Tuesday, January 02, 2007

Will the Federal Reserve Reduce Interest Rates Soon?

Each month since 1994 Creighton University has surveyed supply managers in 9 states located in what we term the Mid-American region. The states included in the survey are: Arkansas, Iowa, Kansas, Minnesota, Missouri, Nebraska, North Dakota, Oklahoma and South Dakota. Each month we produce a Business Conditions Index from the survey which is a leading economic indicator of the region.

Recent surveys have been detecting economic weakness stemming from 17 Federal Reserve rate hikes since May of 2004 and from the 2006 slump in housing. The overall Business Conditions Index for December declined to its lowest level since December 2002. The December index slumped to 53.8 from November’s 54.1 and October’s 55.1. At the same time, inflationary pressures cooled for the fifth straight month as the region’s inflation gauge moved to its lowest level since July 2005. The prices-paid index, which tracks the cost of raw materials and supplies, dropped to 68.3 from November’s 69.4 and October’s 73.1.

Despite recent strength in government job reports which are coincident or current economic indicators, leading economic indicators, such as that produced by our survey, point to slowing economic growth with lower inflationary pressures for the first half of 2007. I expect this scenario to push the Federal Reserve to the sidelines with no interest rate changes until the second quarter of 2007. I do anticipate a rate cut in the second quarter.

Survey participants also reported positive but weak new hiring for the month. The December employment index climbed for the first time since May 2006 to 53.1 from November’s tepid 50.5. Fourth quarter job growth in the region was about one-fourth of what it was in the first quarter of 2006. I expect this slow job growth to continue well into 2007.

The economic soft landing engineered by the Fed will likely be a bit more bumpy than the rate setters intended.

Ernie Goss

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