Economic Highlights for the week ended January 25, 2008

Economic Week In Review: Fed Cuts Rate By 0.75%

Vanguard 1/25 – In a surprise move, the Federal Reserve Board lowered the federal funds rate by 0.75% on Tuesday, in an attempt to revive a weakening economy. This marked the largest single-day cut to the federal funds rate since 1982. Financial markets remained volatile throughout the week, as investors digested the Fed's unexpected move. Otherwise, it was a light week for economic data releases. A report on existing-home sales confirmed what most people already knew: 2007 was a weak year in the housing market. For the week, the S&P 500 Index rose 0.4% to 1,331 (for a year-to-date total return of –9.6%), and the yield of the 10-year U.S. Treasury note fell 7 basis points to 3.58%.

Bear Stearns 1/22 – The FOMC cut the fed funds rate target by 75 basis points this morning, to 3½%, on an 8 to 1 vote (the Fed held an intermeeting session last night). St. Louis Fed President Poole dissented in favor of no move and Governor Mishkin was absent and did not vote. The Board of Governors also approved a 75-basis-point cut in the discount rate, to 4%, on requests from the Federal Reserve Banks of Chicago and Minneapolis.

The rationale for this move today was in Mishkin’s speech a week-and-half ago, which argued that at times of severe financial turmoil, policy had to be “timely,” “decisive,” and “flexible.” Today’s statement carries a clear weakness bias and downplays any inflation risks, which leaves the door open to further rate reduction. Indeed, the statement says that “The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.” This leaves us thinking that the Fed will cut rates again at next week’s meeting (Wednesday, Jan. 30) by either 25 or 50 basis points. The Fed has been unwilling to disappoint the market and fed funds futures are leaning very strongly toward a half-point cut next week. However, we disagree with the Fed over the longer-term outlook for inflation—to us, events have a strong stagflationary feel about them.

Vanguard 1/25 - This was the first time the FOMC has made an unscheduled rate cut since 2001, following the attacks of September 11, and it was the largest rate move since 1994, when the FOMC raised rates by 0.75%.

In its accompanying statement, the Committee voiced concerns about continued downside risks to growth and noted "broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households." The rate cut came a week ahead of the FOMC's regularly scheduled two-day meeting, set for January 29 and 30. This week's rate cut does not preclude further action next week.

Bear Stearns 1/24 – Initial unemployment claims were again lower than expected, falling 1,000 to 301,000 in the week ending January 19th. The four-week average of claims fell 14,000 to 314,750.

January claims have averaged 308,000 versus a 342,000 average for December. The magnitude of the decline in claims at the start of the year suggests that job creation did not deteriorate further in January.

Existing Home Sales Fell 2.2% In December

Vanguard 1/25 – Existing-home sales fell 2.2% in December, capping one of the worst years on record for the housing market. Sales were down 22.0% from their year-ago levels, and for all of 2007, existing-home sales were 12.8% below the 2006 pace. The median price for an existing home fell to $208,400 in December, down from $221,600 one year ago. For the month, price declines were steepest in the West, where median home prices are highest.

Bear Stearns 1/24 – Existing home sales fell 2.2% in December to 4.89 million units from 5.00 million units in November. Single-family home sales fell 2.0% in December, while multi-family sales declined by 3.3%. The weakness in home sales in December was broad based by region and type of property.

The supply of single-family existing homes in relation to sales fell to 9.2 months in December from 9.8 months in November.

This report provides further evidence, along with the sharp declines in housing starts and building permits, that this sector remains a substantial drag on economic activity.

Very Weak New Home Sales Report For December

Vanguard 1/25 – Next week will be a busy one for economic data releases, but the Federal Reserve Board will again take the spotlight. The investment community will be watching to see if the FOMC lowers rates again at their regularly scheduled meeting on Wednesday, Jan. 30. Other data slated for release include reports on new-home sales (Monday – released, reported above), durable goods (Tuesday), consumer confidence (Tuesday), gross domestic product (Wednesday), employment costs (Thursday), personal income (Thursday), unemployment (Friday), construction spending (Friday), and the manufacturing segment of the economy (Friday).

Bear Stearns 1/25 – This week is jammed with economic releases and events. The main focus is likely to be the Fed's policy decision on Wednesday (the two-day meeting begins on Tuesday and an announcement on rates is due at around 2:15pm on Wednesday). While fed funds futures have been extremely volatile, the market continues to look for the Fed to cuts rates by 50-basis-points on Wednesday (and, to date, this Fed has not shown the stomach to disappoint the market).

On the data front, there are a number of important releases. The main focus is likely to be on the January employment report, released on Friday. We look for a 75,000 increase in nonfarm payrolls in January and we see the unemployment rate edging down to 4.9% from 5.0%.

The January ISM manufacturing survey (Friday) and advance release of fourth-quarter real GDP (Wednesday) will likely also be an important focus.

In addition, the Treasury Department will announce the details of its mid-quarter refunding on Wednesday. Given that budget deficit forecasts are being revised higher, we expect marginal increases in the size of the 10-year note and 30-year bond auction. Also, the Treasury Department may float ideas and seek comment on plans to finance the upcoming economic stimulus program that is expected to pass within the next couple of months.