Slower Inflation And Weaker Housing Will Support Rate Cut

It won't matter to the Federal Reserve, but the economic data in the coming week will largely support the Fed's expected decision to cut interest rates. The data are expected to show reduced inflation and a much weaker housing sector. Aside from a few minor numbers, all the big news will come out after the Federal Open Market Committee concludes its meeting Tuesday afternoon, when the committee is widely expected to knock a quarter point off the federal funds target rate and signal further cuts in the fall.

The only two major monthly indicators of the week will be released Wednesday morning when the Labor Department releases the August consumer price index and the Commerce Department estimates housing starts for August. Under the usual procedures, Fed officials won't know the contents of either report when they meet on Tuesday.

Lower gasoline prices should keep overall inflation flat to negative. Numbers on home building could well show further deterioration, even before the recent disruptions to mortgage markets are fully reflected.

One other piece of news will hit the wires just about the time the FOMC breaks for lunch (but before the news release comes out): The home builders are likely to report that builders' confidence reached another new low in September. There will be plenty of other distractions. Alan Greenspan's book will finally be published, giving the former Fed chairman plenty of opportunities to go on national television day after day after day and explain how he didn't see one of history's greatest bubbles inflating right before his eyes. Current Fed Chairman Ben Bernanke, meanwhile, will face yet another congressional grilling on the housing mess on Thursday at Barney Frank's House Financial Services Committee, with Treasury Secretary Henry Paulson at his side.

The consumer price index is expected to be unchanged for August, as falling energy prices offset modest gains elsewhere. Energy prices are expected to fall 2.8%, while food prices should grow at a slower pace of about 0.2%. The core rate (which excludes food and energy prices) is expected to rise 0.2%. The core rate will be restrained by new incentives on new cars, and moderation in shelter prices. Higher prices will be seen for apparel, used cars, education and medical care. If there is a surprise, the odds distinctly favor a downtick to 0.1% over an upward movement.
If the median forecast is right, then the year-over-year gain in the CPI would fall to 2% from 2.4%, while the year-over-year gain in the core CPI would remain at 2.2%.
At 2.2%, the core CPI is probably just inside the Fed's comfort zone. But we all know that the Fed's comfort band gets a lot wider when they are cutting interest rates to boost growth.

Starts of new homes probably fell again in August to a seasonally adjusted annual rate of 1.36 million from 1.38 million in July. It'd be the lowest since 1997.
Building permits probably dropped to 1.34 annual pace from 1.39 million. That would be the lowest since 1995. As bad as the August housing numbers are, remember that they won't reflect the full impact of the massive tightening in mortgage lending that's taking place. Everyone expects construction to slow further; there's little reason to expect a quick turnaround in building. Inventories are already bloated, while foreclosures and adjustable-rate mortgage resets are likely to put even more houses on the market in the coming months. Cancellations remain high, and mortgages are more expensive and more difficult for some buyers to obtain.

The home builders have grown increasingly pessimistic. Their sentiment index fell to a 16-year low of 22 in August. While only a few economists forecast this number, the median forecast is calling for the index to drop to 20, matching the record-low set in January 1991. At 20, the index would show that only a fifth of builders nationwide are confident in the market. The home builders' index will be released at 1 p.m. on Tuesday, just 75 minutes before the Fed meets.