A winter's tale of a policy error: James Saft

Thu Feb 13, 2014 4:23pm EST

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(Reuters) - An exceptionally cold winter in much of the U.S. is slowing the economy, but may also be laying a trap for the Federal Reserve.

Where I live in Alabama we just had our coldest January in about 30 years. That's good luck for my kids, who are now on their third straight day off of school, but bad news for growth in the large parts of the country which have suffered cold, snow and blackouts.

It is also raises risks for the Fed, making it more likely that they may misread the strength of the economy and make what could be a very expensive policy error.

There are two levels to this story. The first, more straightforward, is the fact that people stuck shivering in their cars, or eating day-old bread at home, are not earning, making or buying things in their usual way. It's hard to get a hard number for the total costs, which is well into the billions, but easy to see the damage in the economic data.

Cold weather got the blame for a disappointing pending home sales figure for December which saw a bigger-than-expected drop when announced late last month.

Retail sales data were released today, and again weather came in for much of the blame for being down in January by 0.4 percent. Sales for December were also revised lower, to a fall of 0.1 percent. While doubtless weather played a role, we have to note that Internet sales fell by 0.3 percent as well. That indicates more widespread weakness.

Still, everyone from automakers to restaurants to clothing stores are using the weather as an explanation for poor sales, and by and large the Fed is buying into that analysis. For one thing they are living it - Janet Yellen's second day of testimony before Congress was scrubbed today due to snow.

Speaking before lawmakers on Tuesday she indicated that recent soft jobs data wouldn't, by itself, prompt the Fed to suspend or slow the taper.

"We have to very careful not to jump to conclusions interpreting what those reports mean," she said. "There were weather factors. We've had unseasonably cold temperatures that may be affecting economic activity in this job market and elsewhere."

And in the Fed policy-makers' statement accompanying their decision to keep tapering last month, they attributed a "pause" in growth to being "in large part because of weather-related disruptions and other transitory factors."

To be sure, bad weather in some of the country has played a role, and to the extent it has, we'll get some bounce-back in some areas of the economy.

NOT BUYING IT

But the weather has not been bad everywhere, and Mark Hanson, a California-based mortgage banking veteran who provides real estate advisory services, doesn't buy that it has been the fundamental cause of poor data. After all, the West is having a drought but dry weather is no impediment to buying a house or a car.

"So funny that nobody ever talks about the best house and car shopping weather in a generation west of the Rockies. They look out their windows in NY and think it's the same in LA," he said by email, noting widespread weakness in many of the formerly hot western real estate markets.

"I maintain that the economic gains we should be enjoying due to historically warm weather should offset the losses due to the bad weather elsewhere."

Now remember, the Fed is in something of a tight spot. For it to pause the taper, or increase bond buys, is an expensive and risky decision. Janet Yellen is new to the chair and must be putting a premium on appearing serene and in control.

The risk is that the bad weather is exacerbating underlying weakness which was already apparent. If softness in the economy goes beyond weather the bounce-back we'd normally see in consumption once spring comes won't fully happen. By the time we see that data, in May and June, the Fed will likely have carried on tapering.

Here is the thing: the Fed toolbox is looking bare. Few are enthusiastic about the risks of QE, there is no room to cut rates, and forward guidance is, in essence, just talk.

That, in combination with uncertainty about the weather, gives the Fed a lot of reasons to err on the side of delaying any change of course.

If this is about more than a bad winter, that will prove to have been an extremely expensive error.

<For a Reuters Insider video by James Saft on this subject, see: reut.rs/1gb8LQ3

(James Saft is a Reuters columnist. The opinions expressed are his own)

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

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