Improving Trade Deficit Contributes to Economic Growth

MBA (5/12/2008 ) Velz, Orawin
Last week’s economic reports were generally upbeat, outside of the housing and mortgage markets. The trade deficit narrowed in March following a widening in February. Exports fell for the first time in a year, but the decrease in imports was nearly double the decrease in exports.
The Bureau of Economic Analysis estimated that net exports added 0.2 percentage points to first quarter economic growth in its advance estimate of gross domestic product. It appears that trade’s contribution to growth will likely be revised upward to close to one percentage point.

While the narrowing trade deficit was a pleasant surprise, the drop in exports was a source of concern, as it likely reflected slowing economic growth in Europe, our major trading partner. With crude oil futures climbing past $126 a barrel on Friday, record high oil prices remain a hurdle to improving the trade balance despite lower oil demand.

Activities in the service industry also improved in April, according to the Institute for Supply Management Nonmanufacturing Survey. The nonmanufacturing index increased to expansion territory for the first time in four months.

Nonfarm productivity growth was strong in the first quarter despite weak economic growth as the number of work hours declined. The growth of unit labor costs decelerated in the first quarter, showing that labor costs are contained and exerting no inflationary pressure on the labor markets.

The housing market has shown little sign of stabilization. The Pending Home Sales Index from the National Association of Realtors, which is based on signed contracts for existing single-family homes, condos and co-ops, fell in March for the second consecutive month. Combined with the Mortgage Bankers Association purchase applications index, which dropped in March and April, the decline in pending home sales suggested continued weakness in home sales in the near term. Both the Pending Home Sales Index and the purchase applications index are considered leading indicators of home sales because signing a home contract and applying for a purchase mortgage both generally precede the closing of a home by one to two months.

Tightened lending standards were one of the main reasons that kept many potential homebuyers out of the market. The mortgage market continued to experience stricter standards during the first quarter, according to the Federal Reserve's Senior Loan Officer Opinion Survey. What began as more stringent lending standards for subprime and nontraditional residential mortgage loans, in the beginning of 2007, have spilled into the overall mortgage market, including prime mortgages. About 62 percent of banks tightened standards on prime mortgage loans, compared with about 53 percent in the January survey. The April survey also showed a broadening credit crunch from residential and commercial real estate lending to other household and business lending.

The April survey released on May 5 was available to the Federal Open Market Committee (FOMC) on April 30 when it cut the federal funds rate by a quarter percentage point. While the Fed appeared to be less pessimistic about economic conditions, according to the post-meeting statement, it acknowledged that financial markets remain under a great deal of stress. It also warned that tight credit conditions and the deepening housing downturn will likely weigh on growth for the rest of the year.

Long-term interest rates declined last week. Financial concerns and rising commodity prices continued to weigh down investors. The yield on 10-year Treasury notes stayed around 3.77 percent by mid-Friday afternoon, 12 basis points lower than the rate on the previous Friday.

Housing and Mortgage Indicators:
The Federal Reserve Senior Loan Officers Opinion April Survey tracked demand for consumer and business loans, and the lending conditions on them, for three months, ending in mid-April. The survey showed that lending standards are now tighter on most types of credit, including business, credit card and other consumer loans, residential and commercial real estate loans as well home-equity lines of credit.

The mortgage market continued to experience stricter standards in the first quarter. What began as more stringent lending standards for subprime and nontraditional residential mortgage loans, in the beginning of 2007, has spilled into the overall mortgage market. About 62 percent of banks tightened standards on prime mortgage loans, compared with about 53 percent in the January survey. Banks also made lending standards more stringent for subprime mortgage loans, with about 78 percent of banks reporting an increase in standards, slightly more than the 72 percent reported in the January survey. For nontraditional mortgage loans, 76 percent reported that they had tightened standards, declining from 85 percent in the previous survey.

For commercial real estate, nearly 80 percent of banks said they had tightened lending standards, slightly down from 80.3 percent in the January survey, which was the highest share since the Fed began the survey in 1990.

In response to special survey questions on home-equity lines of credit, 60 percent of banks had tightened their standards and nearly half had tightened terms on existing loans. The main reasons were declines in home values (which have put the equity in the home below the collateral requirement), increased defaults and changes in borrowers' finances.

The National Association of Realtors’ (NAR) Pending Home Sales Index showed that the number of potential homebuyers signing contracts to buy previously owned homes declined in March. The index fell 1.0 percent to 83 after a drop of 2.5 percent in February. This is the lowest reading since the index’s inception in 2001. The index was down 20.1 percent from last March.

Economic Indicators:
The Institute for Supply Management (ISM) nonmanufacturing index rose to 52.0 in April from 49.6 in March. This was the first time in four months that the index showed a reading above 50, indicating an expanding service sector.

Nonfarm business productivity growth accelerated to 2.2 percent (seasonally adjusted annualized rate) from 1.8 percent in the fourth quarter. Unit labor costs rose an annualized 2.2 percent in the first quarter, up just 0.2 percent from a year ago.

The trade deficit in goods and services narrowed to $58.2 billion in March from $61.7 billion in February. Crude oil prices increased $5.09 per barrel in March, increasing the total import oil by $33.15 billion despite a lower volume.

The largest decreases in imports were concentrated in automotive vehicles, parts and engines and industrial supplies and materials. The decreases in exports were largely in capital goods and automotive vehicles, parts and engines.