Across My Desk

Wonder how Hurricane Katrina will impact the Fed? Below is how Liz Ann Sonders, chief investment strategist at Charles Schwab sees it.

But before we get into that , The Schwab Report Team, and I, offer our sincere condolences to family and friends impacted by Hurricane Katrina.

Here's the story:

"The Schwab Report: Special Edition
Hurricane Katrina - How Might It Impact Fed Thinking?
September 1, 2005

Here's what history tells us about the aftermath of major disasters such as Hurricane Katrina and the impact we're likely to see on the U.S. economy in the near term:

• Unemployment claims are likely to rise--at least over the short term.
• Assuming claims ascend (and oil prices remain around $70), the Federal Reserve's view toward the necessity of continued "measured" rate increases should adjust.
• Liquidity is what's needed to rebuild after an event such as Katrina. Can the Fed really ignore this need?.
• A meaningful economic slowdown appears even more in the cards in light of Katrina. Other contributing factors include oil prices, a flattening yield curve, a retail spending retrenchment, declining consumer confidence, a faltering PMI and a cooler housing market.
• Growth in the hurricane-plagued regions is likely to slow initially and will likely pick up when rebuilding kicks in.
• Energy and transportation system breakdowns represent negative supply shocks.
• The demand shock is "positive" in terms of the offsetting benefit to inflation (and, in turn, to Fed policy).
• ISI expects there to be a growing number of defaults on consumer, mortgage and business loans (more fuel for the economic slowdown/Fed pause arguments).
• Since it's still a few weeks before the next Fed meeting, there will be a lot more data to digest between now and then. It's too soon to tell whether they'll opt to pause, but the chances of that have increased significantly in the post-Katrina world.
• Katrina may ultimately be defined as the crisis that eased the Fed's foot off the monetary policy brake.

About three million people, or 1% of the population of the United States, currently lack power. Except for New Orleans, economic activity in the impacted area of the Gulf Coast has typically been below average. According to Fitch Ratings, the four hurricanes that hit the Gulf Coast from Aug. 13, 2004 to Sept. 24, 2004 cost the insurance industry about $20 billion in claims.

Beginning Thanksgiving week, two months after the last hurricane hit, wages and salaries surged. Due to the $20-25 billion that policyholders will receive from insurers in the aftermath of Katrina, TrimTabs guesses that growth in wages and salaries could jump significantly by early November.

THE BOTTOM LINE:

Katrina will add to the pressure on the economy, but also on the Fed, and we expect the economic slowdown story to gain traction. However, we expect the Fed to heed this and opt to pause sooner than many expect (possibly by giving us a break with no hike Sept. 20). This view is also supported by the move lower in 10-year bond yields (which touched under 4% today) as we don't think the Fed is likely to purposefully invert the yield curve in a post-Katrina world. Believing the Fed holds the key to market action, we think this will be a net positive for the stock market. Recall that the market performed extremely well during both economic (and oil-price induced) slowdowns in 1985 and 1995.

This information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. It is not intended to be a substitute for specific individualized tax, legal or investment planning advice. The strategies mentioned may not be suitable for everyone. Each investor needs to review investments and strategies in light of his or her own particular situation. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA and/or attorney."