Economic Data Take Turn for Worse Even Before Credit Markets Freeze

MBA (10/6/2008 ) Velz, Orawin
The labor market deteriorated further in September, with payroll losses of 159,000, more than double the loss in August and almost double the average monthly loss this year.
Since the beginning of the year, 760,000 jobs have been lost—an average of about 84,000 jobs per month. Job losses were widespread across industries, indicating that the housing downturn and the financial crisis have spilled over to the broad economy.

Other reports last week confirmed the view that economic growth slipped to an anemic pace in the third quarter. Real (inflation-adjusted) consumer spending was all but certain to decline in the third quarter as it was unchanged in August after declining 0.5 percent in July. Consumer spending likely turned out weak in September according to two early indicators of consumer spending released last week.

First, September auto sales reversed the August increase, slipping to the slowest pace since April 1992. Second, weekly chain store sales for the last week of September fell for the fourth consecutive week and the increase from a year ago was the smallest since early May, before tax rebates began to boost spending. The last time real consumer spending posted a quarterly decline was in the 1990-91 recession. Considering that consumer spending accounts for about 70 percent of the U.S. economy, negative economic growth in the third quarter cannot be ruled out.

Without the strength from consumers, the economy needs other sources of support to continue to expand. Unfortunately, several reports last week indicated that manufacturing activity, business investment, and nonresidential investment in structures weakened from the first half of the year. August’s factory orders posted the largest drop in two years. The component used as a proxy for future business investment in equipment and software dropped sharply, suggesting business investment will likely be a drag to economic growth in the second half of the year.

The Institute for Supply Management manufacturing survey showed that manufacturing activity contracted in September at the fastest pace since the 2001 recession, as support from trade appeared to be fading. While August private residential construction spending saw the first increase in over a year (although July’s data showed a sharp downward revision), private nonresidential construction spending dropped for the second consecutive month. The last economic report last week, the ISM nonmanufacturing survey, fared better than the ISM manufacturing survey but showed that the service industry was barely growing in September.

Finally, financial data last week showed that short-term business lending and borrowing effectively shut down as lenders are increasingly uncertain about the financial health of their clients and each other. The value of commercial paper—a vital source of short-term funding for daily operations at many companies—posted a record decline of $94.9 billion for the week ended Oct. 1. The impact of a freeze in the money markets will be widespread. If businesses have difficulties rolling commercial paper, it will affect the daily activities (e.g., payrolls, payments to suppliers) of the economy.

Another sign of increased financial stress was the continued increase in the Libor rate (the rate that banks charge each other). Interbank rates have soared as banks hoard cash to meet future funding needs and are unwilling to lend to each other on concern that more banks will collapse. The TED spread—the difference between the three-month Libor and three-month Treasury bill rate—rose to a record 386 basis points on Friday. The spread was 113 basis points a month ago and 240 basis points during the height of the previous financial market meltdown in mid-August 2007.

Stock markets as well as the Treasury market were extremely volatile in response to the events on Capitol Hill. The negative economic data also rattled investors, resulting in stock market declines on growth concerns. The yield on the 10-year Treasury note stayed around 3.62 percent mid-Friday afternoon, 23 basis points lower than the rate on the previous Friday. Despite the passage of the Emergency Economic Stabilization Act by Congress last week, fed funds futures fully expected that the Federal Open Market Committee will cut the federal funds rate by 50 basis points at its Oct. 28-29 meeting.

Housing and Mortgage Indicators:
Total construction spending was unchanged in August, following a 1.4 percent drop in July. A 0.8 percent increase in public construction spending offset a 0.3 percent decline in private construction spending.

Private residential construction spending was up 1.3 percent, the first increase since March 2007. Private nonresidential construction was down by 0.8 percent, the second consecutive monthly drop.

From a year ago, private residential construction spending has declined 28.4 percent. By contrast, private nonresidential construction spending was up 13.0 percent over the past year. Residential investment continued to be a drag on economic growth again in the third quarter. During the second quarter, residential investment subtracted 0.5 percentage points from gross domestic product, the smallest drag since the first quarter of 2006.

The Standard and Poor/Case-Shiller home price indices showed that home prices continued to decline in July in selected major cities. The year-over-year declines in the indices continued to set records, while the month-to-month declines in the indices accelerated, reversing the trend seen over the last few months.

The 10-metropolitan area composite index was down 17.5 percent in July from a year ago, the largest year-over-year decline since the inception of the series in 1987. The broader 20-metropolitan area composite index showed a year-over-year drop of 16.3 percent, also the sharpest decline in the history of the broader index since its inception in 2000.

A month-to-month comparison offered a disappointing picture of home price trends. Prior to the July report, price declines had been moderating since February. The 20-metropolitan area composite index dropped 0.9 percent in July, accelerating from a 0.5 percent drop in June. The month-to-month drop in the 10-metropolitan area composite index also accelerated to 1.1 percent in July, compared with a 0.6 percent drop in June.

All 20 metropolitan areas reported year-over-year home price drops, led by a 29.9 percent drop in Las Vegas and a 29.3 percent drop in Phoenix. Charlotte continued to post the smallest year-over-year decline of 1.8 percent. The 20 selected cities do not represent the overall picture of the nation’s housing market, however, with seven of the total coming from the four states experiencing the most significant home price drops in the nation: Arizona, California, Florida and Nevada. Prices in these seven cities have declined by at least 20 percent in July from July 2007.

Economic Indicators:
The Institute for Supply Management Manufacturing Index indicated that the contraction of manufacturing activity accelerated sharply in September, with the index dropping to 43.5 from 49.9 in August. This was the lowest reading since October 2001. A reading below 50 indicates a contraction in the manufacturing sector. The report may be overstating weakness. A strike at Boeing and hurricanes Ike and Gustav could have caused temporary disruption in production during the month.

The ISM manufacturing index is based on a survey of purchasing executives at roughly 300 industrial companies. It includes nine different sub-indices: new orders, production, employment, supplier deliveries, inventories, prices, new export orders, imports and backlog of orders.

New orders fell to 38.3 from the prior month’s reading of 48.3. The production index dropped to 40.8 from 52.1 in August. Weakness in manufacturing employment persisted, with the employment index declining 7.9 points to 41.8. New export orders declined 5.0 points to 52, the lowest reading this year. This suggested that support from trade, which has been critical for manufacturing activity in the face of declining domestic demand, is fading.

The only silver lining in the report was on the inflation front, with the prices that manufacturers paid for inputs dropping for the third consecutive month. The prices-paid index fell 23.5 points to 53.5. This was the largest month-to-month decline in the prices paid index since the inception of the series in 1948 and reflected the sharp decline in energy and other commodity prices—main raw materials used by manufacturers.

The Conference Board's Consumer Confidence Index rose 1.3 percentage points to 59.8 in September. This was the third consecutive increase. The survey results were taken before financial turmoil intensified and therefore did not capture all of the effects of the past week, according to The Conference Board.

The expectations component, based on respondents’ assessment of the outlook over the next six months, led the increase, rising to 60.5 from 54.1 in August. Consumers' appraisal of current conditions eroded further in September. The present conditions component fell to 58.8 from 65.0.

Consumer assessment of current labor market conditions deteriorated further. The share of consumers finding jobs plentiful fell to 12.2 percent—the smallest share in five years—from 13.5 percent. The share finding jobs hard to get increased rose to 32.8 percent in September from 31.7 percent in August.

Factory orders declined 4.0 percent in August, following a 0.7 percent increase in July, which was downwardly revised from a 1.3 percent increase. August’s drop in factory orders was the largest in nearly two years. The factory orders report included a downward revision of durable goods orders data released last week and contained new data on nondurable goods shipments.

Nondurable goods shipments fell 3.3 percent, also the largest drop in nearly two years and the first decline since February. The huge drop in nondurable goods shipments was led by petroleum shipments, which account for about 30 percent of the value of total nondurable goods shipments. The value of petroleum shipments fell 8.5 percent, reflecting the decline in the price of crude oil in August.

Durable goods orders fell 4.8 percent, a downward revision from a 4.5 percent drop in the advance estimate. The downward revision to durable goods orders was broad based, led by a downward revision in electrical equipment, appliances and components. Only computers and electronic products posted a small upward revision.

The downward revision in durable goods orders indicated that business investment spending outlook was even weaker than initially reported. Orders for nondefense capital goods excluding aircraft—a proxy for business investment in equipment and software in the coming quarters—fell by 2.4 percent in August, compared with the 2.0 percent decline reported last week.

The ISM Nonmanufacturing Index edged down to 50.2 in September from 50.6 in August. This is the second consecutive month that the index showed a reading above 50, indicating an expanding service sector.

Both the production and new orders indices increased moderately. However, the employment index fell for the second consecutive month and was near to the January low and reinforces the increase in job losses in the service sector. The export index rebound slightly from August, which posted a reading that matched its record low set in October 2001.

The survey offered an improving inflation picture, showing declining prices firms paid for raw material for a third consecutive month.

Payroll employment fell 159,000 in September, the ninth consecutive month of decline. The August figure was revised up, from a loss of 84,000 to 73,000, while the July figure was revised down, from 60,000 to 67,000.

Goods-producing industries lost 77,000 jobs in September, while private service industries lost 91,000 jobs, with losses spread across industries. Manufacturers cut 51,000 jobs, while builders cut 35,000 jobs. Government payrolls added 9,000 jobs.

Among service industries, the largest job losses were in retail (40,000), temp help (24,000), financial activities (17,000), leisure/hospitality (17,000) and transportation/warehousing (16,000). The only broad job categories that continued to expand are education/healthcare and mining.

Mortgage industry employment fell 6,000 jobs to 349,000 in August. (The Bureau of the Labor Statistics releases some detailed categories of employment with a one-month lag.) Since its peak in February 2006, the industry’s employment has declined by about 31 percent.

The unemployment rate, calculated from a survey of households, was unchanged at 6.1 percent. The labor force contracted by 121,000, while the number of unemployed workers increased by 101,000.

Earnings edged up 0.2 percent from August and 3.4 percent from last September. The index of aggregate weekly hours, a proxy of economic growth, declined by 0.5 percent, the largest monthly decline since April 2003, indicating a contracting economy.