The minutes of the Federal Reserve meeting of November 3rd and 4th were released yesterday. The clear message of the minutes is that short-term rates are going to stay very low for a long time to come.  Below is the summary of the participants’ view of the economy, and my translation/commentary/analysis of it interspersed.

“In the meeting participants’ discussion of the economic situation and outlook, they agreed that the incoming data and information received from business contacts suggested that economic activity was picking up as anticipated, with output continuing to expand in the fourth quarter.”

I agree that we will see positive economic growth in the fourth quarter — perhaps not very robust growth, but it will be comfortably on the right side of zero.

“A number of factors were expected to support near-term growth: Business inventories were being brought into better alignment with sales, and the pace of inventory runoff was slowing; activity in the housing sector appeared to be turning up, and house prices seemed to be leveling out or beginning to rise by some measures; consumer spending appeared to be rising even apart from the effects of fiscal incentives to purchase autos; the outlook for growth abroad had improved since earlier in the year, auguring well for U.S. exports; and U.S. and global financial market conditions, while roughly unchanged over the intermeeting period, were substantially better than earlier in the year.”

Changes in inventories were a substantial drag on growth in the fourth quarter of last year through the second quarter, but that started to turn around in the third quarter. In fact, except for the drawdown in inventories, economic growth would have been a positive 0.7% in the second quarter, rather than the negative 0.7% we saw. In the third quarter, rebuilding of inventories added 0.87 points of the 2.80 total growth. In other words, if inventories had remained unchanged, growth would have been less than 2.0%.

As for consumer spending, the rebound has been muted outside of autos, although it is up rather than down. Over the long term I’m not sure that’s such a good thing, but for the time being we need the consumer to wake up.

The U.S. is not going to be leading the world out of this downturn, China is. However, economic growth is not a zero-sum game, and if places like China are growing, that is good for the U.S. economy. Even though the dollar has not changed relative to the Yuan, the falling dollar will still help our exports, since we are often competing against the Europeans and the Japanese when we sell into places like China. A week dollar makes Boeing (BA) more competitive versus Airbus, and General Electric (GE) well positioned relative to Siemens (SI).

“Above-trend output growth in the third quarter was a welcome development. Moreover, the upturn in real GDP appeared to reflect stronger final demand and not just a slower pace of inventory decumulation.

“While these developments were positive, participants noted that it was not clear how much of the recent firming in final demand reflected the effects of temporary fiscal programs to support the auto and housing sectors, and some participants expressed concerns about the ability of the economy to generate a self-sustaining recovery without government support.”

Well, we learned yesterday that the output growth in the third quarter was closer to trend than above trend, but the Fed did not have that data at the time of the meeting.  I share the concern about the ability of the economy to generate a self-sustaining recovery.  We still need the training wheels.  Without the stimulus, the economy would probably still be headed south.

“Nonetheless, participants expected the recovery to continue in subsequent quarters, although at a pace that would be rather slow relative to historical experience, particularly the robust recoveries that followed previous steep downturns. Such a modest pace of expansion would imply only slow improvement in the labor market next year, with unemployment remaining high. Indeed, participants noted that business contacts continued to report plans to be cautious in hiring and capital spending even as demand for their products increased.”

The Fed members are masters of understatement. Normally when you have a sharp and deep recession, you have a big snap back. It is not unusual to see at least one quarter where growth exceeds 6% coming out of a recession. I see very little chance of that happening this time around. If we can sustain growth rates like we saw in the second quarter of 2.8% for all of 2010, I would count that as a major victory.

Coming out of previous recessions, the consumer was a much smaller part of the economy, and had room to expand. I don’t see that as the case this time, with the consumer at a record 71% of the economy. The savings rate was also much higher coming out of previous recessions,and had room to fall — not true this time around. Business investment actually continued to fall in the third quarter, even as the rest of the economy was growing, mostly due to a 15.1% plunge in spending on non-residential structures. That alone shaved 0.55 points from economic growth.

Spending on Equipment and Software did pick up a little bit (up 2.3% in 3Q, adding 0.15 points to growth), and the software side of that could be helped by the new Windows operating system from Microsoft (MSFT).

“Nonetheless, economic growth was expected to strengthen during the next two years as housing construction continued to rise and financial conditions improved further, leading to more-substantial increases in resource utilization in product and labor markets.”

Yes, housing will probably see some rebound, since it is near a record low share of the economy (set in the second quarter). However, we have too many housing units in the country, so it does not make a lot of sense to be building more of them. We need to see more household formation.

That means we need more jobs — jobs that will get recent college graduates out of their parents’ basements and into houses or apartments of their own. Jobs that will allow people who are now living on their friends’ couches to get their own places. That presents a bit of a chicken-and-the-egg problem, since historically housing is one of the key areas lifting us out of recessions.

“Most participants now viewed the risks to their growth forecasts as being roughly balanced rather than tilted to the downside, but uncertainty surrounding these forecasts was still viewed as quite elevated. Downside risks to growth included the continued weakness in the labor market and its implications for income growth and consumer confidence, as well as the potential for credit availability to remain relatively tight for consumers and some businesses.”

I still see the risks as being tilted to the downside, mostly for the factors that the Fed cites here.

“In this regard, some participants noted the difficulty that smaller, bank-dependent firms were having in securing financing. The CRE sector was also considered a downside risk to the forecast and a possible source of increased pressure on banks.

“On the other hand, consumer spending on items other than autos had been stronger than expected, which might be signaling more underlying momentum in the recovery and some chance that the step-up in spending would be sustained going forward. In addition, growth abroad had exceeded expectations for some time, potentially providing more support to U.S. exports and domestic growth than anticipated.”

I suspect that with banks pulling in credit card lines, that the strength in consumer spending outside of autos (and autos was artificially helped by Cash for Clunkers) will prove to be ephemeral. I would also note that after the Fed meeting we got a downward revision to September retail sales and the October retail sales were decidedly mediocre.

I fully agree that the growth abroad is a major positive force for the U.S. economy. The weaker dollar will also be beneficial in that regard. However, the economy that seems to be leading the world out of this slump, China, seems most interested in importing basic materials. While there are many U.S. based firms that produce those materials, such as Freeport McMoRan (FCX), their actual operations are located mostly abroad, so the effect on the U.S. economy will be muted.

If, on the other hand, Chinese demand for steel leads to an increase in demand for iron ore from Vale (VALE) in Brazil, that might end up stimulating Brazilian demand for U.S. goods.  So then, Chinese growth would have an effect on U.S. growth, even if some of it is indirect.

There is much more in the minutes, if you want to read them in their entirety, you can read them here.

Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience, he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market-beating Zacks Strategic Investor service.
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