EXCEPTIONALLY LOW …….. FOR AN EXTENDED PERIOD ……..

America’s Federal Reserve indicated it would be keeping interest rates at close to zero for the foreseeable future, in order to nurture the economic recovery. While the Fed has declared its optimism that the country’s economy was slowly recovering, it decided to maintain the target federal funds rate at the current level of 0-0.25% in view of a mixed picture of the recovery from recession amidst low rates of resource utilization, subdued inflation trends, and stable inflation expectations.

The Fed is widely expected to maintain the current level of interest rates through 2010. However, more significant will be its moves on withdrawal of the liquidity stimulus programmes running into hundreds of billions of dollars that have been in force since the beginning of the sub-prime crisis – the pace and timing of the unwinding. Also, when it is going to drop the four magic words from its statements – ‘exceptionally low’, ‘extended period’.

Bernanke expects economic rebound, dashes rate cut hopes

Federal Reserve Chairman Ben Bernanke has re-iterated his belief that the US economy will bounce back from its sluggish performance so far this year to advance at a “moderate pace” in the coming quarters - close to or slightly below the economy's trend rate of expansion, even if the housing slump persists. The US economy's trend or normal growth rate is put at around 3-3.25 percent. The assertion dashes the prevailing expectations that Fed will start cutting interest rates in order to stimulate growth. A section of the market has been expecting that Fed will be forced to cut interest rates later this year, as the economy struggles to come out of the slowdown.

Economic growth in the year's first three months nearly stalled, logging just a 0.6 percent pace. It was the worst quarterly showing in more than four years. Bernanke said he believes some forces that figured prominently in that poor performance — including a bloated trade deficit, cutbacks by businesses in inventory investment and weak federal defense spending — "seem likely to be at least partially reversed in the near term."

The Fed meets next on June 27-28 and many economists predict policymakers will again hold a key interest rate steady at 5.25 percent, where it has been for a year. Many economists think rates will stay where they are for the rest of this year.

Regarding the housing slump, the US Fed Chairman accepted that it may continue to be a drag on economic growth for longer than previously expected. The saving grace is the housing market's problems haven't spread through the broader economy in a significant way. "We have not seen major spillovers from housing onto other sectors of the economy," he observed.

America’s Economy

Sunny outlook, but the weather may turn


THE primary job of any pundit is to forecast all the ways in which things could go wrong. So far, however, the American economy has stubbornly defied the dire prognostications of those expecting bad weather. Economic growth has swayed and faltered. Revised figures announced on Thursday May 31st showed that the economy grew at an annual rate of 0.6% in the first quarter of 2007, less than half the initial estimate. But no matter how close recession seems, somehow the storm clouds never quite break. This may explain why Americans are gaining in confidence, despite a negative household-savings rate, a collapsing housing market, increasing global competition, and a currency that looks decidedly anaemic.

The Conference Board's consumer-confidence index has risen, admittedly from a five-month low. And house prices are still increasing, though at the slowest quarterly rate for ten years, according to the Office of Federal Housing Enterprise Oversight. And even if the American economy is doing all right now, what of the future? This is the question asked in a new survey by the Organisation for Economic Co-operation and Development. The report is surprisingly upbeat on current trends, saying that the economy seems to be weathering the sharp correction in the housing market surprisingly well. Though the Federal Reserve must restrain lingering inflationary pressures without unduly straining growth, the outlook for the short term seems reasonably sunny.

Over the long term, however, America faces gloom: a shrinking labour force. In essence economic growth depends on two things: how fast the number of workers rises and how much more they can produce. For most of the past two decades, both have grown briskly. And the American economy has enjoyed the fastest pace of growth in the developed world.

Since the 2001 recession, however, the labour force has not grown as robustly as after previous downturns. More importantly, labour-force participation is still more than a full percentage point below what it reached in 2000. If the size of the labour force does not track population gains, the remaining workers will have to work harder, or more efficiently, if living standards are to keep rising.

There are reasons to think that the slowdown in labour-force growth is permanent. The great transition of women into the working world, which has boosted participation rates for decades, seems to be over. The proportion of women working is expected to remain roughly stable, or grow only slowly, barring big social or institutional change. Meanwhile, another enormous demographic shift is on the way: the retirement of the baby boomers. That will place an extra burden on tomorrow's workers unless productivity growth is strong enough to plug the gap.

On this point, the OECD is sceptical. American productivity growth has been well above the OECD average for more than a decade and should remain strong. But expected gains will come more slowly than in the past ten years. Unless America undertakes structural reform to make its economy even more competitive, the nation will struggle to support its ever-increasing number of dependants.

The proposed reforms are mostly tricky: trade liberalisation and an end to the distortions caused by farm subsidies; tax reform to broaden the base and remove economically inefficient tax breaks; changes to social security in order to encourage saving and delay retirement; and deep changes to the education system at all levels. Most of these will be politically unpopular. Even improving education, by itself an uncontroversial proposition, generally ends up becoming highly contentious when the details of reform start undercutting powerful interest groups such as the teachers’ unions.

The OECD also wants changes to disability benefits. Some evidence indicates they depress labour-force participation rates. Low-income workers struggling to find jobs may be turning to permanent sick leave when their unemployment benefits run out. But picking on the sick and old to make life easier for young workers will be a hard sell even to the hard-hearted American electorate looking for protection as the clouds begin to gather.

Source : Economist

S&P Beats 1500, Dow Jones at New High

Better-than-expected earnings, positive economic data, M&A news driving the market

The raging bulls continue to scale the mountains as S&P500 beat the 1500 point once again since late 2000 and the Dow made another new high of 13241.38. The economic data continues to paint an optimistic picture of controlled inflation and steady growth. That, along with the great earnings so far, continues to fuel the bulls ahead.

Besides economic and earnings data, what has added to the upbeat mood on the Wall Street is a spate of corporate takeover news. After Rupert Murdoch’s News Corp. offered to buy Wall Street Journal publisher Dow Jones & Co. for $5 billion, there are reports that Microsoft has renewed talks to take over Yahoo Inc. and Reuters Group has received a preliminary takeover offer. The frenzied activities on M&A front are seen as bullish signs for the future of the economy.

Dow Jones dream run continues

The Dow Jones Industrial Average reached an all-time high marking a record for the third day in a row, as Federal Reserve Chairman Bernanke painted a broadly optimistic picture of the economy. The 30-stock index has risen seven straight months - the longest winning streak since 1995 - and has gained 2.4% in 2007. It closed at 12,767.57 this Friday, basking in the optimism generated by Bernanke's testimony and positive data on wholesale prices, while shrugging off another set of data that showed a continued slowdown in the housing market.

The Fed Chairman sounded less hawkish in his semi-annual congressional testimony than expected, spurring expectations that interets rates will remain on hold and will be cut later this year. He assessed that there were some indications that inflation pressures were beginning to diminish. Since there was much noise in monthly data, it may be some time before the Fed could be confident that underlying inflation was moderating as anticipated. He noted that core inflation rate remained somewhat elevated. However, if activity expanded over the next year or so at a moderate pace as anticipated by the FOMC, pressures on both labour and product markets should ease modestly. Consumer spending has been the "mainstay" of growth, and the worst housing slump in more than a decade won't have a significant effect on other parts of the economy, Bernanke said.

Reflecting anticipation of lower rates, the yield on the benchmark 10-year U.S. Treasury note has fallen to 4.69 percent.

US hopeful of soft landing

Interest Rates Unchanged

The U.S. Federal Reserve has left interest rates unchanged at 5.25 per cent for the fifth time running. The widely expected move comes amid signs of the US economy staying reasonably strong and inflation being more under control. While recognizing “somewhat firmer economic growth” and “signs of stabilization” in the housing market, the rate-setting Federal Open Market Committee has expressed growing confidence that inflation is running lower. "Readings on core inflation have improved modestly, and inflation pressures seem likely to moderate over time," the central bank said. At the same time, it also repeated its caution that "some inflation risks remain" - a sign that it is likely to keep its benchmark rate at current levels for the near future (or, may even raise further). The US economy grew faster than expected in the last three months of 2006, as increased consumer spending offset a housing market slowdown. The GDP rose at an annual rate of 3.5% from October to December, while the growth rate for 2006 as a whole was 3.4%, more than 2005's 3.2% expansion. The Fed's policy aim is to achieve a “soft landing” - a mild slowdown in growth that would cool down inflationary pressures but not spiral into a recession.

US jobs data beats forecasts,

Japan surprises on the negative side


The US economy beat forecasts by adding more jobs in November than expected, showing the economy's resilience as housing and manufacturing slump. According to the Labour Department report released on Friday, 132,000 jobs were added last month, a marked improvement from the 79,000 in October, and higher than market expectations of 110,000. The jobless rate rose to 4.5 percent from a five-year low of 4.4 percent.

The US economy expanded at a 2.2 percent annual rate in the third quarter - the slowest this year - largely owing to a slump in the housing sector and reports suggest that the weakness may be spreading beyond housing. Manufacturing, which accounts for about 12 percent of the economy, contracted for the first time in more than three years last month as inventories grew and orders slowed, according to the Institute for Supply Management report.

The jobs data is consistent with the soft-landing scenario and shows that the economic slowdown remains mild. The central bank has held its benchmark lending rate steady for a third straight month in October and is expected to maintain the stance at its forthcoming meeting next week. The Federal Reserve Chairman Ben S. Bernanke maintains that the economy will continue to expand and even pick up next year.

While the latest data release comes as a silver lining in the cloud of economic slowdown for the world’s largest economy, there were fresh clouds over the economic recovery of Japan. The world’s second largest economy has been emerging from a decade of stagnation, recession and deflation. According to the final numbers released by the Government, GDP in the July to September quarter was up 0.8% on a year ago, compared with the 2% estimated earlier. The main reason for the disappointing figures was a drop in domestic demand, which contracted by 0.2% from the previous three-month period.

The slower economic growth may prompt the Bank of Japan to delay interest rate increase which was expected to come as early as later this month. The Bank of Japan had raised interest rates from almost zero to 0.25% earlier this year in July, as the economy gained in strength and is expected to follow-up with more hikes in future.

US FOMC minutes hawkish again, inflation eases, Japan rates untouched

US Fed officials maintain a hawkish tone on inflation in the minutes of the last month’s meeting. The Federal Open Market Committee, which decides on interest rates on monetary policy actions, had decided to keep interest rates on hold at its October 24-25 meeting.

This marks a pause for the third time in a row. US interest rates have risen over the past two years as the world's largest economy has recovered and price growth has picked up. The US central bank has kept interest rates steady at 5.25% since August, and is expected to maintain its current stance when it meets next month.

According to the minutes released Wednesday, the Fed noted that reducing inflation to counter expectations of higher prices was its 'greatest concern' and worried that inflation might not recede as hoped and an inflationary psychology could set in, making its job tougher. It assessed that core inflation was still uncomfortably high and that a tight labour market could lead to wage pressures. However, Fed officials also observed that high profit margins may be able to absorb some part of the higherlabour costs. On the housing market, the minutes said that ongoing adjustment was likely to depress real activity in the near term, but thatthis effect was expected to wane gradually.

Meanwhile, consumer prices fell in October for the second month in a row, on the back of cheaper oil. The reading will offer some comfort to the policy-makers when they meet next month. The Labor Department said that prices fell by 0.5% in October, more than many analysts had forecast. The annual inflation rate was 1.3%.

The Bank of Japan (BoJ) voted to keep policy rates steady, as widely expected. Japanese GDP grew 2% annualised for the quarter ended September, twice thatexpected, but the data did not provide sufficient fuel for the BoJ to act this time around.

US rates on hold - what next?

The US Fed has decided to keep interest rates unchanged at 5.25%, but remains wary of inflationary risks to the economy. The decision to keep the rates on hold for the third consecutive month after a series of 17 successive hikes over past two years is on the expected lines. As before, Richmond Fed President Lacker was the lone dissenting member of FOMC favouring a quarter percentage point rise hike.

The Fed observed that economic growth has slowed over the course of the year, but going forward, the economy is expected to expand at a moderate pace. While recognizing that inflation pressures are likely to moderate over time, the FOMC continues to emphasise that “… some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.”

The Fed's current 'watch and wait' policy on rates follows signs that price pressures are easing and that the economy has slowed since the start of the year. There has been perceptible easing of price pressures owing to lower energy prices, contained inflation expectations, cumulative effects of past monetary policy actions and other factors restraining aggregate demand, though the Fed does not want to let the guard down. On the other hand, there has been a noticeable output drop in the second quarter and the once-buoyant housing market has cooled considerably. The challenge before the Fed Policymakers is to control inflation while ensuring that the slowdown in economic activity does not worsen into a prolonged downturn.

The Fed's decision to keep its policy options open has left the market guessing on the future course of interest rates. Although it is widely believed that Fed will keep interest rates steady in the near future, the market is divided on the likely Fed action in 2007. On the one hand, as the Fed continues to warn on inflation risks, rate hikes may be required in future. On the other hand, there is a section of the market that believes that continued economic slowdown and weakness in the housing market may force the Fed to reverse the cycle and start cutting the rates sometime in second half of 2007.