The Fed's Tightrope Walk

Includes: CAT, IR
by: Shailesh Kumar

Many signs are now pointing towards a possibility that we may have seen the worst of the economic downturn. This is certainly a conclusion that is being drawn by many leading economists. In recent days we have seen two major housing reports showing unexpected increases in both new home sales as well as sales of existing homes.

A few companies, such as Caterpillar (NYSE:CAT) and Ingersoll-Rand (NYSE:IR) have reported an uptick in machinery and refrigerated trailer sales, which have traditionally been quite a reliable indicator of economic activity on the rise.

However, consumer spending is likely to stay at low levels as the unemployment rate will continue to rise for the immediate future. And with the consumer focused on rebuilding savings and paying down debt, one would expect the credit sector and the retail sector to take longer to regain growth.

Cyclical manufacturing companies may be a good place to invest any new funds at this time. Recession and the large price volatility in the commodities last year have left most inventories very lean and even a little growth in demand is likely to produce robust growth in manufacturing. As it is, the numerous stimulus programs (around the world) have mostly focused on infrastructure projects which means the demand will also rise significantly as these projects start to come online.

At this point, inflation is a greater worry and the Feds have now signalled their willingness to raise rates faster if needed to contain recession even before the unemployment trends start reversing. This can be troublesome as it has a potential to cause added stress to the housing market by making new and existing mortgages more expensive for the consumer and also make credit more expensive for the businesses.

This is a very tightrope the fed has to walk and one hopes they are up to it.