The Federal Open Market Committee

The Federal Open Market Committee (FOMC) will leave the fed-funds rate target unchanged at 5.25% at their next meeting on September 20, 2006. The combination of such factors as the decline in the housing market, the Federal Reserve staff estimate of GDP running below potential over the next six quarters, and the easing of inflation that should accompany those expectations would ordinarily point to a decrease in the rate target. However, the fact that inflation remains above the 1% to 2% target is worrisome. As evidenced by the hawkish discussion found in the minutes of the last meeting, suggesting a reduction in the rate target is unlikely at this time.

Since the last meeting, we have seen declines in the new and existing housing markets nationwide. The home sales results for July show a decline of 4.1% from June and a troubling 11.2% from the year earlier period nationwide. However, the Northeast, Midwest, and West were the primary drivers of the decline. The South fared better overall with just a 7% decline from the year earlier period (Conkey). Troubling indications that mortgages, especially sub-prime mortgages, are falling past due is compounding the decline. The prevalent use of adjustable rate and other, more exotic loan types by all credit quality customers during the most recent housing expansion could exacerbate the potential problems (Eisinger). Significant rate increases, especially in the 10-year Treasury note that provides the basis for most mortgage rates, could result in significant defaults from customers unable to service their new payment at the higher rate. Going forward, banks have to increase loan/loss reserves and face a reduced appetite for these risky loans in the secondary market. Those actions will put further constraints on the housing market.

The significant decline in the consumer confidence index released on August 29, 2006 show that the consumer, which has been a driving force in U. S. economic growth over the last few years could lose fuel (Nava). This serves as a constraint to actual personal spending, which grew at 0.8% in July; twice June's pace. The more troubling figure for the Fed's price stability goal in the 1% to 2% range was the year over year growth of core PCE of 2.4% (Bater and Ives-Halvorson). Dallas Federal Reserve Bank President, Richard Fisher, noted in prepared remarks for a speech to the North Dallas Chamber of Commerce this week, the discussion in the July FOMC meeting acknowledged the lag associated with monetary policy (Derby). Therefore, barring significant, dramatic evidence between now and the next FOMC meeting, the target rate should not change.

Second quarter GDP was revised upward to 2.9% from the original 2.5% estimate, expectations for that revision were 3%; the 2.9% figure is still below potential (Karp & Amador).

The moderate second quarter GDP revision to 2.9% fell 0.1% below the 3.0% expectations. Further, the 2.9% rate is a significant decline from the torrid 5.6% growth rate posted in the first quarter. Included with the GDP revision was continued, but declining growth in corporate profits. Corporate spending drove the bulk of the 2.9% increase for GDP, but perhaps problematically, by increasing inventories (Bater). If the consumer is slowing consumption faster than corporate America expects, it could lead to severe compression of corporate profit margins.

On the international stage, it appears that the FOMC has company in choosing to hold rates steady at their current level. The European Central Bank left its benchmark rate unchanged at 3% recognizing a slowing economy and the continued risk of inflation. The ECB suggested that they would raise rates should inflation not abate (Wall Street Journal). In Asia, Japanese industrial output declined in July after finally showing signs of life at the beginning of the year (White and Buckland) while China just revised their 2005 GDP growth figure to 10.2% from the original estimate of 9.9% (Wu). However, news of the revision to China's GDP accompanied concern surrounding excessive spending on capital improvements and troubling credit quality. The global markets could face increasing pressure based on the lower growth rate exhibited by U.S. imports from the second quarter. While imports grew at a 0.6% rate (revised upward from 0.2%),