FED SEEN CONTENT WITH U.S. FEBRUARY ECONOMY
U.S. February reports reflecting slim
gains in industrial output and moderating inflation pressures
reinforced expectations that the Federal Reserve will continue
to follow a stable course of monetary policy, economists said.
    "If you're the Fed, there's no reason to do anything," said
Steve Slifer of Lehman Government Securities Inc.
    "There are hints that GNP is picking up. On the inflation
front, all is well," he said. "Money supply is well under
control. It's an absolutely ideal situation."
    February U.S. industrial production rose 0.5 pct, slightly
less than the 0.7 pct gain the financial markets had expected.
This compared with a slim 0.1 pct rise in January's production
number, previously reported as a 0.4 pct increase.
    The February U.S. producer price index gained only 0.1 pct,
less than a 0.3-0.4 pct expected rise. This followed a 0.6 pct
rise in the PPI in January.
    "The Fed is going to look at this positively," said Allan
Leslie of Discount Corporation. "Certainly inflation is not as
bad as what Volcker (Fed Chairman) has said lately. Industrial
production growth is along the lines of what the Fed wants."
    The energy products component of PPI rose 4.0 pct in
February, after a 9.8 pct increase in January.
    "This shows that the impact of energy prices on inflation
is behind us in terms of the move from 15 dlrs to 18 dlrs per
barrel," said Maria Ramirez of Drexel Burnham Lambert Inc. "The
trend is still 3.5 pct in the first half of the year."
    In 1986, declining energy prices contributed to a 2.5 pct
decline in the PPI.
    Economists said that a rise in energy prices was expected,
but a sharp drop in auto prices was not. Passenger car prices
fell 3.4 pct and light truck prices dropped 1.3 pct.
    Yesterday, Federal Reserve Chairman Paul Volcker said that
a possibility of renewed inflation remains a concern in both
the financial markets and the Federal Reserve.
    "The Fed may be lowering its own inflation expectations
today," said Robert Brusca of Nikko Securities International.
    While low inflation permits the Fed to maintain an easier
monetary policy, Brusca said if import prices do not rise this
could necessitate a weaker dollar.
    "The outlook for the dollar is still up in the air," he
said. "We need inflation for U.S. producers to compete with
foreign producers."
    Brusca said prices of electronic equipment dropped 0.8 pct
in February's PPI. With many electronic goods produced
overseas, this may show that foreign producers are not raising
prices which bodes ill for U.S. competitiveness, he said.
    If further dollar declines are needed, this could diminish
overseas investment in U.S. debt, Brusca added, which might
necessitate higher interest rates and lower bond prices.
    By contrast, Slifer said imported goods prices rose 11.8
pct from first quarter 1985 to first quarter 1986 reflecting to
a large degree a 22 pct drop in the trade-weighted real value
of the dollar from February 1985 to February 1987.
    Slifer said import prices may rise further as
manufacturers' contracts put in place before the dollar dropped
to current levels expire, and new contracts are made that
reflect a weaker dollar.
    David Wyss of Data Resources Inc noted that imported
manufactured goods prices rose 8.5 pct at an annual rate in the
second half of 1986, which has contributed to rising U.S.
industrial output.
    "It's the other side of the lower dollar," Wyss said.
"Producers are beginning to find themselves more competitive
and they are increasing output."
    Wyss said that the latest data point to an average
industrial production gain of 0.3-0.4 pct in the first quarter.
"It's an encouraging sign that the manufacturing sector is
beginning to revive."
    But Stephen Roach of Morgan Stanley and Co Inc was not 
convinced that the February reports portend economic gains. He
said much of the strength came from factors that do not point
to a sustained rise in industrial output.
    Roach pointed out that stikers returning to work in farm
equipment industries helped account for a one pct rise in
February business equipment production.
    Utilities output rose 0.7 pct in February after gaining 1.2
pct in January, but Roach said it shows mostly that more energy
was produced, not that manufacturing activity gained.
    Finally, he pointed out that auto production accounted for
half of the industrial production gain as production of auto
assemblies rose to 8.3 million units at an annual rate from 7.5
million units.
    "In the first quarter, it looks like automakers are
producing at an 8.5 mln unit annual rate, but selling at
roughly a seven mln unit rate," Roach said. "The disparity
between output and sales is showing up in inventories."
    Economists pointed to sharp rise in January U.S. business
inventories as a sign that production may be outstripping
demand in the first quarter of 1987.
    January business inventories rose 0.9 pct, the largest gain
since July 1979 when inventories rose 1.7 pct, the Commerce
Department said. Business sales dropped 4.5 pct in January, the
largest monthly sales drop on record.
    Nonetheless, economists do not expect the Fed to react to
month-to-month changes. "The Fed has been standing pat for the
last seven months," Ramirez said. "They will continue to stand
pat for at least the next couple of months."
 Reuter
