Beige Book Blues

In the Fed’s Beige Book, central bank officials highlighted some bright spots in the US economy but cautioned that there are still dark clouds on the horizon. Let’s take a look at the recent improvements to see whether their economy will be strong enough to weather a storm.

The Good News:

Consumer spending enjoyed an upward revision from 1.6% to 2% in the second quarter, a notch higher than the 1.9% reading in the previous period. This contributed to 1.38% of the second quarter GDP, reflecting how consumer activity continues to be a driver of economic growth. Meanwhile, private investments also boosted GDP as investments in equipment, software, and non-residential structures stayed positive.

Other sectors of the economy also show rays of hope. Industrial production jumped by 1.0% in July, following a 0.1% downtick in June. Manufacturing production also rebounded by 1.1% from a 0.4% decline. It seems that the US economy is fine and dandy. What’s up with all the gloom and doom?

The Bad News:

I bet you knew this was coming! Without further ado, let’s move on to the bad news.

Apparently, the Fed believes that the good things we saw during the first two quarters of this year and the final quarter of 2010 will not persist as the year marches on. In other words, this pace of recovery is NOT sustainable.

The revision on the Q2 2010 GDP report showed that the US economy only grew at a rate of 1.6%, a huge downgrade from the 2.4% initially printed. This means that US GDP growth for this year could slow all the way down to 0.9% once we hit the fourth quarter. The problem, it seems, is that recovery in the US is uneven. Even though five districts said that growth was modest in their area, another five reported that economic activity was slowing down.

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The Verdict:

So, we’ve got the good news – improvement in consumer spending and industrial production – and the bad news – decelerating growth, but what’s the verdict?

We can’t deny that we have seen growth. But apparently, temporary factors such as census hiring and first-time home buyer rebates are the ones responsible for boosting growth in the past. Unfortunately, the effects of these momentary boosts are already beginning to fade. Hey, even Mario’s power star has a timer! (See what I did there?)

In spite of the few silver linings we’ve seen, we’ve yet to see any real signs of sustainable growth. On the contrary, early Q3 2010 data seem to be hinting at an economic slowdown. I guess this is why many are expecting weaker growth through year-end, according to the Beige Book.

If you ask me, the implications for the mighty dollar are still a bit hazy. It’s true that if the US economic slump persists or worsens, investors might continue to buy up the dollar in response to risk aversion. But for how long can that go on? Will we ever reach the point where US fundamentals become so bad that traders abandon the dollar altogether? Only time will tell.