The Fed's Job Gets Trickier

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Removing Inflation Pressure from the FOMC

Mar. 14's figures also took the edge off the February retail sales report, which still translates to a 0.1% nominal gain for personal consumption in February, though this now implies a flat "real" consumption figure for the month rather than a small drop. The 1% decline in gasoline service station sales in February was a surprise at the time, though with hindsight it likely reflected the early-month price restraint rather than a cutback in driving and hence inflation-adjusted sales, as some economists speculated. Our first-quarter gross domestic product forecast remains at –0.3%, though we now expect a tiny 0.2% growth clip for first-quarter real consumption.

The February CPI restraint and drop in year-over-year measures will take some inflation pressure off the FOMC next week, though soaring commodity prices suggest another problematic price round in March. Year-over-year inflation figures will remain elevated by the late-April two-day FOMC meeting.

University of Michigan Consumer Sentiment Index

The Michigan sentiment index revealed a downtick in the preliminary March report, to 70.5, following the 70.8 reading for February, marking a new low for this measure in the GDP down cycle of the 2007 fourth quarter and 2008 first quarter. The present situation index managed to rise to 84.6 from 83.8 in February, though the future expectations index fell to a new low of 61.4 from 62.4, as the preponderance of negative news from the financial markets continues to boost fear. Though the inflation-expectations measures often play second fiddle in this report, it's noteworthy that the one-year ahead inflation measure soared to 4.5%, from 3.6%, though the 5- to 10-year outlook dipped to 2.9%, from 3%.

We will assume a small bounce in the March consumer confidence index to 77, from a 75 reading in February.

Confidence declines over the last nine months have outpaced the declines through the various episodes of negativism that have plagued this expansion, just as the pullback in consumer spending, as captured in the Mar. 13 retail sales report, outpaced prior moderations in this expansion. The combination has reinforced the assumption that we have entered a recession.

Yet, nominal (unadjusted for inflation) spending growth is still remarkably outpacing income growth since the market turmoil began in August. Further spending shortfalls beyond February might finally allow the long-awaited uptick in the savings rate beyond the still-lean 0.2% that looks likely for February, following rates of 0.2% to 0.5% through most of the middle months of 2007. For now, however, the consumer is still not a factor "pulling down" GDP. Indeed, given available spending figures, consumer spending continues to modestly outpace income growth to provide a modest buffer to GDP, despite the powerful array of headwinds that are obviously affecting confidence.

Englund is principal director and chief economist for Action Economics.