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Has the Fed misjudged the economy?

February 07, 2014

| MoneyRates.com Senior Financial Analyst, CFA

The first business day in February brought more bad news about the economy. Following disappointing data in January on employment growth and the housing market, the manufacturing sector kicked off February with more signs of slower economic growth.

This raised the question of whether the Federal Reserve mistimed its decision to go ahead with tapering its quantitative easing program in its recent meeting, rather than holding off until the economic signals are clearer.

Manufacturing sector is latest disappointment

On February 3, the Institute for Supply Management (ISM) released its Manufacturing Report on Business for January. This report, based on a survey of manufacturing supply managers, indicates that the manufacturing sector of the economy is still growing, but at a sharply slower pace than previously.

Signs of slowing growth appeared across a variety of indicators from the ISM survey. The overall Purchasing Manager's Index declined by 5.2 percentage points in January. Especially troubling for future months, the New Orders Index declined even more drastically, with a 13.2 percent drop. Production and employment also reported lower figures.

Like the disappointing jobs and housing reports previously, the disappointing manufacturing report was blamed by some on bad weather. Although the weather has been unusually harsh this winter, it is important to remember that most economic data is seasonally adjusted. In short, weather is taken into account to some extent, so there may be deeper problems here than the polar vortex.

What is the Federal Reserve seeing?

Though the manufacturing report was not out yet when the Fed met in the last week of January, the weak employment and housing data were. Despite that, the Fed decided to continue to taper back its quantitative easing program, on the grounds that "economic activity picked up in recent quarters."

That's a narrative that seemed true until December and January data started to come out. The financial markets certainly feel recent signals are troubling. The S&P 500 has dropped by about 5 percent so far in 2014. Meanwhile, 10-year Treasury bond yields have dropped by about 40 basis points since the end of 2013. The steep downward trajectory of bond yields continued despite the Fed's decision to cut back monthly bond purchases by another $10 billion -- a decision that under normal circumstances would be expected to send bond yields higher, not lower.

Translating those bond market rates into consumer interest rates means good news for borrowers, and bad news for savers. Current mortgage rates are some 21 basis points below where they were the first week of January. That is good news for anyone looking to take advantage of low home purchase or refinance rates.

On the less happy end of the spectrum, the accumulation of discouraging economic news means continued low rates for savings accounts, CDs and money market accounts. Their future depends on whether the Fed's apparent optimism is more accurate than the stock market's recent pessimism.

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