Fed to Pause on Rate Hike?

(Headlines - scroll down for full stories)
1. Fed to Pause on Rate Hike?
2. Labor Costs Spur Inflation
3. Condo Conversions Turn Into Reversions
4. IBM Scores Landmark Pension Judgment

1. Fed to Pause on Rate Hike?

Many economists anticipate that the Fed will forego a rate increase when the Federal Open Market Committee convenes today - but many also say that the respite will be temporary, as skyrocketing energy prices keep the specter of inflation alive and well, forcing the Fed to take action.

After 25 months of raising interest rates, the target rate is at 5.25%, and a number of investors refer to 1995, when - after rates had soared higher for a year - the Dow Jones Industrial Average jumped by 40%.

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"Even if the Fed doesn't raise rates today, it's unlikely to give Wall Street the all-clear signal it wants," says The Wall Street Journal. "Until last Friday's weaker-than-expected July jobs number, plenty of economists were betting on a rate increase at today's Fed meeting. And many still believe the Fed could move again before the year ends."

Despite the expected rate standstill, the latest economic data released today demonstrated that labor costs, a key inflationary gauge, are rising just as growth in workplace productivity is slowing down.

"Economic data since the last FOMC meeting has clearly shown that the economy is slowing. Job reports have been tepid, GDP growth was much lower in the second quarter relative to the first quarter, and consumer and business spending were sluggish," according to MarketWatch.

So while the Fed might hold steady this time around, many analysts are forecasting at least one or two more hikes this fall.

"It is our view that they are going to have to hike again because there are going to be some pretty unpleasant surprises in the inflation numbers," Nariman Behravesh, chief economist at economic forecasting firm Global Insight, told the AP. "Inflation is likely to get worse in the next few months and the Fed can't sit on its hands."

And the news service cites another well-known economist who says that should elevated oil prices cause the Fed to raise rates a few more times to 6%, the chances of a full-blown recession in 2007 would be greatly increased.

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2. Labor Costs Spur Inflation

American workers demanded more money for less work in the April - June quarter indicates a report from the Labor Department.

The growth in productivity, the amount of output per hour of work, slipped to 1.1 percent in the second quarter. That's compared to a 4.3 percent growth rate in the first quarter.

At the same time, labor costs rose at an annual rate of 4.2 percent. That's the fastest increase since the fourth quarter of 2004, says the Associated Press. Last quarter, labor costs increased just 2.5 percent.

The one-two punch of slowing productivity and rising labor costs could make the Fed second-guess its widely-expected decision to pause interest rates.

"These numbers will be viewed with some concern at the Fed," Dean Maki, chief U.S. economist at Barclays Capital, tells Bloomberg News. "One of the things the Fed had found reassuring on inflation was that unit labor costs were subdued, and they no longer have that reassurance."

The Fed generally points to rising productivity as a factor that contains inflation. Explains the AP: "Strong growth in output allows businesses to pay their workers more without having to raise the cost of their products, which fuels inflation."

But in this case, businesses are paying employees more but aren't getting the output in demand. Rising labor costs squeeze profits and force employers to raise prices, which in turn spreads inflation.

"The inflation warning signs contained in this report represent a problem for the Fed," David Greenlaw, chief U.S. fixed income economist at Morgan Stanley, tells Bloomberg. "Even though there will be a pause in the tightening campaign at today's meeting, concerns about building cost pressures should encourage the FOMC to retain a tightening bias."

In other words, even if the Fed does pause interest rates, it will likely maintain the threat of raising rates sooner rather than later.

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3. Condo Conversions Turn Into Reversions

Even when it was clear in December that the condo market was slowing, Ted Charron went ahead and bought a two-bedroom, two-bathroom condo in Tampa, Fla., where some industry experts say the froth is especially frothy.

He did not buy the condo to turn it for a quick profit, however, but to the tap growing demand for rentals, a by-product of the condo conversions that have swept through metropolitan areas nationwide.

"It wasn't a flip, more of a long-term investment," said Charron, an information technology director who works in nearby St. Petersburg. "Because there are so many of these conversions, there's just not a lot of places to rent, so I think the demand for rentals is actually going to go up."

Growing demand for rentals stems from many factors. Buyers are finding the market less affordable, leading to fewer sales and a greater pool of renters. And conversion of condos took rental inventory off the market. Now that demand for condos has cooled, conversions are slowing and in some instances, condos revert back to rentals.

"There was a huge craze," said Larry Leitzman, a Tampa-based research and marketing coordinator at Grubb & Ellis, a national real estate agency. "Everybody was taking apartment buildings and converting them to condos. A lot of them are reeling them back in and taking the apartments that didn't sell and converting them back to rentals."

The new owners of the Preserve at Mobbly Bay in Tampa responded to those pressures as well, but in a slightly different way. They had every intention of converting the Mobbly Bay apartments to condos when they bought the 17-building complex in November of last year.

Eight months later, however, the answer to whether the property is going condo is: Absolutely not. Atlanta-based Mobbly Bay LLC decided that so many condos have been built or converted in the last two years, that it will wait another year or two to consider when it can convert the 316 units.

Other markets that have seen reversions include Miami, Fort Lauderdale and Orlando in Florida, as well as Las Vegas, San Diego and Phoenix, according to Hessam Nadji, managing director of research services at Marcus & Millichap, a national real estate investment brokerage company. Between 25 percent to 40 percent of the condos being developed or converted in those markets are likely to be offered as rentals instead, he said.

Condo conversions nationwide peaked in September 2005 and by June of this year levels had fallen back to those last seen in early 2004, before the bulk of the conversions happened. Nearly 28,000 units costing more than $4 billion were converted in September, while only 3,354 units were converted in June at a total cost of $449.4 million, according to a report from Real Capital Analytics, a research and consulting firm.

Nadji sees further softening in the second half of 2006 and in 2007, the market will be absorbing the bulk of the excess condo units. He estimates the market correction should have run its course within 18 to 24 months.

"We have a ways to go before we bottom out," he said.

Greater demand for rentals, however, should soak up some of the excess capacity. And evidence exists that it is already doing so.

The number of condos being turned into rentals is actually greater than what can be tracked, said real estate consultant Michael Slater, of Triad Research & Consulting in Tampa. There is a shadow market in rentals, where condo buyers become landlords and apartment managers, and that can also act as a band-aid for the slowing condo market, he said.

Diane Lee, president of DLG Management Services in Tampa, said about 40 percent to 60 percent of condos that were planned for conversion there are reverting to rentals, and that many of the condos were bought by investors, so they are essentially rentals anyway.

"Now what's happened in the last five to six months, a lot of converters have bought an apartment building, started sales, and it's died off, so they're choosing to stop sales," she said.

One developer of rental apartments in the Washington, D.C., area said the reversions will certainly help meet the burgeoning demand for rental apartments. Tom Buzzuto, chief executive of the Buzzuto Group, anticipates a growing number of such reversions. While his company's development activity is up 25 percent this year, acquisitions of apartment buildings have doubled and one of his current projects is a building that had originally been built as condos.

The trend that is prevalent in southeast Florida appears to be spreading to markets in Washington, D.C., and San Diego, said Michael Cohen, research strategist at Property & Portfolio Research.

"Florida was on the leading edge of the trend so it would make sense that they would peak first," said Chris Bates of RealFacts, a Novato, Calif.-based research firm.

In certain markets, though, condos have not succumbed to the reversion trend and solid sales are expected, Nadji of Marcus & Millichap said. He expects Seattle, Philadelphia, Tucson and Portland to continue to see healthy demand, while New York and Chicago will also be fairly stable.

And in Tampa, Charron successfully rented his newly bought condo after figuring out what price the market would support. He initially asked for $1,200 a month in rent but lowered the price twice before finding a large enough pool of candidates to suit him.

Charron, really, is sort of the opposite of a speculator, buying when the market is showing weakness and with the intent to keep the condo when others are trying to liquidate.

As he put it, "My goal is not to sell."

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4. IBM Scores Landmark Pension Judgment

In what is likely to be a landmark pension case that will affect countless other American companies, a U.S. appeals court has overturned a previous judgment, ruling in favor of IBM after the computer giant moved to rework its pension plan into what is known as a "cash-balance" arrangement.

A number of employees initiated a lawsuit claiming the move amounted to age discrimination, and had the initial decision been upheld, IBM would have been forced to pay out some $1.4 billion, compared to the $320 million it will now give to plaintiffs.

While a cash-balance plan is still technically a classic defined-benefits package - one that provides retirees with benefits based on their length of service - the cash-balance arrangement also includes some aspects of the newer and increasingly popular defined-contribution plan (such as a 401K) through which an employee pays into a plan, the employer matches that amount and the aggregate funds begin to accrue interest.

"For younger workers not due to retire for many years, the compounding effect of the interest payments can result in a far larger pension entitlement than for workers who start their service at a later stage," according to the Financial Times.

"That has led to lawsuits against IBM and a number of other U.S. companies alleging age discrimination, resulting in a slowdown in the adoption of such plans."

Previously, a lower court had ruled that IBM's move to the cash-balance system caused older employees retiring at age 65 to receive a smaller benefit than younger workers who were expected to work considerably longer - thereby hurting older IBM employees.

According to Bloomberg News, U.S. District Judge Patrick Murphy at first declared the plan was discriminatory because younger workers would end up being credited with more benefits than their older colleagues.

But appellate court judge Frank Easterbrook later ruled that Murphy had misinterpreted a federal statute related to the plans.

"Under the district court's analysis, compound interest becomes a scourge, for the younger the employee with any given year's salary is earned, the greater the payout `expressed in the form of an annual benefit commencing at normal retirement age,' " Easterbrook wrote, according to the report.

Editor's Note:

A massive demographic tidal wave is about to hit the U.S. as 77 million Baby Boomers retire - swamping pension systems and the health care system. Some sectors will suffer massive, long-term losses as others post huge gains. Find out how you can profit from investing in these sectors. Go here now.

Editor's Notes:

Bernanke's blunder could be the biggest opportunity of the last decade for savvy investors. Go here now.
Three steps to success! Discover how you can multiply your profits and cut risk down to size in three easy steps. Go here now.
Housing prices nationwide could fall by as much as 40% over the next few years. Find out how the five ways to protect yourself and profit from the coming real estate crisis. Go here now.
A massive demographic tidal wave is about to hit the U.S. as 77 million Baby Boomers retire - swamping pension systems and the health care system. Some sectors will suffer massive, long-term losses as others post huge gains. Find out how you can profit from investing in these sectors. Go here now.
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