COMMERCE BANK ECONOMIC REVIEW - August 2005

A Hot Summer in Many Ways

By Joel L. Naroff, Ph.D.

It has been a really hot summer and I am not just talking about the weather. The worries about the economy disappeared in a string of solid economic data. Growth turned broad-based and even the job market firmed. But nothing comes for free. The Fed raised rates again, and oil and housing prices pushed through the stratosphere into places only Captain Kirk had gone. Thus, we still have to watch over our shoulders for inflation, housing bubbles and interest rate hikes.

The economy is doing just fine, thank you. Second quarter GDP growth checked in at 3.4%, which is not too shabby. It was only a touch below the first quarter, but it exceeded the pace posted at the end of last year. We’re talking sustainable growth here, something I could live with every quarter.

Most encouraging was the broadbased nature of the spring gains. Business investment in software and equipment boomed. That shows how confident executives are about the future. Consumers emptied their wallets as they took advantage of the great motor vehicle deals, visited the malls and took vacations. Even our exporters did well, selling a ton of stuff overseas.

When an economy starts hitting on all cylinders, you expect the job market to follow.  For a while, we thought that would never happen. But like the weather, the job market changed quickly as well. Okay, the 207,000 workers added in July didn’t remind us of the go-go days of the late 1990s. Nonetheless, it was a keeper. Coming after two months of modest increases, it raised hopes we would see even better gains ahead.

But the really good news was in wages. Instead of barely inching along, as they had been, they jumped sharply in July. With the unemployment rate at only 5%, there is not a large pool of skilled workers. As a consequence, businesses are starting to bid for workers and that means wages should continue to rise nicely.

Although workers may be cheering the possibility that their income may actually rise faster than health care or energy costs, the Fed might not look at the rise in wages so positively. The FOMC raised short-term rates once again. Starting in June 2004, the Fed’s rate setting committee has gotten together ten times for coffee and a rate hike, increasing the funds rate 2.5 percentage points in thirteen months.

Now normally, you would think such a large rise in rates would slow business activity.  On the surface, that didn’t seem to occur. But don’t think the hikes had no impact. If the Fed had not raised rates, there is a real possibility the economy would have overheated.  Had that happened, the rate hikes would have been larger and longer-term rates, such as mortgages, would have spiked as well. Maybe the Fed does know what it is doing.

Energy prices remain the major concern. When people start paying their cooling bill, there will be a lot of unhappy campers. But with growth still solid, the Fed will likely continue raising rates and that will keep the heat on.

Joel L. Naroff, Ph.D., is Chief Economist for Commerce Bank. Commerce Bank, "America’s Most Convenient Bank,” is a leading financial services retailer with nearly 330 convenient stores in New Jersey, New York, Pennsylvania, Delaware and new markets Washington, DC and Virginia. For more information about Commerce, please visit the company’s interactive financial resource center at commerceonline.com.