INSIGHT: US Fed rate freeze signals long-term economic chills

11 August 2011 16:14  [Source: ICIS news]

By Joe Kamalick

US economy may be on the edge of a new recessionWASHINGTON (ICIS)--In a week of economic earthquakes, perhaps the least noted but most serious tremor came on Tuesday when for the first time in its 98-year history the US central bank guaranteed that it would not raise interest rates.

The Federal Reserve Board, the US central bank, said that it was maintaining its current federal funds interest rate at 0%–0.25% – where it has held steady since December 2008 – and would likely keep that key rate at “exceptionally low levels" at least through mid-2013.

Never before has the Fed locked in its interest rate policy.

The action was aimed at shoring up consumer and market confidence in the US economy in the wake of the nation’s debt limit crisis, the loss of its triple-A credit rating, sharp downturns on Wall Street and worldwide markets and growing fears of a new global recession as Europe teetered on the brink of a sovereign debt debacle.

But as much as the unprecedented Fed rate guarantee was meant to reassure business, investors and consumers, it also was a startling admission that the central bank does not expect the US economy to improve much at all over the next 24 months, and perhaps longer.

In its statement about the economy, the central bank’s rate-setting Federal Open Markets Committee (FOMC) said that since its last meeting in June, “economic growth so far this year has been considerably slower than the committee had expected”. 

“Indicators suggest a deterioration in overall labour market conditions in recent months, and the unemployment rate has moved up,” the statement said. 

“Household spending has flattened out, investment in non-residential structures is still weak, and the housing sector remains depressed,” the central bank added.

The Fed also noted that while some temporary factors have contributed to the slowing US recovery – supply disruptions related to the Japan earthquake, and higher food and fuel prices – those conditions “appear to account for only some of the recent weakness in economic activity”.

That statement was seen as indicating that US economic problems are far more fundamental and long term, and cannot be attributed to one-off outside factors.

Indeed, while the impact of the Japan tsunami has eased along with domestic US food and fuel prices, the Fed said that it “now expects a somewhat slower pace of recovery over coming quarters” than it did at its June meeting.

With US GDP having nearly flatlined at 0.4% in the first quarter, and second-quarter GDP performance at a barely breathing 1.3%, the Fed appeared to suggest that the nation’s economy will not do much better over the next eight quarters.

The Fed also said that it anticipates that the unemployment rate will decline only gradually and that “downside risks to the economic outlook have increased”.

That phrase is Fed-speak meaning that another recession is entirely possible.

Martha Gilchrist Moore, senior director for policy analysis and economics at the American Chemistry Council (ACC), said she would put the odds on a new recession at one-in-three, an increase from the earlier one-in-four probability that the council’s economics team offered just a month or two earlier.

Moore pays particular attention to the four indicators most closely followed by the National Bureau for Economic Research (NBER): personal income, industrial production, payroll employment and real business sales.

The NBER is the private, non-profit research group that is the accepted arbiter of when US recessions or recoveries begin and end.

Two of those key NBER measures, industrial production and real business sales, hit post-recession high-water marks in March but now are in decline, Moore noted.

“The challenges are that throughout the recovery [which officially began in June 2009], it has been manufacturing and exports that have taken the lead, and both of those are now softening quite a bit,” she said, citing the recent dour report of manufacturing performance by the Institute for Supply Management (ISM).

“There is a tremendous amount of uncertainty in both the business and consumer sectors,” Moore said, “and that speaks to the Fed’s announcement of Tuesday”, locking in its near-zero interest rate for two years.

In that interest rate guarantee, she said, “the Fed was trying to provide some certainty”.

“But on the other hand, what the Fed has done is to signal that they don’t foresee any good growth prospects over the next couple of years,” she said, adding: “And that is very disconcerting.”

All things considered, Moore agrees that “the canary in the coal mine looks pretty dizzy”.

Moore's estimate of a one-in-three chance for a new recession is fairly conservative. NBER president emeritus and Harvard economist Martin Feldstein thinks there is a 50% chance of a new US recession.

Lawrence Sloan, president of the Society of Chemical Manufacturers and Affiliates (SOCMA), said he does not think the US economy will nose into another recession.

“But I do feel that unfortunately we will be in a status quo of sluggishness for quite a while,” he said.

Sloan sees the US economy as suffering a low-grade fever, one that will take considerable time to cure.

“I think we have a fundamental imbalance in the US economy, and I don’t see it going away for years,” he said.

“We have rising productivity, with companies able to produce more with fewer workers than ever before,” he said. “At the same time, we have a huge retiring population that is growing in numbers every day, with fewer and fewer workers available to support each retiree.”

Sloan pointed out that when the US Social Security system came into force in 1936, there were 16 workers for every retired person in the country. That ratio now has shrunk to 3-1 and will only worsen as millions of Baby Boomers move into retirement over the next five years.

In addition, he said, the US has a growing number of unemployed workers who lack the kind of skills needed in the modern workplace – what economists call structural unemployment, workers who are unlikely to see another pay check. That will contribute to persistently high unemployment.

Under a bombardment of what Sloan called over-arching regulations, the US manufacturing base is shrinking, with more capacity moving offshore.

“In the longer term, if consumers are skittish about the economy, they want to save more, pay down their debts and spend less,” he said. “And that means less consumer-driven demand for manufacturing, and consequently less demand for chemicals.”

Sloan said that he has anecdotal evidence that SOCMA member companies that six months ago were planning to expand production, their laboratories or warehousing are now rethinking those plans.

“Companies across the board are going to be rethinking their investments,” he said.

($1 = €0.70)

Paul Hodges studies key influencers shaping the chemical industry in Chemicals and the Economy


By: Joe Kamalick
+1 713 525 2653



AddThis Social Bookmark Button

For the latest chemical news, data and analysis that directly impacts your business sign up for a free trial to ICIS news - the breaking online news service for the global chemical industry.

Get the facts and analysis behind the headlines from our market leading weekly magazine: sign up to a free trial to ICIS Chemical Business.

Printer Friendly

ICIS news FREE TRIAL
Get access to breaking chemical news as it happens.
ICIS Global Petrochemical Index (IPEX)
ICIS Global Petrochemical Index (IPEX). Download the free tabular data and a chart of the historical index

Related Articles