Market News International - To the extent the economy has been suffering from an inventory correction, there is reason for the Federal Reserve to be hopeful about the economic outlook, and indeed it is, Market News International is reliably informed.
That hopefulness, in turn, suggests that Wall Street hopes for further aggressive Fed easing, including another interest rate cut before the next Federal Open Market Committee meeting on May 15, could be disappointed unless the Fed gets weaker than expected data in coming weeks.
The larger than expected improvement in the National Association of Purchasing Management's March index of manufacturing activity has given the Fed additional reason to be both cheerful about the prospects for economic growth and reticent about radical rate cutting. Not only did the NAPM report show signs of improvement in new orders, production and employment, its inventory component declined further.
The Fed was already encouraged by the progress it perceived companies to be making in liquidating inventories. In announcing its third 50 basis point rate cut on March 20, the FOMC stated that "the associated backup in inventories has induced a rapid response in manufacturing output and, with spending having firmed a bit since last year, inventory adjustment appears to be well underway."
Among other reasons for the Fed's optimism on the inventory front has been the weakening in commercial and industrial loans in recent weeks. That otherwise gloomy looking indicator, which coincided with senior loan survey results showing a further tightening of business lending conditions, was seen at the Fed less as a worrisome sign of credit constriction than as proof that businesses were borrowing less to finance inventories. And the Fed has been getting other reports suggesting that inventory liquidation is proceeding apace.
From the beginning of the economy's unexpectedly dramatic slowdown, the Fed has identified inventory adjustment as the primary cause of cooling activity. Companies that had counted on continued strong demand found themselves with excess stocks of unsold goods when personal consumption expenditures slowed to a 2.8% annual rate in the fourth quarter. Firms have been curbing production to work down those stocks.
In March, the NAPM's inventory component declined from 45.7 to 44.2, and NAPM survey coordinator Norbert Ore voiced encouragement that finished goods inventories will be "back in line" within "a couple of months." Already he said factory inventories of raw materials "are starting to move in line."
Much the same feeling prevails among Fed officials. Although the duration of inventory adjustment is considered uncertain, some officials are quite optimistic about a relatively quick turnaround.
In the near-term, of course, inventory liquidation, as opposed to inventory building, is a drag on production and GDP, causing much gloom in the markets and the public. But the Fed looks beyond this near-term slough to what it hopes will be the not very long term, when the stage will be set for a rebound in output, business investment and, eventually, factory payrolls.
The Fed has been wary of a possible "breach" in confidence that could contract consumption and send the economy into recession, for example. But consumer confidence has rebounded, according to both the Conference Board and the University of Michigan. Consumption appears to have picked up its pace modestly in the first quarter. And, by definition, if inventories are being reduced that means consumption is exceeding production factory payrolls.
Inventories are not everything to the Fed. Policymakers still view the economy as vulnerable to downside risks and therefore remain on course for further easing, but the Fed is relatively upbeat about the economic outlook. An inter-meeting rate cut would likely require weaker numbers than it has been getting.