Last week: This week’s batch of numbers shows consumers in a slightly better mood, and apparently taking advantage of steep discounting for holiday gifts. The story in housing however, throws some cold water on this holiday cheer. The Case-Schiller Home Price Index had been turning up for most of this year but started to fall again over the past two months. It would seem as if the labor market is improving while the housing market is losing some steam. Can the labor market continue to regain ground while the housing market slips? The housing market slump might be very limited. Unfortunately, the improvement in the labor market might also be limited. Can business afford to add expensive labor even as profit margins narrow? The third quarter rise in profits was centered in the financial sector. Nonfinancial corporate earnings were more modest, and likely to stay modest going forward. Will there be enough work going forward to convince employers that they need more staff?

THE SITUATION ABROAD

The reasons may vary, but borrowing rates are beginning to rise, a trend likely to continue in 2011. China could be growing by more than 9 percent in 2011, with the inflation rate a little above 5 percent, and its currency slowly appreciating (perhaps by 5 percent). India may see a little less growth (perhaps 8.5 percent), but more inflation (a little above 8 percent). Interest rates are going up in both countries now and will likely continue to move higher in 2011. Bond yields are rising in Europe, but not because economic growth is picking up. Borrowing related to the financial problems in Greece and Ireland are sending yields higher. Portugal and Spain are adopting austerity measures to address budget and public debt questions, but their borrowing costs are also rising, along with fears that more bailouts may be needed. Finally, one consequence of rising borrowing costs is slower global trade. Exports rose more slowly in the third quarter, and higher financial costs could be factor as to why trade will continue to slow into the first half of 2011.

FACT OF THE WEEK

3 percent.  Greece and Ireland are already operating under bailout conditions. They are implementing austerity programs. Speculation continues about others that might require a bailout. In part, these questions are about excess public spending, falling tax revenue growth, and inadequate banking capital (due to nonperforming loans). But a more fundamental problem lies underneath this nexus of problems: falling competitiveness, due to anemic productivity growth. For example, Germany (the strongest economic performer in the zone) experienced a 22 percent gain in productivity from 1998 through 2008. France experienced an 18 percent gain over the same period. But Italy, stronger economically than Greece or Ireland but well below Germany and France, experienced a mere 3 percent gain.

QUESTION OF THE WEEK

What is the outlook for natural resources for the next two years?

The economy is still trying to recover from a devastating recession as well as adjust to major economic and demographic shifts. Consumers are still trying to build up savings and pay off debt. This combined with slower household formation (relatively smaller size of the millennial generation), among other factors, probably means the U.S. housing market will still be struggling to regain its footing for much of 2011. Likewise, domestic demand for consumer durables is also likely to be slow next year. Finally, business investment in equipment and software, and especially in structural projects, is likely to be constrained by questions about profitability right through mid-decade.

These conditions suggest U.S. demand for energy, metals, and other natural resources (including wood) is likely to remain relatively soft in 2011, and therefore so will prices. In fact, demand for metals could actually be falling through much of 2011, resulting in minimal price increases. Both demand and price could finally be on the road to recovery in 2012, assuming home building, the labor market, and the general economy are on a road back to general health. Demand for metals could be in the 5-to-10 percent range, with prices rising in the 3-to-5 percent range. Energy prices, however, could be rising a little faster.

Elsewhere, some of these same economic and demographic forces are at play in the Euro-zone, along with sharp questions about public finance and private banking. In the Asia/Pacific region, continued strong growth in China and India could result in significantly faster demand and higher commodity inflation. In fact, as the accompanying chart shows, China alone was increasing metal demand while the rest of the globe has been coping with recession and trying to recover from recession over the past two years. Lastly, financial speculation has sent resource pricing up even in periods of weak demand. There is no guarantee this won’t happen again, especially if bond and stock trading remains subdued.

The one natural resource not included in this discussion is water. Demand, supplies, and prices for fresh water are generally not a big consideration today. And that is not likely to change over the next two years. But sooner rather than later, demand (for personal use, commercial use, energy conversion, and food production) will start to stretch supplies, sending prices up, perhaps even faster than energy prices.