovation and the Internet mean that businesses must continue to invest heavily on high-tech goods that allow companies to boost productivity and create a presence on the Net. In fact, orders for electronics and electrical equipment soared 26% in May, more than offsetting the 17.6% plunge in April. These investments recognize the ongoing fundamental changes in the way business is done. They are not affected by short-term shifts in demand. In addition, businesses still face tight job markets and rising labor costs. As a result, businesses are switching to cheaper capital to produce their goods or services. That shift will help to keep profits growing, generating the cash to buy more equipment. That's not to say higher interest rates aren't causing the cancellation of some investment plans, especially for building projects. Nonresidential construction is still growing strongly, with outlays in April up 10% from a year ago. But far fewer projects are on the drawing boards. New contracts for nonresidential projects in May were down a stunning 15.1% from May, 1999--just before the Fed began to hike. Also, growth in low-tech gear, such as construction machinery and industrial equipment, is slowing. Even so, the Fed isn't fretting about robust capital spending. Instead, policymakers will base their rate decisions on future consumer behavior. If spending again gets as steamy as an August afternoon, don't be surprised if the Fed tries to beat the heat with another rate hike on Aug. 22. By JAMES C. COOPER & KATHLEEN MADIGAN _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS U.S.: The Fed Is Watching Consumers and Waiting for August CHART: Consumers' Spirits Slip a Bit in June CHART: Mortgage Rates Head Back Down CHART: A Soaring Backlog of Capital Goods Orders INTERACT E-Mail to Business Week Online

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