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Economy Improves, But Retail Sales Show Weakness

The Federal Reserve upgraded the U.S. economy's performance by a notch this week, but an unexpected decline in retail sales showed that consumers are still wary of opening their wallets to power a more sustainable recovery.

The Fed said in a statement that "economic activity is leveling out," which was a bit more optimistic than the previous statement in June, when it said that the "pace of economic contraction is slowing." But despite this glimmer of optimism, the Fed said household spending is constrained by "ongoing job losses, sluggish income growth, lower housing wealth, and tight credit." The Fed said it was leaving interest rates at the historic lows between zero and 0.25 percent "for an extended period."

Another optimistic sign came in a poll of economists published by the Wall Street Journal. The newspaper reported that 27 of 47 economists surveyed believed the recession which began in Dec. 2007 had ended. They said they expected growth in the third quarter to be about 2.4 percent.

But the economic news was not all so positive. The Commerce Department said retail sales fell by a seasonally adjusted 0.1 percent. While that may seem trivial, economists had been expecting sales to go up by 0.7 percent, so the performance was well under par.

According to the Commerce numbers, the "cash for clunkers" program did manage to produce a 2.4 percent increase in automobile sales, but grocery, furniture and appliance stores all registered significant declines.

The figures are extremely important because consumer spending accounts for 70 percent of the economy and without strong consumer sales, the economy may keep bumping along the bottom. Wal-Mart stores reported that even though sales declined 1.4 percent compared with the same quarter last year, it still managed to increase profits by a penny a share. That shows that consumers faced with a financial crisis flock to the least expensive retailer to do their shopping.

There was a similar good news/bad news quality to reports on the housing sector. Existing home sales in the second quarter showed healthy gains. According to the National Association of Realtors, existing home sales rose 3.8 percent to 4.76 million in the second quarter, up from 4.58 million units in the first quarter. "With low interest rates, lower home prices and a first-time buyer tax credit, we've been seeing healthy increases in homes sales," said NAR economist Lawrence Yun.

At the same time, home builder Toll Brothers said new home contracts rose 3 percent from the same quarter last year and were 44 percent higher than the earlier quarter this year. It was the first quarterly increase in four years. "The mood has changed," chief executive Robert I. Toll told the New York Times.

On the other hand, the Mortgage Bankers Association said its index of mortgage applications, which include both home purchases and refinancing loans, decreased 3.5 percent in the week ended Aug. 7. Borrowing costs on 30-year fixed rate mortgages averaged 5.38 percent, the highest rate since mid-June, but they were still less than a year earlier.

There was even grimmer news on the housing front. A Deutsche Bank analyst, Karen Weaver, told Fortune magazine that she expects nearly half of homeowners with mortgages will end up owing more than their home is worth by 2011. She estimated that 14 million homeowners currently are "under water" on their mortgages. She expects home prices to decline another 14 percent from their already low levels in the months to come.

The economy is still a very mixed bag of hope and painful news. The general trend seems to be that even though the economy is in bad shape, it's still better than six months ago. But as the Fed made clear, the worst is not over yet.

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