Here I Am, Stuck in the Middle With You

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Actually, recent economic news hasn't been as bad as some gloomy analysts portray. The economy continues to grow, the number of payroll jobs is falling relatively slowly, and it just may be that the break in commodity prices that Fed officials have long expected is at hand. Crude-oil prices have dropped almost 20 percent over the past month, to $118.60 a barrel from a peak of $147.27. Corn prices have plummeted more than 30 percent, to $5.45 a bushel, over the same period.

Higher food and energy prices have been major contributors to the 5 percent increase in consumer prices over the past year. If the run-up slows -- or in the case of gasoline, reverses -- that would not only ease inflation pressures, it would ease some of the squeeze on consumers' pocketbooks and encourage more spending on other goods and services. Even in the face of soaring consumer costs, the gross domestic product increased at a 1.9 percent annual rate in the second quarter, with consumer spending bolstered by the tax- rebate checks many households received. Meanwhile, there are growing signs of stabilization in the hard-hit housing sector. New-home sales were higher this spring than originally reported, and sales of existing homes fell only 1 percent from December to June. And the backlog of unsold new homes dropped sharply in June. The slowing decline in housing was evident in the second quarter, when cutbacks in home construction knocked only 0.6 percentage point off the increase in the gross domestic product. That's an improvement over the fourth quarter of 2007, when the drag from housing reduced the GDP growth rate by 1.3 percentage points, and the first quarter, when it was 1.1 percentage points.

The second-quarter GDP number would have been considerably larger, except that a sizeable portion of the goods sold this spring came out of business inventories rather than new production. In fact, except for the big change in inventories, growth would have been at a 3.8 percent rate in the quarter rather than 1.9 percent. A significant improvement in the nation's trade balance also provided a large boost to growth. Chances are, growth in the second half of the year isn't going to match the second-quarter pace. Nevertheless, the incessant warnings that the economy faces a deep recession are overdone.

The FOMC correctly said that ``downside risks to growth remain,'' including problems in financial markets. Those risks are diminishing, partly because of the Fed's active efforts to provide liquidity to the markets by lending cash and Treasury securities to financial institutions and primary dealers. So the Fed can do -- and is doing -- more than adjusting interest rates to support the economy. On the inflation front, there's good news in addition to the possible break in commodity prices.

One concern of some Fed officials has been that the jump in food and energy prices could cause workers to demand larger pay increases. That isn't happening, according to the employment cost index, the Labor Department's broadest measure of employers' labor costs. The ECI, which includes wages and salaries and the cost of benefits, rose 0.7 percent in the three months ended in June and 3.1 percent in the year ended that month, the department reported July 31. Both increases were smaller than those in the previous quarter and year. In other words, there is no hint of a wage-price spiral, with higher headline inflation spilling over in a significant way into core inflation.

While the FOMC said the inflation outlook ``remains highly uncertain,'' it also said it still ``expects inflation to moderate later this year and next year.'' That relative optimism has been based partly on the anticipation that commodity prices would stop rising rapidly and, possibly, come down. Richard W. Fisher, president of the Dallas Federal Reserve Bank, again dissented yesterday in favor of an increase in the lending rate target. At the FOMC's June meeting, Fisher said he wanted a rate increase because the risk that inflation would not moderate as expected ``had increased substantially.''

His counterparts in Philadelphia, Charles I. Plosser, and in Minneapolis, Gary Stern, who had indicated in recent weeks that they would like the target raised, didn't join Fisher in dissent. If the growth and inflation pictures aren't any clearer six weeks from now at the FOMC's Sept. 16 session, standing pat may again be the best policy choice."

Although we diverge in expectations as to how that September 16 meeting will eventually turn out, for the time being, this is the background situation, and it can be said that most of the available gauges and barometers are reflecting it fairly. Including gold.

Happy Trading.