The Fed Is Worried — And You Should Be Too

The Fed is worried, and you should be too.  That is the major take-away from yesterday’s FOMC statement, combined with its release of updated projections and Bernanke’s press conference.  Despite the market’s cheering of the promise of a near-zero fed funds rate until late 2014 and the prospect of QE3, the Fed is fighting a lonely battle against severe economic headwinds—-and they know it.  In answering a reporter’s question, Bernanke made it crystal-clear that he does not believe that the recently optimistic economic releases are sustainable.  He has good reason to think so.

The FOMC reduced its current central tendency 2012 GDP growth projection from 2.5%- 2.9% to 2.2%-2.7% and its 2013 number from 3.0%-3.5% to 2.8%-3.2%.  The previous projections were made in November.  Although they reduced their unemployment projection slightly, they are still projecting unemployment rates as high as 8.2% to 8.5% for 2012 and 7.4% to 8.1% in 2013.

It’s significant that these reductions were made despite better than expected economic releases in the last few months in jobs, production and consumption.  Although some may wonder what the Fed knows that others don’t, the reasons for their caution are no mystery to anyone familiar with the numbers.  Disposable income is growing very slowly, and even this tepid pace is a largely a result of temporary tax cuts and transfer payments, while real wages are flat.  Consumer spending growth was supported mainly by a reduction in household savings rates from 5% in June to 3.5% in November.  December retail sales have already weakened as holiday sales were disappointing.

Employment growth is still not enough to raise real wages or reduce unemployment by much.  While initial unemployment claims have declined, new hiring is still disappointing and household wealth has been declining as a result of the continuing slide in home prices.