COMMERCE BANK ECONOMIC REVIEW - January 2006

2006 Began on a Decidedly Undecided Note

By Joel L. Naroff, Ph.D.

It’s a New Year and the time to look forward and make lots of economic prognostications. But to do that, it would be nice to fully understand how the economy ended 2005. The problem is, economic activity was clearly unclear. For every solid sector, we seemed to have one that was not that great. So it is time to bring out the two-handed economist and give the “on the one hand, on the other hand” forecast.

The biggest question remains the consumer. Some retailers had a great holiday season, while for others it was not very impressive. Vehicle sales picked up, but they weren’t particularly spectacular. November consumption was okay, but it looks as if fourth quarter spending was essentially flat. The modest buying occurred even though households used all their income. That is – the savings rate was negative.

For spending to improve, we need better income and job growth. We thought we had moved past the hurricane-created problems, as the November employment gain was awesome. But then came the December numbers and they were soft. Although the unemployment rate did recede to 4.9%, when you add only 108,000 new positions, you can’t say the labor market is robust. There are signs that job openings are improving and wages did increase solidly. 

Although the labor market should be good going forward, it would be nice if payroll gains were more consistently solid. Interestingly, consumer confidence did manage to improve and, if we do get the expected job increases, spending should be decent.

Then there is the housing market. While new home sales tanked in November, existing home demand only edged lower. The level of mortgage applications is dropping. More importantly, price increases are generally slowing while declines are becoming more prevalent. And, there are an awful lot of homes on the market, so the pressures on prices are likely to build. It’s still not clear how quickly the housing bubbles will deflate, but they are starting. 

And then there is manufacturing. Hooray for manufacturing! The nation’s factories produced a whole lot more goods in November. In December, conditions seemed to throttle back a bit. But with orders growing moderately, backlogs building and payrolls expanding, this sector should continue to lead the way. 

As you can see, no good number has gone unchallenged. It is in that context that the Federal Reserve must figure out what to do next. The FOMC did raise rates again on December 13th.  When the Committee noted that “ some further measured policy firming is likely to be needed”, it was clear further tightenings would occur. 

Why is more tightening needed? Simple: “Possible increases in resource utilization as well as elevated energy prices have the potential to add to inflation pressures.”  Inflation remains job one and the job is not yet done.

So, where do we stand? The tea leaves are a little soggy. Going forward, growth should be decent, but we should not expect a surge in economic activity. As for interest rates, the Fed may tighten one or two more times. In other words, some good with the not so great. 

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 more than 370 convenient stores in New Jersey, New York, Connecticut, Pennsylvania, Delaware, Washington, DC, Virginia and southeast Florida. Commerce Bancorp (NYSE: CBH) is headquartered in Cherry Hill, NJ and has more than $36 billion in assets. For more information about Commerce, please visit the company’s interactive financial resource center at commerceonline.com.