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Alex and Dave's Economic "Fore-guess"
Farm Business Management Update, June/July 2006
By Alex White (firstname.lastname@example.org), Extension Specialist, Finance, and David M. Kohl (email@example.com), Professor Emeritus, Department of Agricultural and Applied Economics, Virginia Tech.
We’ve been getting a lot of questions concerning what’s in store for the U.S. economy. Mainly,
these questions deal with interest rates, the stock market, inflation, and a possible recession.
After examining a few of the major U.S. economic indicators, here’s our best guess as to the
future of the U.S. economy.
We see inflation rearing its ugly head at the moment. We have six main reasons to expect higher
inflation in the economy over the next six to eight months:
On the positive side, the economy appears to be growing but at a slower rate.
- The Unemployment Rate has been slowly decreasing over the past year. More people in
the workforce are earning and spending money. More money in the economy may lead
to inflationary pressures.
- The Purchasing Managers Index (PMI) is relatively strong and has been increasing since
2005. This index indicates a positive outlook for the retail industry, a reflection of
relatively strong perceived demand by U.S. consumers.
- The Capacity Utilization Rate is relatively strong and increasing. This rate measures the
percentage of production capacity that manufacturers are currently utilizing. An increase
in this rate indicates that producers are gearing up their production processes to meet
higher expected demand for their products. It also means they may start hiring more
workers to meet the increased production. Both of these factors indicate inflationary
- Oil prices are well above the long term average, leading to increased costs of gasoline,
oil, heating fuel, chemicals, and other petroleum products. These increased costs are
especially scary for agricultural producers!
- The Core Inflation Index is increasing. This index measures the cost of living, excluding
food and energy costs. Compound this increase with the surging of gold and copper
prices, which have more than doubled in recent years, leads investors to predict future
- On a special note, the recent minutes from the Federal Reserve indicate a balanced
economy but with inflation bias. One of the main goals of the Federal Reserve and
Chairman Bernanke is to maintain inflation rates under long term averages of 4 percent.
What should we be looking for in the upcoming months? Our best guess is
- The stock market is showing signs of life, in part due to the perceived increase in demand
for U.S. goods. Increased production hopefully leads to increased profits, which in turn
may lead to growth in corporate stock prices.
- We do not see a big threat of increased unemployment in the near future. Again, as
manufacturers are increasing their production, look for the unemployment to possibly
- In looking at the ratio of 30-year mortgage to 3-month treasury note yields, we’re starting to
see a flat yield curve. This flattening yield curve is a signal of slow growth in the
economy over the next six to eight months.
What about a recession? Three tell-tale signs indicate a recession should be ahead in the U.S.
- Continued slow growth in the economy;
- The Federal Reserve Board to inch up the Federal Funds Rate to try to curb inflation. It
could possibly be 5.50 to 5.75 percent by year end if the inflation bias continues, and
interest rates on consumer loans and adjustable rate mortgages will probably start to
- Increases in the everyday cost of living – not just gasoline, but in all consumer goods. You
may want to increase your inventory of non-perishable goods now before the cost
- Oil prices are higher than the long term average;
- Interest rates are increasing; and
- The yield curve has been flat to slightly inverted, that is, short term rates are equal to or
higher than long term rates.
Since 1971 these three factors have predicted every recession. Why not this time? Housing
and real estate appreciation have fueled refinancing strategies to pump liquidity into the
economy. Last year housing and real estate pumped nearly $1 trillion into a $12 trillion
economy. So goes housing and real estate; so goes the economy!
Virginia Cooperative Extension