[Fredslist] 12-16-05 Economic Commentary

[Dichter, Dan [PVTC]]

The Fed raised the funds rate to 4.5% this week.  In doing so,
policymakers managed to leave out the statement about "policy
accommodation" without significantly disrupting markets.  Nevertheless,
they left no doubt that "some further policy firming" may be needed.
They linked future actions to the inflation outlook, citing resource
utilization and possible energy-price pass through. 

We continue to expect the funds rate to peak at 4.5% in January.  But,
we acknowledge that any further action ultimately will depend on whether
slowing demand persists, limiting the risk of higher inflation.

November CPI fell 0.6%, the steepest decline in nearly 20 years.  The
decline was driven exclusively by a 16% plunge in gasoline prices.  Core
CPI increased by 0.2% for a 2.1% year-to-year rise.  This increase
translates to a 1.8% yearly advance in the core PCE deflator, which is
at the upper end of the Fed's comfort zone.

Demand growth fell sharply in the fourth quarter.  Retail sales posted
its third consecutive 0.3% rise in November.  The latest rise included
large offsetting swings in motor-vehicle sales and gasoline prices.
With everything factored in, the sales figures suggest that real
consumer spending is headed for about a 1% gain in the fourth quarter. 

But underlying demand growth appears to be softening, not collapsing.
Much of the current weakness reflects payback for the surge in
motor-vehicle sales in the third quarter.  Apart from autos, we look for
real consumer spending to expand by about 3%, which would be modestly
below trend.

The trade deficit widened to a new record $68.9 billion in October.  On
its own, trade will subtract heavily from fourth quarter output.
However, we anticipate a sizable jump in inventories to offset this
widening in the deficit.  So we see no reason to change our 3.0%
forecast for fourth-quarter GDP at this time.

Inventories are one of the most interesting aspects of the current
quarter forecast.  Stock building surprisingly fell last quarter,
subtracting 0.4% from GDP.  We expect that inventories rebounded sharply
in the current quarter, adding about 2 percentage points to growth.
That would be one of the biggest contributions in this decade. 

The lion's share of the expected inventory buildup should be in motor
vehicles.  Although car and truck sales fell off sharply in the fourth
quarter, vehicle production remained steady. The excess went into dealer
lots.  The growth-distorting gyrations in the auto sector appear to be
running their course and should be less disruptive next year.

As always, please don't hesitate to contact me with any questions or
needs.  Have a great weekend!

Regards,

_______________________________________
Daniel G. Dichter
Second Vice President - Investments
Smith Barney | Citigroup Global Markets, Inc.
31 West 52nd Street, 23rd Floor
New York, NY 10019
p. (212) 603-6178
f.  (212) 307-3863
dan.dichter at smithbarney.com



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