COMMERCE BANK ECONOMIC REVIEW - September 2006

Will This Be the Autumn of the Economy’s Discontent?

By Joel L. Naroff, Ph.D.

The summer is over and it is time to start looking toward what the next year may bring. At least that is what a lot of corporations do at this time of year. Will there be the modest slowdown that the Fed is banking on, or a more serious cut back in activity? That’s a key question whose answer will help determine investment and spending plans.

The last month has not clarified things. The war in the Middle East caused oil prices to soar, but by early September we were looking at the lowest prices in five months. Of course, $2.75 for regular gasoline is not low, but it is better than what it had been. Interestingly, it was not the price of crude oil that was the driving force. Sufficient supplies of gasoline and a – so-far – mild hurricane season have helped.

The situation with gasoline is crucial because households have been pressured by the high cost of energy. Wage gains have been picking up – the fastest in several years – but inflation has eaten that all up. Indeed, the savings rate in July was negative for the sixteenth consecutive month. Ultimately, we must start saving again and when we do, spending is likely to slow fairly sharply. 

Unfortunately for the economy, job growth, although not terrible, is not great either. August’s payroll increase of 128,000 was enough to get the unemployment rate down a touch, but it is not enough to produce large increases in income. And that is a bad cycle. Businesses are cautious – slowing job and income growth. And without solid income gains, spending slows, further worrying business.

The continued softening in the housing market also is affecting consumers’ purchasing decisions. July sales were weak and we are starting to see prices come down in many parts of the country. We were all using our homes as ATM machines, taking out equity to fund our spending binge. The decline in prices already has caused equity borrowings to drop significantly. They are back to 2004 levels and sinking rapidly.

Will the housing market go bust and take the economy with it? Unlike previous periods where the housing downturn was in part brought on by high mortgage rates, that is not the case now. Indeed, long-term rates fell quite sharply at the end of August and early September. Of course, if you have a variable rate mortgage and it is being reset, the shock is likely to be great. But so long as mortgage rates don’t spike, the housing market may falter, but not likely collapse.

The Federal Reserve faces another key decision this month. The rate setting committee will meet again and the members have to decide whether to continue the pause started in August or increase rates again. Although inflation remains above where the Fed would like to see it, it is not accelerating rapidly. I suspect the members don’t want to raise rates again and are hoping that the next move they make is to lower them. Whatever they do at the next meeting will not be the end of the discussion. Stay tuned. 

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 400 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 $43 billion in assets. For more information about Commerce, please visit the company’s interactive financial resource center at commerceonline.com.