Will Further Rate Cuts Spur Economic Growth?

May 6, 2008--As expected, the FOMC cut rates to 2% in an attempt to spur economic growth. The BEA released the first estimate for GDP on Wednesday, indicating higher-than-expected economic growth. While employers shed thousands of jobs in April, consumer confidence continued to decline. Last, as the ISM index remained unchanged in April, factory orders fell.

 

Federal Open Market Committee Meeting
The FOMC lowered the federal funds rate 25 basis points to 2%. The committee noted their worries over stressed financial markets, restricted credit, and weakening labor markets. With this latest cut, the FOMC has dramatically reduced rates--down 3.25 percentage points, from 5.25%--since it began loosening monetary policy mid-year. The Fed continues to weigh uncertainty in financial markets and the prospect of weak growth ahead as its primary policy goal in the short term and believes inflation will moderate going forward.

 

Gross Domestic Product
The Bureau of Economic Analysis' earliest estimate of 1st quarter GDP revealed that the economy grew at a weak 0.6% annual rate. Economic growth continued at the same rate as in the 4th quarter. On a year-ago basis, GDP increased 2.5%, slightly below its long-term growth potential of 2.75%. The number of positive factors for growth is dwindling, as positives included consumer spending on services, inventory investment, exports and federal government spending during the first quarter. Negative factors included residential construction, consumer spending on durable goods, and increased imports (which hurts GDP growth). The overall economy is very weak, especially as the effects of the faltering housing and credit markets ripple through the broader economy.

 

Employment Situation
The labor market shed 20,000 jobs in April, following a downwardly revised 81,000 job loss in March. April's loss was much better than anticipated, as most analysts projected a loss of 75,000 jobs. Manufacturers and builders slashed payrolls by 110,000 workers. Positive numbers in private service-producing jobs, though, helped to offset the negative numbers witnessed in the manufacturing and building sectors, adding 81,000 jobs. Gains were especially noticeable in professional and business services, education, and leisure and hospitality. Average hourly earnings increased a paltry 0.1% to $17.88; increased food and energy prices have not affected the labor market. Last, the unemployment rate fell 0.1% to 5.0%, as the number of discouraged workers increased.

 

Consumer Confidence
Consumer confidence dipped once more in April, down 3.6 points to 62.3 from an upwardly revised 65.9 in March. Currently, the index stands at its second lowest point in the last 15 years. Increased energy prices, uncertainty in financial, housing and credit markets, tight household finances, and a weakening labor market continue to worry consumers.

 

ISM Index
The Institute for Supply Management's Purchasing Manager's Index (PMI) remained unchanged in April at 48.6. For the third straight month, the PMI is below 50, the threshold for expansion.  Looking at the components of the headline number, new orders were flat, while backlogs increased to 51.5 from 47.5. Production inched up to 49.1 from 48.7. In the early stages of production, inflation remains a concern as prices paid ticked up 1 point to 84.5. If current conditions hold, analysts expect the ISM to remain between 45 and 50 during the first half of the year.

 

Factory Orders
Factory orders fell a greater-than-anticipated 1.4% in March after a downwardly 0.9% decrease in February. Orders for core capital goods, which are a proxy for business investment spending decreased at a rate of 1.0% for the month. A 2.6% increase in nondurable goods led the overall improvements in shipments, as they increased 1.1%. Inventories and unfilled orders both grew, at a rate of 0.9% and 1.1%, respectively.