As the FOMC prepares to meet this week, there is increasing evidence that the recession is ending and that a return to positive growth is imminent. One of the best real-time indicators of economic activity is initial jobless claims. At or near the end of recessions, initial claims begin to fall significantly, and that is happening now. So far in June, initial claims are running 50,000 below their level in March, the largest decline since the post-Hurricane Katrina plunge in 2005.
If historic logic holds, this type of plunge is a hallmark of the end of recessions. Other data has also been consistent with this signal. The index of leading indicators is surging 's as it usually does at the end of recessions 's and the move above 50 in the ISM manufacturing new orders index is another typical end-of-recession signal. Even the long decline in housing market activity appears to be coming to an end. On an annualized quarter on quarter basis, single-family housing starts and permits broke into positive territory in May for the first time since the housing downturn began in 2005.
While the recent backup in mortgage rates is a headwind for the housing market, the June homebuilders' survey edged down only slightly, suggesting that increased confidence among home buyers is at least partially offsetting the drag from higher rates. It seems that the broad swath of recent data will lead the Fed to feel more confident in its forecast of a recovery in the second half than it did at its April meeting when the following statements were made public: "the pace of contraction appears to be somewhat slower" and that "economic activity is likely to remain weak for a time."
The Eurosystem staff projections published by the ECB lately were, in part, predicated on a number of technical assumptions relating to commodity prices, FX rates, and interest rates. Most of those assumptions were derived from a simple arithmetic average of observations recorded in the two-week period ending 13 May. As a result, the oil price assumptions mechanically fed into the staff projections were a 2009 average of $54.5 per barrel, rising to an average of $64.5 per barrel in 2010.
However, since the end of that two-week period (and, indeed, even during those two weeks) oil prices have continued to rally such that the oil futures strip is consistent with annual averages (in Brent crude) of around $61.5 per barrel this year, and around $76 per barrel in 2010. Although that increase has been partly offset by the appreciation of the euro (versus the $1.33-1.34 assumption in the staff projections) one can calculate that if the ECB were to update the staff's assumptions to allow for current market rates, the euro-denominated oil prices factored into the projections for 2010 would be at least 12 percent higher than previously assumed.
The Eurosystem staff forecasts this month showed annual average midpoints for euro area HICP inflation of 0.3 percent in 2009, and 1.0 percent in 2010. At a national level, only the Netherlands, Finland, Luxemburg and Cyprus did not see record lows in annual HICP inflation in May. Of Germany, France, Spain and Italy, only Italy's HICP inflation rate still remained in positive territory. It is noteworthy that core inflation has fallen sharply in Ireland and Spain, the two economies most affected by surging unemployment on account of the collapse in the construction sector.
Central and Eastern Europe
Latvia's IMF review seems more difficult than it was envisaged. Although the parliament did approve the announced budget cuts on Tuesday, the IMF response was rather lukewarm, suggesting that this was still not enough to complete the program review. The EU seems somewhat more forthcoming in its statements, but they typically coordinate with the IMF. If no agreement can be reached this week, concerns about Latvia's situation could resurface. Protests by Latvian labor unions against the spending cuts also highlight the political difficulties the harsh fiscal adjustment will create.
The IMF mission's visit for the second review of the $16.5 billion stand-by arrangement with Ukraine is expected to start this week. The focus will be on the progress of the bank recapitalization program. Last week the government decided to inject capital in three relatively smaller sized commercial banks, while the timing of the state's entry to the two larger banks seems dependent on the banks' success with the external debt restructuring. As the quantitative performance criteria of the program have been satisfied, the adoption of some legislative changes is the only condition left unfulfilled. The parliament is expected to adopt the required changes over coming weeks and chances of $3.1 billion third tranche to be released in mid-August look pretty good. The government and IMF are likely to hold negotiations over the size and duration of the program as well.
*** Written using materials from Bloomberg and Reuters Research