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Consumers retreat, savings grow

Yesterday's improvement in consumption spending that was contained in the advanced GDP report is being tempered somewhat today by a 0.2% drop in consumer spending last month, suggesting that the quarter ended on a soft note. Personal income also came under modest pressure but the savings rate increased from 4.0% to 4.2%.

The data show that despite signs spending may be stabilizing and consumer confidence is slowly improving, consumers remain uneasy and the economy is not yet on solid ground.

Inflation held steady in March. The core Personal Consumption Expenditures Index, a broad measure of prices that is closely followed by the Fed, rose 0.2% for the third month in a row. There has been plenty of chatter about deflation and the Fed reiterated yesterday that "inflation could persist for a time below rates that best foster economic growth and price stability." Nonetheless, the biggest two-quarter drop in GDP since 1957 has yet to bring the rate of price increases to dangerously low levels.

This may partly be occurring due to the residual impact of the steep rise in commodities and oil prices that occurred in much of the decade. Commodity prices have since tumbled but are off the lows amid indications that economic activity may be getting ready to stabilize, so the risk of deflation seems low in my opinion.

Wage growth, however, is nearly flat, and in some cases, is actually falling. And the smallest rise in Employment Cost Index on record in 1Q bears watching since it may hinder spending and raise the odds of inflation falling below the Fed's implied target of 1-2%.

Steep recessions and subsequent recoveries

Much has been made about the current recession and there are lingering worries that the banking crisis and debacle in housing will prevent anything other than a sluggish recovery.

Tight credit conditions and the desire by banks to forgo all but the safest loans have many analysts concerned, including myself. And yesterday’s disappointing Gross Domestic Product report (see: GDP tumbles in 1Q) only served to remind us of the difficulties that must be overcome.

But we have seen the resilient American economy shake off tough times before and bounce back vibrantly as the chart below indicates. Despite the challenges we face, a decent rebound is a possibility.

1957-58 Recession - GDP

4Q1957	1Q1958	2Q1958	3Q1958	4Q1958	1Q1959
-4.2%	-10.4	2.4	9.6	9.5	7.9

1974-75 Recession - GDP

3Q1974	4Q1974	1Q1975	2Q1975	3Q1975	4Q1975
-3.8%	-1.6	-4.7	3.0	6.9	5.4

1981-82 Recession - GDP

4Q1981	1Q1982	2Q1982	3Q1982	4Q1982	1Q1983
-4.9%	-6.4	2.2	-1.5	0.4	5.0

Current Recession - GDP

3Q2008	4Q2008	1Q2009	2Q2009	3Q2009	4Q2009
-0.5%	-6.3	-6.1*	?	?	?

*advance Data provided by BEA Note: the current recession began in late 2007 but the full brunt was not felt until late 2008

Many of us are aware of the steep recession that occurred in the 1970s, which was followed by the Fed-led contraction of the early 1980s when interest rates soared to double-digit levels. Each of these slumps was followed by solid recoveries, though the late 1970s were plagued by high inflation.

But to find a larger two-quarter drop in GDP, one has to go back to the late 1950s. There are differences this time around, but like today, manufacturing was hard hit and global growth came under pressure. Still, the economy came roaring back.

Fed infers worst may be past

The Federal Reserve's decision to unanimously vote to keep the fed funds rate in the range of 0 to 0.25% comes as no surprise given the magnitude of the recession. As always, policymakers released a more detailed statement regarding the economy and recent actions taken to support economic activity.

For the most part, the Federal Open Market Committee (FOMC), which is the arm of the Fed that decides monetary policy and interest rates, made just small adjustments in its commentary. Fed officials just barely bumped up the assessment on the economy, noting that "household spending has shown signs of stabilizing" and the "outlook has improved modestly since the March meeting."

But the Committee remains concerned that inflation could fall to undesirable levels, and it reiterated that it will "employ all available tools" to promote a recovery and preserve price stability.

One item traders were looking closely at was whether the Fed would alter last month's decision to buy up to $300 billion of Treasury securities. Those hoping for new purchases or any details were disappointed as the Fed stood by its prior decision, and Treasury prices reacted negatively.

The Federal Reserve has taken extraordinary measures to prevent the worst recession in over 50 years from becoming our first depression since the 1930s. Fed Chief Ben Bernanke is probably the foremost expert on the causes of the Great Depression, and so far, the Fed can claim success.

But an eventual economic recovery presents Bernanke with a new challenge: How to carefully remove excess stimulus and prevent a new round of inflation from materializing without creating new turmoil in the bond markets.

GDP contracts more than forecast

Those who expected the fallout from September's flare-up in the credit crisis to trip up the economy have something else to crow about today. The initial estimate for Gross Domestic Product , or advance GDP, fell at a larger-than-expected annualized rate of 6.1% in the first quarter, exceeding the consensus view of a nearly 5.0% drop.

The decline in the January-March period follows a 6.3% contraction in the final quarter of last year, which eclipses the worst two-quarter period of the 1982 recession as well as the 1974 contraction, which was caused by the oil embargo and spike in oil prices.

Personal consumption, which makes up close to 70% of the economy, managed to rebound by an annualized 2.2% rate following weakness in the second half of 2008, suggesting that the modest improvement in consumer confidence (Consumer mood brightens) is being reflected at the retail level. And that improvement is supporting stocks in early action.

But the culprit for the plunge in activity comes from a record 51.8% decline in investment spending, underscoring how much businesses have been slashing outlays in response to falling demand and tight credit.

In addition, a 30.0% decline in exports is more proof that the global economy has not been immune to the swift falloff in US economic activity. Clearly, this recession is shaping up as the worst in over 60 years.

One final thought. Most observers feel that the worst of this mess in the rear-view mirror - remember, the report is backward-looking. The improvement in personal consumption is an indication that a bottom is taking shape, and the early look at output for the world's largest economy will be revised during the next month when data is more complete.

Consumer mood brightens

Consumer spending makes up almost 70% of total output in the US, and fears of job losses and uncertainty in the outlook have hobbled spending, sending the economy into a tailspin. That's why today's unexpectedly-large jump in the Consumer Confidence Index portends an improvement in trends may be around the corner.

The survey of 5,000 households showed that consumer confidence increased from 26.9 in March to 39.2 in April, with the Present Index rising modestly while the Expectations portion of the survey improved considerably. Despite rising unemployment and steady layoffs, the public is starting to feel better about job prospects. And if consumers start to feel more comfortable with their personal economic situation, they may be more inclined to spend, lending support to economic activity.

Wall Street liked what it saw in the numbers, helping shares erase early losses. Still, the index is hovering well south of the 100 mark, which was seen when the economy was expanding.

Meanwhile, tomorrow's first look at 1Q GDP and the conclusion of the Fed's two-day meeting will come into focus. Gross Domestic Product is the broadest measure of economic activity and encompasses the value of all goods and services produced. Most economists see another steep drop of about 5% on an annualized basis, but recent data suggest we will see some improvement from here.

The Fed's press release and interest rate decision out in the middle of the day tomorrow is always closely followed by analysts and traders. Policymakers will likely keep the fed funds rate at rock-bottom levels so their take on the economy and a read on the many unconventional measures taken so far to support economic activity will be highly sought after.

Swine Flu Fears Met with Yawns

Confidence is the cornerstone that keeps our capital markets afloat, helping us maintain a vibrant financial system even as banks hemorrhage red ink and stock prices wither from the heat of the recession.

One only has to look as far as last September when the failure of Lehman Brothers caused a very small number of money market funds to post losses, which rattled confidence and nearly caused a full-blown panic to develop.

Today’s modest pullback in stocks following this weekend’s heavy coverage of the swine flu suggests that, at least for now, the possibility of a pandemic seems remote and noticeable damage to the economy is unlikely. Now I’m the first to realize that sentiment can get out of whack. Many of us are still smarting from the rampant pessimism that bogged the Street down in March and took the Dow Jones Industrials below the 6,600 mark.

The markets may not have a perfect track record when it comes to divining future events, but at this juncture, the collective wisdom of all investors - both novice and seasoned - signals that the latest worries will eventually fade. Stay tuned.