“Political Dysfunction Continues in Washington…” 12/14/12

As gridlock in Washington remains at the forefront in investors’ minds, there basically is nothing new to report on the fiscal cliff that is reliable after another week of posturing between the two parties.

Although the media is consumed with the fiscal cliff, there has been some good news on the economy lately. Vehicle sales, ISM non-manufacturing, unit labor costs, November jobs and housing activity have shown improvement. The Consumer Price Index (CPI), the key measure of inflation, fell 0.3% in November primarily due to the 7.3% decline in the price of a gallon of gasoline.  Overall, core prices are still up 1.8% compared to a year ago. (A reading of 2% in core inflation is considered within the Federal Reserve’s comfort zone).   The relief at the pump may translate to more disposable income for holiday shopping.  Strong consumer spending this holiday season could offset some of the weakness in other areas such as corporate investment.

Facing little threat of inflation, the Fed agreed to expand asset purchases this week in a continuing bid to spur growth and reduce unemployment.   The Fed stated that rates will remain low “at least as long” as unemployment remains above 6.5% and inflation remains in check.  Bernanke reiterated that inflation is not an immediate concern when he stated, “Longer-term inflation expectations continue to be well anchored” in a press conference Wednesday.

The unemployment rate is currently at 7.7% and in order to drop that to 6.5% today, it would require 1.9 million jobs to be created immediately.   Currently, our economy is creating around 150,000 new jobs per month on average.    The Fed predicts that it will take until 2015 to bring the unemployment rate down to 6.5%; which indicates the Fed does not anticipate raising rates anytime soon.

Outside the U.S., China’s economy is gaining momentum. China’s economy has grown at an average annual rate of 10% a year for the past three decades, but growth slowed to 7.4% in the most recent GDP report as weak demand for Chinese produced goods, especially in the Eurozone, weighed on exports.  The Chinese economy is heavily dependent on the manufacturing sector, which appears to be mounting a recovery.   Both industrial production and retail sales rose in November. These reports follow the improvement in manufacturing reported last week. After hitting a four year low on December 3 the Shanghai Composite index has risen 6 percent.  We expect China to continue their accommodative monetary policy stance to counter-balance the external weakness in demand for exports, which should bode well for continued growth.  China is also beginning to see an emerging middle class among its citizens as internal consumption among Chinese citizens will be a catalyst for continued growth in China going forward.

We will keep you informed as things continue to develop in Washington.