Economic Data Support Extended Fed Pause

MBA (5/5/2008 ) Velz, Orawin
Last week’s economic reports showed that while economic activities outside of the housing and consumer sectors have remained weak, they have not deteriorated significantly.
Manufacturing activity has performed better than expected, supported by strong export demand. The Institute for Supply Management’s Manufacturing Index stabilized in April at a level showing mildly contracting manufacturing activities. Factory orders increased in March for the first time in three months. Although construction spending fell sharply in March, February data were upwardly revised. In addition, nonresidential construction spending saw the biggest monthly increase since last September.

The pace of job loss has moderated going into the second quarter. Nonfarm payrolls fell 20,000 in April after declining an average 80,000 a month in the first quarter. Job losses in goods-producing industries accelerated to 110,000 for the month, the most since February 2007. The bulk of these losses are in housing-related industries, with builders shedding 61,000 jobs, compared with 46,000 shed in March.

Service-producing jobs, especially those in professional and business services, education and leisure and hospitality, helped support the labor markets. One area of the service industries that is having difficulty is retail trade, which cut 26,800 jobs in April. This was the fourth consecutive of sizable payroll cut, consistent with the first quarter’s anemic inflation-adjusted consumer spending growth seen in the gross domestic report last week.

Consumer-related news was bearish at the start of the second quarter. April consumer confidence eroded further and April vehicle sales showed the slowest monthly sales pace since mid-1998. The good news: some of the tax rebate checks were already in the mail or directly deposited to taxpayers’ bank accounts last week. The rebates will be front-loaded under the Treasury’s accelerated schedule for fiscal stimulus payments, with the largest flow of weekly payments getting to households in the middle of May.

The Federal Open Market Committee (FOMC) met last week and cut the federal funds rate 25 basis points. In the post-meeting statement, it signaled that an extended pause is likely. The committee removed the sentence “downside risks to growth remain” and a reference to acting in a “timely manner” from the previous statement.

Treasury yields declined during the week but partially reversed on Friday as stronger-than-expected payroll data supported the view that the Fed will keep interest rates on hold when the FOMC meets again in June. The yield on the 10-year Treasury note rose to 3.84 percent by mid-Friday afternoon, seven basis points lower than the closing rate on the previous Friday.

Housing and Mortgage Indicators:
The Standard & Poor’s Case-Shiller Home Price Indices showed that home price declines in some cities accelerated in February. The 10-metro area composite index was down 13.6 percent in February from a year ago, the largest decline since the inception of the series in 1987. The broader 20-metro area composite index showed a year-over-year drop of 12.7 percent, the sharpest decline in the history of the broader index since its inception in 2000.

Nineteen out of 20 metro areas reported year-over-year home price drops, with only Charlotte, N.C., showing a small gain of 1.5 percent. Las Vegas posted the largest year-over-year decline of 22.8 percent, followed by Miami’s 21.7 percent drop. Price declines for metro areas have accelerated over time. In February, 17 of the 20 metro areas reported record year-over-year home price declines (10 of which were in double digits), compared with 16 in January and 13 in December.

The 20 selected metro areas 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: California, Florida, Michigan and Nevada. The metro areas for these states account for more than half the rate of the decline. The Case-Shiller index for the nation is only available on the quarterly basis.

Construction spending fell 1.1 percent in March. The Department of Commerce revised total construction spending in February to a gain of 0.4 percent from an earlier report of a 0.3 percent drop. Public construction spending fell 0.8 percent in March. Private construction spending dropped 1.7 percent, as the 4.6 percent decline in private residential construction spending outweighed the increase in private nonresidential construction spending of 1.9 percent. This was the largest decline in private residential construction spending since May 1980. From a year ago, private residential construction spending has been consistently 19.9 percent lower. By contrast, private nonresidential construction spending was up 15.4 percent from a year ago.

Economic Indicators:
The Conference Board's Consumer Confidence Index fell 3.6 points to 62.3 in April, following a drop of 10.5 points in March and 10.9 points in February. The index has reached its lowest reading since March 2003, during the U.S. invasion of Iraq, and its second lowest since October 1993. So far, the index has dropped nearly 50 points since the August 2007 financial turmoil.

The present conditions component fell 9.9 points, while the component gauging expectations for the next six months edged up to 50.1 from a record low of 49.4 in March. Weak labor markets, rising energy prices, falling house prices and credit market concerns likely weighed on confidence.

Consumers’ assessment of current labor market conditions continue to deteriorate. The share of consumers finding jobs plentiful fell 2.6 percentage points to 16.6 percent. The share finding jobs hard to get rose 3.4 percentage points to 24.5 percent. The survey reported that plans to buy homes declined in April to the lowest level since December 1982.

The advance estimate of the first quarter gross domestic product showed that the economy barely expanded in the first quarter of 2008, supported by an inventory buildup. Real (inflation-adjusted) GDP grew 0.6 percent, according to advance estimate of the Bureau of Economic Analysis. (Unless otherwise noted, data in the GDP report mentioned here are seasonally-adjusted annualized rates.)

Economic growth matched the pace seen in the fourth quarter of 2007. Inventory investment was a positive for growth in the first quarter, reversing the decline in the fourth quarter of 2007. Inventory investment contributed 0.8 percentage points to growth. Real final sales of domestic product, which is real GDP minus the change in inventories, fell 0.2 percent, compared with a 2.4 percent growth in the fourth quarter. This was the first decline since the fourth quarter of 2005.

Slowing demand likely caused an unintended increase in inventories, which bodes ill for the economic growth in the current quarter as businesses will likely pare down production to reduce unwanted stockpiles. About half of the increase came from motor vehicle inventories. Some automakers are already planning to cutback. This week, General Motors Corp., the world's largest automaker, reported that it is cutting production of large pickup trucks and sport-utility vehicles by 138,000 this year.

Offsetting the inventory buildup were weaker real personal consumption spending (PCE), higher imports and a decline in nonresidential investment. Government spending grew at the same pace as the fourth quarter last year.

Consumers pulled back significantly in the first quarter. Real PCE rose only 1.0 percent, moderating from 2.3 percent in the fourth quarter. This was the weakest growth since the second quarter of 2001. Real PCE added 0.7 percentage points to growth in the first quarter, less than half of its contribution in the fourth quarter last year. Real spending declined for both durable and nondurable goods. The drop in real spending on nondurable goods was the largest since the fourth quarter of 1991.

The housing market remained the biggest drag, with real residential investment declining 26.6 percent in the first quarter, the biggest quarterly drop since the fourth quarter of 1981. Real residential investment subtracted 1.2 percentage points from growth, the same as during the fourth quarter last year. Housing has been a drag on growth for nine straight quarters, the longest downturn since the mid-1950s.

Nonresidential investment fell 2.5 percent as a result of declines in both nonresidential construction and equipment and software investment. This was the first decline since the fourth quarter of 2006.

The trade sector, which has been a positive influence on economic growth over the past year, barely added to growth in the first quarter as imports rose strongly. Net exports of goods and services added only 0.2 percentage points to growth in the first quarter, after adding one percentage point in the previous quarter. This was the smallest contribution from trade in a year. Final domestic sales—real GDP minus net exports and minus the change in inventories—dropped 0.4 percent. This was the first decline since the fourth quarter of 1991.

The employment cost index (ECI) rose 0.7 percent, as wages and salaries grew 0.8 percent while benefit costs were up 0.6 percent.

Personal consumption expenditures (PCE) increased 0.4 percent in March after a weak 0.1 percent gain in February. However, much of the gain was due to higher prices. Adjusted for inflation, real spending rose only 0.1 percent. Meanwhile, personal income increased 0.3 percent, moderating from a 0.5 percent gain in February. The report showed that inflation, as measured by the PCE index, accelerated to 0.3 percent in March from 0.2 percent in February. Core prices (excluding prices and energy items) rose 0.2 percent. Over the past year, the core PCE increased 2.1 percent, accelerating from 2.0 percent in February, just exceeding the upper end of the Federal Reserve implicit target of 1.0 percent to 2.0 percent.

The Institute for Supply Management (ISM) Manufacturing Index remained unchanged at 48.6. A reading below 50 indicates a contraction in the manufacturing sector. Although this was the fourth reading below 50 in the past five months, the index is showing signs of stabilizing: manufacturing activity continues to slump, but the slump is not deepening.

Forward-looking components of the index suggest continued slow activity ahead. New orders were unchanged at 46.5, the lowest level since October 2001. While the production index rose slightly to 49.1, it showed back-to-back readings below the 50 threshold for the first time since 2003. Manufacturers continue to see export orders increase from strong demand for capital goods overseas, which has helped support the overall activity.

The employment component of the index declined 3.8 points to 45.4, its lowest since mid-2003. The component related to prices continued to show a worrisome trend, with the prices that manufacturers are paying for inputs trending up. The prices-paid index increased one point to 84.5 and has reached its highest reading since May 2004, surpassing the level seen in the aftermath of Hurricane Katrina. Elevated commodity prices, including oil, have pushed input prices up.

Despite its weak readings over the past several months, the ISM index has performed much better than it did during the recession in 2001. It dipped to a five-year low of 48.3 in February of this year, but has improved since. In the 2001 recession, the index reached its low at 40.8 in October and averaged 43.4 for the 8-month duration of the recession.

Factory orders increased 1.4 percent in March after dropping 0.9 percent in February. Durable goods orders were upwardly revised to an increase of 0.1 percent from a 0.3 percent decline in the advance release. Nondurable goods orders rose 2.6 percent, following a decline of 1.1 percent in February.

Nonfarm payrolls fell 20,000 in April and the Bureau of Labor Statistics revised downward employment in prior months for a total of 8,000 jobs.

The unemployment rate fell to 5.0 percent from 5.1 percent in March. Average hourly earnings edged up 0.1 percent, a reflection of weakness in the job market.