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More Fed coverage
The Fed stays in the picture
Drop in wholesale prices, slower economic data, don't necessarily mean Fed can stop raising rates.
July 15, 2004: 2:03 PM EDT
By Mark Gongloff, CNN/Money senior writer

NEW YORK (CNN/Money) - Though the U.S. economy has hit several speed bumps on its way to a full-fledged boom, and though wholesale prices dropped unexpectedly in June, economists still see reasons for the Federal Reserve to keep hiking interest rates.

That raises an uncomfortable question for investors: Could the "Goldilocks" economy turn into a different kind of fairy tale, something a little more -- pardon the pun -- Grimm?

A slew of economic data in recent days has confirmed what most economists and analysts already knew: The economy wasn't feeling quite itself in June.

Industrial production posted an unexpected decline in June, its biggest in more than a year, the Fed said Wednesday. On Wednesday, the Census Bureau said retail sales also fell in the month, and job growth, as measured by the Labor Department, was also surprisingly weak, to boot.

The optimists, including most economists, believe this weakness was the delayed effect of May's jump in oil prices. Since most consumers can't avoid higher gas prices, needing automobiles to get to work and the shopping mall, higher energy costs act as a sort of tax, hurting spending on other items. Businesses suffer, too.

Oil prices fell in June, helping wholesale prices beat a hasty retreat in the month. Hopefully, lower oil prices will lead to a rebound in consumer demand, which will encourage a rebound in business output.

Two possible signs that just such a happy dynamic is already in place were reports from the New York Fed and the Philly Fed that their surveys of regional factory activity jumped unexpectedly in July.

"The data today suggests that there was only a temporary pause in this sector and that we can expect more growth going forward," Lehman Brothers senior economist Drew Matus wrote in a note to clients.

What's more, economists said June's national factory data from the Fed were affected by cooler-than-usual weather, meaning fewer air conditioners were running at full blast, leading to a drop in utility output, along with a sharp drop in the production of cars and trucks. If these trends reverse in July, industrial production could rebound.

"The [Fed industrial production] data are a bump on the road, not a change of direction," said Ian Shepherdson, chief U.S. economist at High Frequency Economics.

Fed still in the game

If the optimists are right, then that's good news for the economy, but it also keeps the Fed in the game.

Central bank policy makers have already raised their key overnight lending rate once, to 1.25 percent -- still a 40-year low and still below the rate of inflation -- and are widely expected to so again in August and a few more times before the end of the year.

"1.25 percent is just the wrong rate. It's not consistent with an economy that will some day reach full employment again," Bob Gay, economist and strategist at Commerzbank Securities, told CNNfn. "It might take a year or two years, but by the time we reach [full employment], we need to be back at a policy that's no longer stimulative, so it's a foot race."

And excluding food and energy prices, wholesale prices continue to accelerate, which could fuel inflation in consumer prices further down the pipeline. Though core wholesale prices have risen just 1.8 percent in the past year, they've risen 2.5 percent in the past six months and 2.9 percent in the past three months -- they're gathering steam, in other words.

"Despite the decline in headline producer price pressures, the risks of deflation have clearly vanished and signs of inflationary pressures have emerged," said Brian Wesbury, chief economist at Griffin Kubik Stephens & Thompson in Chicago. "With the Fed holding real rates below zero, we expect producer prices to continue their upward trend in the months ahead."

What's more, there's been another recent spike in oil prices, back above $40 a barrel on the New York Mercantile Exchange, which could add to inflation pressures, even as it keeps consumer demand weak.

Disinflation's not dead, either

On the other hand, higher energy prices could also have a deflationary impact on some sectors, if they make consumers snap their wallets shut. Airlines, for example, have recently started slashing prices to get people flying again. Other industries could follow suit if business is bad.

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"Eventually you have other prices going down to compensate for the fact that energy went up," said Robert Brusca, chief economist at Fact and Opinion Economics. "But that doesn't work itself out in a month or two; it works out over a period of time."

Meanwhile, Brusca warned, other service prices, such as health care and education, continue to rise, putting upward pressure on the consumer price index (CPI), which could force the Fed to keep raising rates, even if economic growth decelerates.

Consumer spending makes up more than two-thirds of the total economy, and the pessimists believe debt-laden consumers could be hampered by an unpalatable cocktail of higher inflation and interest rates, with some terrorism fears thrown in for good measure.

Meanwhile, there are signs that businesses aren't picking up the slack from consumers. Technology companies have been warning of lower-than-expected sales and earnings, and there were troubling numbers about business confidence in the Philly Fed survey, despite the encouraging headline.

For example, the percentage of firms expressing confidence in their prospects for the next six months fell to its lowest level since February 2003, when worries about the Iraq war were hampering business.

"In spite of the good current news, there remains a fair amount of caution," said Joel Naroff, president and chief economist at Naroff Economic Advisors.

If interest rates rise and consumers and businesses keep sitting on their hands, then the "Goldilocks" scenario of steady economic growth and slowly rising interest rates, which Wall Street and the economy have enjoyed in recent months, could turn uglier.  Top of page




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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.