Feds Beige Book Update and Commentary: Turbulence Ahead

The latest Federal Reserve Beige Book was released today and as expected the news was grim, which almost guarantees a substantial interest rate cut next week. The beige book contains the Fed’s latest snapshot of business and economic conditions looking at factors such as housing, manufacturing, credit, prices, wages and financial market conditions across 12 Fed districts . Following my last update on the Beige book, things have gotten worse and no sector or district has escaped the downturn. Here are some of the highlights and commentary:

– Since the Fed released its last beige book in mid-October, economic activity has softened further across all 12 of the nation’s Federal Reserve districts (which includes all major cities). The latest report shows that the slump has intensified, as the credit crisis takes its toll on local and state economies throughout the country.

– Consumer spending weakened further during the reporting period with retail sales dropping as expected, despite heavy discounting ahead of the holiday season. However, discount stores reported stronger sales volumes than department stores (which explains why the Dollar Store at one point had a great market capitalization than Citibank).

– Vehicle sales also deteriorated since the last report, with sales of more expensive and less fuel efficient vehicles particularly slow. A number of car buyers had difficulty obtaining financing, reinforcing the fact that cash is king when it comes to buying a car.

– All districts reported weak housing markets, as selling prices took a beating amid slowing sales activity. Though house prices look to be stabilizing. Commercial real estate markets generally declined in most districts as lending standards tightened.

– Manufacturing activity declined noticeably since the last report with all 12 Districts reported weaker manufacturing conditions (to varying extents). Previously strong energy and mining sectors have turned softer in light of lower output prices.

– The Fed’s Beige Book also noted that labor markets weakened as firms in many districts reported accelerating layoffs. This was backed up two new reports from the Institute of Supply Management (ISM) and ADP employer services report. The ISM reported that service industries in the U.S. contracted the most in at least 11 years. ADP Employer Services said in its report that companies eliminated an unexpectedly 250,000 jobs, the most since November 2001. With further job cuts on the horizon, particularly in the manufacturing and financial services sector, the U.S. job market is nowhere near bottom and the upcoming government payrolls report (due to Friday) could exceed current expectations for 320,000 job losses in November. A silver lining from the weak jobs outlook was that wage pressures were largely subdued, suggesting that inflation is no longer a threat.

Fed officials will review the somewhat anecdotal information at their policy meeting on interest rates next week. It is almost certain an interest cut will occur, the only question is whether it will be a 50 basis point (half a percent) or 100 basis point (1%) cut. My opinion is that they will go for the steeper rate cut given things look to have gotten worse and neither financial markets nor consumer spending has stabilized. With inflation no longer a real threat, the Fed can afford to be ultra-aggressive. Fed chairman Ben Bernanke has already signaled a number of other (joint) measures will be pursued to combat the current recession and frozen credit markets.

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