THE LATEST SIGNS SAY THIS RECOVERY HAS STAYING POWER
What do you get when you cross the largest increase in final sales in four years with a big liquidation of inventories? Answer: a recovery. That's exactly what happened in the first quarter. The combination almost guarantees a pickup in output in the second quarter that will fuel growth in jobs and incomes and keep the upturn on track.
Real gross domestic product rose a modest 2%, at an annual rate, last quarter. That number will be revised twice, but for now, it means that the pace of economic growth was the fastest in three years. The best news, though, was that spending by consumers, businesses, government, and foreigners jumped 4.8% (chart).
The huge imbalance between demand and output led to a $26.1 billion decline in business inventories last quarter. That drawdown clearly left stockpiles extremely thin as the second quarter got under way. Many companies will have to gear up production, if only to replenish their depleted inventories.
Some early signs of just such a pickup are beginning to crop up. The Commodity Research Bureau's index of raw-materials prices jumped more than 6% from late February to late April, after trending downward for a year and a half. Rising commodity prices typically accompany inventory rebuilding as industrial demand strengthens.
Another sign of peppier output is the three-week drop in new jobless claims to an annual rate of 404,000 for the week ended Apr. 11. Claims have not fallen for three weeks in a row since last August. The decline so far already suggests a rise in April payrolls. A further slide below 400,000, a level that last year's recovery attempt failed to penetrate, would be strong evidence that the job market--and the economy--are turning around for good.
The classic mix of strong demand and low inventories has fueled many a recovery, but this upturn is also classic because it is consumer-led. Real consumer spending rose at an annual rate of 5.3% in the first quarter, fueled partly by lower interest rates and mortgage refinancings that put more cash in people's pockets. That gain was also the largest in four years, and it accounted for three-fourths of the quarter's growth in final sales.
Don't count on consumers to spend at that pace in coming quarters, though. Real aftertax income rose at an annual rate of only 3% last quarter, meaning that consumers dipped into their already skimpy savings to finance their outlays. Savings as a percentage of aftertax earnings fell from 5.2% in the fourth quarter to 4.7% in the first quarter, the lowest rate in 2 1/2 years.
Still, real income was on a rising trend through the first three months, although a temporary jump in farm-subsidy payments accounted for much of the March gain. And if job growth this spring meets expectations, household spending will be able to rise further, though less robustly, in the second quarter.
Consumers are obviously feeling better about the economy and their future. The Conference Board's index of consumer confidence rose strongly for the second consecutive month in April. It was up 8 points, to 64.8, the highest reading in seven months.
While households are still somewhat uneasy about their present situation, they have greatly improved expectations for the next six months (chart). The Conference Board says that the two-month jump in the expectations index, a reliable forecasting gauge, suggests that the economy is in the early stages of a recovery.
Although consumers still complain about current employment conditions, fewer of them are doing so. The proportion of households that rate jobs as "hard to get" has declined for two consecutive months, after a steady rise. Moreover, people are a good deal more optimistic about the job outlook.
Except for consumer spending and inventories, there was little other action of note in the first-quarter GDP report. Housing, state and local spending, net exports, federal nondefense purchases, and outlays for business equipment--listed by the size of their contribution--rounded out the gain in final sales.
Defense spending was a downer last quarter, as was business investment in buildings and other structures. It posted the seventh drop in the past eight quarters, reflecting the glut of commercial buildings.
With sales up, businesses are also more confident about the future. Their bottom lines are already perking up. Corporate profits last quarter were generally better than expected, reflecting the surge in demand.
Manufacturers seem ready to enjoy their share of better times. New orders for durable goods rose 1.6% in March. The three-month average of orders, which smooths out the monthly gyrations, also rose in March after declining steadily since last September. Auto production is set to rise considerably in the second quarter, according to Detroit's schedules. As usual, that will provide a broad lift for the factory sector.
The only red flag in manufacturing is the persistent decline in unfilled orders. They fell 0.6% in March, the seventh consecutive drop. Factories will not feel confident enough to boost output and payrolls until their order backlog starts to rise. New orders will have to make further gains for that to happen.
Homebuilders are also doing better, though not as well as the early-year numbers had suggested. Sales of new single-family homes plunged 14.8% in March, to an annual rate of 513,000 (chart). The drop was the largest in 10 years, but sales were erratic last quarter.
In January and February, excitement over the now-defunct tax credit for first-time buyers and warm weather boosted sales. In March, the absence of those factors, plus a slight uptick in mortgage rates, hit sales hard. Still, first-quarter sales were 4.8% above the fourth-quarter level. And for the week ended Apr. 24, 30-year mortgage rates averaged below 9%, a level that will support rising demand.
FLAT ON ITS
Although long-term rates are still high, mortgage rates are not likely to rise inordinately as long as the inflation outlook remains so rosy. Despite growing evidence of a true recovery, price wars among domestic competitors are breaking out (page 36). That's a reflection of excess capacity in many industries. Some companies are trying to grab market share by cutting prices.
More direct measurements also show that inflation is on the wane. The Commerce Dept. reported that its GDP fixed-weight price index, one of the broadest gauges of inflation, rose at an annual rate of 3.1% from the fourth quarter to the first quarter. Measured from a year ago, that means inflation using this index is running at 2.8%. That's down from 4.5% a year earlier.
The slowdown in labor costs is a chief reason why inflation pressure continues to abate. The Labor Dept.'s employment cost index, which measures wages and benefits of civilian workers, rose at an annual rate of 3.6% in the first quarter, the same as in the fourth quarter. Benefits are still the fastest-rising component of labor costs.
Measured from the same quarter a year ago, labor costs are up only 3.9%. That's down from 4.6% last year and from 5.3% the year before (chart). The rebound in productivity growth that typically accompanies a recovery will enhance the inflation impact of this moderation as 1992 wears on. A productivity pickup will allow unit labor costs to slow as well, and unit costs determine price pressures.
Meanwhile, the bonus for households is that, despite the slowdown in wages and benefits, inflation has slowed even more, allowing purchasing power to rise.
Stronger demand--especially from consumers--and low inventories are classic business-cycle gasoline. Lower inflation and interest rates than a year ago are the oxygen that will keep it burning. The spark, however, has to come from job growth. If the early employment indicators are right, the resulting fire should heat up the economy right into 1993.JAMES C. COOPER AND KATHLEEN MADIGAN