NEWS / Foreign Exchange

Opinion on Downside Risk of Economic Growth ??“ Key Aspect of Minutes of March

Minutes of the March 20-21 FOMC meeting will be published on April 11. Chairman Bernanke has testified, following this meeting, on March 28. At the March meeting, the FOMC abandoned the tightening bias of the January policy statement which said that ???additional policy firming??? is possible and replaced it with ???future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.??? At the same time, ???the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected.??? The Fed??™s views about near-term growth in the economy that brought about change of stance will be the most important aspect of the minutes. Readers will need to draw inferences about the pace of inflation and growth the Fed is willing to tolerate.

Incoming data about inflation continue to justify the reason for the Fed??™s tough stance about inflation. The personal consumption expenditure price index excluding food and energy rose 2.4% from a year ago in February, after posting a decelerating trend between September and December 2006. The recent high for core inflation was a 2.44% year-to-year increase in August 2006. The March reading of core inflation will be published on April 30.

However, inflation pressures from labor compensation data are less threatening. Hourly earnings increased 4.0% from a year ago in March. The recent peak of hourly earnings was 4.28% year-toyear gain in December 2006. The Employment Cost Index rose 3.3% on a year-to-year basis in the fourth quarter of 2006, unchanged from the prior quarter.

After a sharp increase of 5.6% in the first quarter of 2006, real GDP growth has moderated significantly. It averaged only 2.4% in the three quarters ended Q4:2006 and appears to have grown at an annualized rate of only 2.0% in the first quarter of 2007. The complete spillover effects of the housing market slowdown are not visible as yet. The economy is predicted to grow below potential GDP in 2007, with the assumption that a lower federal funds rate should improve economic growth by the end of the year.

Incoming reports point to a soft performance in several sectors of the economy. Respondents of both the ISM manufacturing and non-manufacturing surveys noted that slowing economic conditions are expected in 2007. The composite index of the manufacturing ISM survey is flirting with contraction of factory activity. The PMI, as shown in Chart 4, averaged 50.9 and 50.8 in the last quarter of 2006 and first quarter of 2007, respectively. Readings below 50 historically have been associated with a contracting factory sector.

The quarterly average of the employment (51.6) and new orders (54.7) indexes of the nonmanufacturing ISM survey of March are at the lowest level since the third quarter of 2003 and the second quarter of 2003, respectively (see chart 5).

Auto sales have slowed to an annual rate of 16.3 million units in March from a 16.7 million pace in January. Non-auto retail sales data for March will be published on April 16. Total retail sales excluding autos rose 0.2% in January and fell 0.1% in February.

Our opinion about the March employment report is summarized in the April 6 commentary, "An Autopsy On the March 2007 Employment Situation Report". The headline numbers sent a questionable message of strength. Stay tuned for our comments on the minutes of the March FOMC meeting on April 11.