The minutes of the Jan.26-27th FOMC meeting have been released.


Excerpts from the Release...


The information reviewed at the January 25–26 meeting indicated that the economic recovery was firming, though the expansion had not yet been sufficient to bring about a significant improvement in labor market conditions. Recent indicators of foreign economic activity suggested that the global recovery was strengthening. Much of this strength was centered in the emerging market economies (EMEs), where widespread increases in exports and in manufacturing purchasing managers indexes (PMIs) pointed to a resurgence in economic growth


The labor market situation continued to improve gradually. Private nonfarm payroll employment increased in December at a pace roughly the same as its average for 2010 as a whole, and the average workweek for all employees was unchanged. Services industries continued  to add most of the new jobs in the private sector. Initial claims for unemployment insurance trended lower in December and early January, and some indicators of job openings and firms’ hiring plans improved. The unemployment rate decreased to 9.4 percent in December, but this decline in part reflected a further drop in the labor force participation rate. Long duration unemployment remained elevated, and the employment-to-population ratio was still at a very low level at the end of the year. 

Participants noted that many of the factors that contributed to the recent apparent rise in structural unemployment were likely to recede over time. Some participants stressed that certain determinants of the unemployment rate, such as mismatches in the labor market and firms’ hiring practices, were both difficult to measure in real time and not directly affected by monetary policy. Others emphasized that in the current situation, monetary policy could still play an important role in reducing unemployment.

Available measures of labor compensation showed that labor cost pressures were still restrained, as wage increases slowed along with inflation and productivity gains appeared to remain substantial. The 12-month change in average hourly earnings for all employees continued to be low in December.


Total industrial production posted solid increases in  November and December, in part because colder weather boosted the output of utilities. Most indicators of near-term industrial activity, such as the new orders diffusion indexes in the national and regional manufacturing surveys, were at levels consistent with further increases in industrial production in the near term; in addition, motor vehicle production was scheduled to move up again in early 2011.


Growth in consumer spending appeared to have picked up in the fourth quarter from the more modest pace seen earlier in the year The available data suggested that consumer spending was supported by gains in personal income in the fourth quarter of 2010. Moreover, household net worth appeared to have risen in the fourth quarter, as the large increase in equity prices more than offset further  declines in house values. Consumer credit started to increase again in October and November after having generally declined since the fall of 2008.


Real business investment in equipment and software appeared to have increased further in the fourth quarter, although likely at a more moderate rate than in the first three quarters of 2010. After declining in October, nominal orders and shipments of nondefense capital goods excluding aircraft rose in November, and the level of new orders remained above the level of shipments, indicating that the backlog of unfilled orders was still rising. Available indicators suggested that business purchases of software stayed on a solid uptrenduptrend, and outlays for computing and communications equipment appeared to have risen briskly. Business outlays for nonresidential structures stayed weak, reflecting high vacancy rates and low property values for office and commercial properties, as well as tight credit conditions for commercial real estate.


Measures of underlying consumer price inflation remained low. In December, the core consumer price index (CPI) edged up, as goods prices were unchanged and prices of non-energy services rose slightly. The 12-month change in the core CPI remained near the very low readings of the previous two months. However, consumer energy prices moved up sharply in December, and prices of most types of crude oil increased during December and into January.

Foreign inflation picked up noticeably in the fourth quarter of 2010, mostly because of an acceleration of energy and food prices. Measures of core inflation remained much more subdued, although they also moved up in some countries. In the EMEs, concerns  about inflation prompted a number of central banks to tighten policy. Some EMEs reportedly took steps to limit the appreciation of their currencies by intervening in foreign exchange markets, and some acted to discourage capital inflows.


Activity in the housing market remained weak in an environment characterized by soft demand, a large inventory of foreclosed or distressed properties on the market, and tight credit conditions for construction loans and mortgages. Moreover,
measures of house prices declined further in recent months, and survey responses indicated that households remained concerned that home values might continue to fall.

Rates on conforming fixed-rate residential mortgages edged down a bit during the intermeeting period after having risen appreciably in November and early December, leaving their spreads over the 10-year Treasury yield down slightly. Refinancing activity, which had fallen in response to the increase in mortgage rates in November, remained at a low level during the period. Outstanding residential mortgage debt declined further in the third quarter of 2010, reflecting weak housing activity and tight lending standards. Serious delinquency rates on prime and subprime mortgages flattened out in October and November after having moved down earlier in the year. Signs of improvement were  evident in the consumer credit market, where issuance of consumer asset-backed securities was strong early in the fourth quarter. In addition, delinquency rates on consumer loans


Plain and Simple:  The minutes note an improving confidence level among Board members but Fed officials remain defensive due to anemic growth prospects in the labor market (mismatch of labor skills and jobs demanded. Education needed!). The Board recognizes the potential for rising energy and food prices to creep into core inflation metrics but says underlying trends indicate inflationary pressures remain subdued. On the topic of QEII, a few members were unsure of the program's impact but felt changes were not appropriate at this time. If consumer demand sustains a rapid recovery pace, the Fed will be forced to reconsider their expansionary monetary policies. Downside risks include a structurally weak jobs outlook, a stagnant housing market, and headline risks associated with European debt and U.S. municipal bonds.

In their discussion the Fed did speak on high levels of productivity and anemic wage growth. Quote, "Available measures of labor compensation showed that labor cost pressures were still restrained, as wage increases slowed along with inflation and productivity gains appeared to remain substantial."

If you've been a long time MBS Commentary reader you know we've had an axe to grind on labor productivity and its impact on hiring trends. Many economists say a work force can only be so productive before it runs out of energy and firms are forced to hire just to keep up with demand. Humans are after all only capable of producing so much output per hour before they get tired and need a break. Robots on the other hand do not need rest.  Robots also don't have health insurance premiums to pay or social security benefits to cover.  Businesses are investing in technology to improve productivity and reduce labor costs.  This is why we've been harping on education as a means to an end when it comes to giving guidance to the unskilled portion of our jobless labor force. Many of the jobs that were lost over the past two years will be lost forever to advances in automation.

THE BOTTOM LINE: Job creation is the most important factor in a sustained economic recovery. Unfortunately because consumer demand has yet to prove consistent, firms are only hiring when labor is needed.  Making matters worse, businesses are investing heavily in technology to further improve already very high levels of productivity (automation), which reduces reliance on human brains and brawn. High levels of automated productivity and a large pool of unemployed Americans will only serve to restrain wage growth. Combine these observations with rising living costs and we're looking at a margin squeeze on Main Street.  That spells trouble for consumer spending in the year ahead. Unless of course America leans on their credit cards to absorb rising food and energy prices.  Then we're talking about a whole other problem all together.....

READ MORE: Productivity Gains Darken Hiring Outlook. How Might that Impact Housing?

READ MORE: Beige Book: Housing is Weakest Link. Wage Growth Missing. Margin Squeeze Looms

READ MORE: Margin Squeeze On