COMMERCE BANK ECONOMIC REVIEW - June 2005

“It’s all so confusing.”

By Joel L. Naroff, Ph.D.

It seems as if the economic world turns upside down every few weeks. The economy seems strong, but then we get a series of soft numbers and everyone panics. Then, when the consensus forms around a soft spot, job growth soars. Okay, so we don’t have a soft spot. But then the employment report turns ugly once again and interest rates collapse, for what reason is not clear. Indeed, even Fed Chairman Alan Greenspan expressed his confusion about why we were seeing rates so low. What a way to make a living!

So, what is going on? Good question! Let’s start with the economy. It really is in fine shape. Or, as the Federal Chairman stated, “the U.S. economy seems to be on reasonably firm footing.” First quarter GDP growth was revised up to a very solid 3.5%. The strength was quite widespread as consumers spent, businesses invested, builders built and even exporters sold more overseas. That was followed up by a quite nice report on durable goods, which showed that households and firms are not simply buying little items but are purchasing all types of machinery, equipment and appliances. And the housing market just kept going and going and going.

So, what’s the problem? It’s the job market! It refuses to behave. Just when we thought it was safe to say that the economy had moved into a more consistent and solid job growth mode, we found out that was not the case. In May, businesses once again played Scrooge and cut back hiring dramatically. Nevertheless, the unemployment rate fell to its lowest level in almost four years. So you tell me: Is the labor market weak because of the few jobs being added or is it strong because the unemployment rate is down? 

But the questions keep building. Long interest rates fell quite sharply during May and into early June and that usually happens when the markets think the economy is going to weaken sharply. This was such a surprising turn of events that Chairman Greenspan called it a conundrum. Every explanation held some water, but didn’t really tell us what was happening. 

Does anyone around here really know what is going on? Here’s my guess. The economy really is in good shape. The job growth numbers understate the true condition of the labor markets as businesses are still hiring. Everyone agrees that pricing power has begun to return and that only points to higher inflation. That says, at least to me, that interest rates should rise. 

Looking outward, though, there likely will be more confusion until the markets and the monetary authorities get in synch. That may not be for some time. And if there is one forecast I can be sure of, it is that the data will tell us that the economy is, or isn’t strong and that inflation is, or isn’t rising and that interest rates will, or will not stay low.

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 325 convenient stores in New Jersey, New York, Pennsylvania and Delaware. For more information about Commerce, please visit the company’s interactive financial resource center at commerceonline.com.