Another month has gone by in 2004 and sure enough, another record high in oil prices was achieved. The Fed raised short-term interest rates again. A hurricane hit Florida. Another hurricane hit Florida. For the moment, things seem to be humming along at a steady beat, albeit, not necessarily on a positive track for the U.S. economy.

The near-term impacts of the five tropical storms and hurricanes that have caused significant damage in the southern U.S. thus far in 2004 -- Charley, Gaston, Francis, Ivan and Jeanne -- will be negative in national economic statistics. This is due to lost corporate profits on insured losses and lost rents due to uninsured losses to residential property and higher prices for agricultural crops from the region -- these losses are on the order of $21 billion. The longer-term impacts will be large and positive -- rebuilding all the homes and businesses destroyed by the storms will add to GDP and add jobs. Florida already has one of the strongest housing markets in the economy and booming home construction activity. The rebuilding effort will make the construction market even tighter, with fierce competition for construction workers and materials.

The Federal Reserve has said it will continue with its measured increases in the federal funds rate. We believe this means another quarter-percentage point increase in short-term interest rates when the Fed's Open Market Committee next convenes on November 10th. Low inflationary pressures excluding energy and food prices continue to allow the Fed room to be accommodative and it is still about one-percentage point shy of neutral monetary policy. With low inflation there is no reason for longer-term interest rates to rise, and this means bargain mortgage rates for several more months.

The major risk to our economic outlook is oil. The record high prices for petroleum and related products are expected to be temporary, although they have already lingered longer than initially anticipated. Consumers are starting to react to higher prices at the gas pump by cutting back on other spending, which significantly affects GDP growth (about 70 percent of GDP is made up of consumption spending). Furthermore, energy costs are starting to feed into retail prices as producers try to pass on higher transportation and material costs to consumers, and the already weak airline industry is buckling under the higher fuel costs. If high energy prices continue or rise even further this will put the brakes on the economy and could turn a soft patch into something much worse. The Fed has bought itself some wiggle room with the recent interest rate increases, which it can undo if necessary to help bolster the economy. Our worry is that they may have to.

Published: October 7, 2004

Use of this article without permission is a violation of federal copyright laws.