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Economic Watch: Leading Indicators Rise, Fed Dampens 2014 Expectations

June 19, 2014

By Evan Lockridge

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A measure of the health of the nation’s economy shows it has increased again, while concerns linger by the Federal Reserve about economic growth for  the remainder of the year.

The Conference Board’s Leading Economic Index for the U.S. increased 0.5% in May to 101, following a 0.3% increase in April and a 1% increase in March. The index is a gauge of economic conditions during the next three to six-months.

“May’s increase in the LEI, the fourth consecutive one, was broad based,” said Ataman Ozyildirim, economist at the private research group. “Housing permits held the index back slightly but the LEI still points to an expanding economy and its pace may even pick up in the second half of the year.”

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Recent data suggests the economy is finally moving up from a 2% growth trend to a more robust expansion,” said Ken Goldstein, economist at The Conference Board.

The news follows the Federal Reserve on Wednesday completing a two-day policy meeting when it opted to leave interest rates unchanged and continue to reduce monthly bond purchases by $10 billion, taking them down from $45 billion to $35 billion, as expected.

The Fed also lowered the 2014 gross domestic product forecast range from 2.8% to 3.0%, to 2.1% to 2.3% for all of 2014, but left the 2015 range of 3% to 3.2% unchanged.

“What was most notable, however, were the updated economic projections showing a clear contradiction between the Fed's downgraded expectations for near-term growth and the committee members' accelerated expectation for policy firming,” said Lindsey Piegza, chief economist at the investment firm Sterne Agee. “Chairman Yellen explained away this juxtaposition as a reflection of ‘uncertainty’ in monetary policy. More acutely, however, this represents a growing divergence between expectations, which are reflected in the dot-plot, and a more lackluster reality upon which monetary policy will be based.”

Piegza said this means the Fed is “consistently overly optimistic” in their growth forecasts, “historically outpacing economic reality for more than a decade, but changes in monetary policy or the first Fed rate hike will not occur until that presumed improvement comes to fruition.”

She noted unlike the previous Fed Chairman, Ben Bernanke, Yellen is much more willing to wait and see realized gains rather than preemptively adjust short-term rates based on heightened expectations alone.

Meantime, economic reports from earlier this week show, increasing momentum, following a lackluster first quarter, with consumer prices increasing the most in more than a year while housing starts broke a barrier for the second straight month, despite a drop.

The Consumer Price Index increased in May by 0.4%, its biggest gain since February 2013, following an increase of 0.3% in April, according to the U.S. Labor Department.

So-called core prices, which strip out the volatile food and energy sectors, show a 0.3% increase in May, the biggest gain since August 2011.

Piegza said this latest increase signals inflationary pressures may be moving closer to the Federal Reserve's target of no more than 2% annually.

“From a monetary standpoint, rising inflation further justifies the Fed's pathway of winding down quantitative easing and expectantly ending monthly bond purchases by the end of the year,” she said. “Going forward, however, temporary inflationary pressures, particularly those from the energy sector, will not be enough to force the Fed's hand to begin to raise rates. The Fed remains focused on the labor market; the Fed is watching for further employment gains and faster wage growth to signal the appropriate timing for rate increases.”

A separate report from the U.S. Commerce Department shows housing starts in the U.S. during May remained above the one million mark annually, for the second straight month, but fell 6.5% from the month before.

A gauge of future building activity, the number of new building permits issued in May, fell 6.4% to 991,000 annuall, after being past the one million level annually for four consecutive months.

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