Benchmark stocks indices had been up the entire session, despite horribly weak housing data, but the Fed’s afternoon decision provided additional fuel to the rally. The broad market jumped 3.4% in the final 90 minutes of trading.
Market Activity for December 16, 2008
Financial shares led the rally, as the S&P 500 index that tracks the group jumped 11.25%. Basic material, industrial and consumer discretionary shares also outperformed the market.
Economic Data
On the economic front, the Commerce reported builders broke ground on new homes at the lowest level on record – data goes back to 1959. Housing starts plunged 18.9% in November to 625,000 units at an annual pace. Multi-family starts (condos etc.) fell 23.3%; single-family units were down 16.9%.
The degree of weakness was a shock, but the fact that housing starts remained weak was not. Last month’s October building permits figure, showed a 9.3% decline (down 38.2% year-over-year), which was a great indication the reading was going to be very low. Housing starts have declined 72.5% from the January 2006 peak!
Permits for November, which was also out yesterday, do not indicate improvement for December as the figure dropped 15.6% last month to 616,000 – also a record low.
While this news is inauspicious, it is a necessary condition for the housing market to recover. The good news is new homes available for sale have plummeted, so when sales do bounce back the very elevated inventory/sales ratio will fall fast.
In a separate report, the Labor Department reported the consumer price index fell 1.7% in November, the biggest decline in 61 years and follows the 1.0% decline for October. Over the past 12 months, consumer prices are up 1.1% -- that figure was 3.7% in the previous month, 4.9% in September and 5.4% in August – just another illustration how quickly things have changed.
The core CPI was unchanged in November, lowering the year-over-year rate on ex-food and energy prices to 2.0% from 2.2% a month back.
The decline in CPI was virtually completely due to a large 17.0% decline in the overall energy component and a 9.8% in transportation. Gasoline, in particular, plunged 29.5% last month; natural gas was down 5.2%.
This dramatic decline in energy costs is great news for the consumer. As the boys at RDQ Economics point out, energy prices within the CPI fell to their lowest level since February 2007. U.S. consumers spent $670 billion on energy goods and services over the past 12 months – at February 2007 prices, the same level of consumption would have cost just $540 billion. This represents a $130 billion addition to real household incomes. This savings should show up in the December retail sales data.
Energy prices are down some more in December, but the degree of decline will wane and with OPEC planning a production cut oil prices will very likely level out before rising again.
The decline in CPI should not be confused with overall deflation, we’ll point out the food and beverage component rose 0.2% in November and is up 4.1% three-month annualized and 6.0% over the past 12 months. This is an energy-price driven event as we come off of the insanely elevated levels back in the spring and summer of this year.
The Fed has nearly tripled its balance sheet and the trillions in liquidity pumped into the system will combine with an infrastructure-based stimulus package to drive commodity prices and overall inflation higher again.
The price gauges will appear to indicate a deflationary event is upon us for a couple of months still, but it won’t be long before this concern has passed and the Fed will have to start thinking about how they’ll take back some of their easing as the economy slowly and tepidly bounces back. When things do improve, whenever that might be, massive liquidity injections will fire through the system. This is one reason a tax-rate response to the current woes is superior. Such a decision would boost confidence immediately, and offer businesses an incentive to produce over time; we’ll need an increase in goods to absorb all this money that will be flowing. If not, inflation is coming and it will be higher than we’ll like.
The Fed Decision
In a 10-0 decision the Federal Open Market Committee (FOMC) chose to cut the target on the federal funds rate from 1.00% to a range of zero and 0.25% (acknowledging the near-zero effective fed funds rate relative to the target), while stating they will “employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.” Good luck with that ladies and gentlemen of the FOMC.
The group of 10 signaled they’re willing to keep the funds rate low by stating, “the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rates rate for some time.”
Nine rate cuts and nearly $2 trillion in emergency lending via roughly 10 new facilities over the past 12 months have yet to fully reverse the credit situation – although certainly facilities like their commercial paper funding program has certainly kept things from fully collapsing.
The statement also noted the Fed has already announced it will purchase “large quantities” of agency debt and mortgage-backed securities (to bring mortgage rates lower) and they “stand ready to expand these purchases as conditions warrant.” They continue to think about whether or not to buy longer-term Treasuries. (At 2.19% on the 10-year we’re not sure how much further they think the yield should go, so it’s unlikely they’ll engage in this action)
All-in-all, the Fed went well beyond expectations. The target FF cut was larger-than-expected; the establishment of a range for the funds rate and the discussion of quantitative easing (focusing on supporting financial markets and stimulating the economy through sustaining the high level of the Federal Reserve’s balance sheet) all suggest they will throw everything at the current situation. Overall, we knew this but to get explicit statements in their language is big.
The fact that they suggested they may up the size of GSE (Fannie and Freddie) debt purchases, while entertaining the thought of buying long-dated Treasuries really takes their actions to a whole new level.
If we could only get a tax-rate response to the economic distress that truly began to take hold in mid-September, we could spark confidence in a sustained way, which is more than half the battle in my view.
Have a great day!
Brent Vondera, Senior Analyst
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