When the Commerce Dept. first reported the second quarter's weak economic growth, economists said not to worry. Their argument: The mix of sturdy demand and a slowdown in inventories implied good things about future growth. The way the third quarter is shaping up, you can get ready for the same spiel.
Based on the third-quarter data available so far on consumer spending, construction, and personal income, and on the implications from the latest purchasing managers' report, real gross domestic product last quarter appears to have grown at an annual rate of about 2.5%, up from 1.3% in the second quarter. The final number will depend greatly on what Commerce estimates for inventory growth and net foreign trade--two sectors of the economy for which there are little third-quarter monthly data available.
What's clear is that demand by consumers and businesses held up well. Real final sales probably advanced close to their 3.4% pace of the second quarter. Rising aftertax incomes, good job gains, and a surge in August car buying combined to lift consumer outlays. And while business investment in equipment slowed, outlays for nonresidential building took up some of the slack in investment.
At the same time, businesses kept whittling away at their excess inventories. The rebound in industrial output suggests that whatever surplus merchandise that had built up was sold off by the end of September (chart). Inventory adjustment no longer will be a significant drag on GDP growth in coming quarters. In fact, Commerce's monthly data show that manufacturing inventories held steady in August.
This mix of resilient demand and stable inventories is why the outlook for the fourth quarter and beyond suggests the economy will be stronger than its 2%-or-so pace during the first three quarters of 1995.
IMPROVING GROWTH PROSPECTS were a key reason why the Federal Reserve held rates steady at its Sept. 26 policy meeting. In fact, as far as future policy decisions go, the economy's health and inflation seem likely to take a back seat to the federal budget debate.
That was the implication from the recently released minutes of the Fed's Aug. 22 meeting. The report said that "consideration would need to be given to an adjustment in the committee's policy stance, especially if substantial fiscal restraint were to be enacted."
Such an overt statement might have been directed at Congress and the White House, rather than at the financial markets, the usual target of arcane Fedspeak. The Fed appears to have been extending the carrot of lower rates if Washington can put together a credible package of deficit reduction.
The Fed next meets on Nov. 15, two days after the expiration of the current continuing resolution, which is temporarily funding the government. Unless a budget agreement is hammered out by then, the Fed seems likely to leave policy on hold yet again.
IF THE LATEST DATA were the only factor in the Fed's thinking, you could start putting away your hopes for another rate cut. They suggest that, just when the maximum impact of past rate hikes is coming to bear, the economic outlook is gradually improving.
For example, throughout this year's slowdown, consumer spending has been resilient. That has been a key factor helping businesses restore balance to their inventories. Consumer spending on goods and services, adjusted for inflation, surged 0.8% in August. Even if September outlays were flat from August, real consumer spending for the third quarter will have risen at an annual rate of 3.5% (chart).
A jump in car sales accounted for most of the August increase. Excluding motor vehicles and parts, real outlays rose only 0.2%. Car sales in September appear to have cooled off from August's 15.7-million annual pace. However, the strike at Ryder Systems Inc., the trucking company that delivers a lot of Detroit's vehicles--especially for General Motors Corp.--depressed sales.
Nonauto sales seem to have held firm in September, judging by the weekly survey of department and discount stores by Johnson Redbook Service. Through Sept. 30, the Redbook tally shows a 1.4% sales gain from August.
One reason is healthy income growth. Although personal income was flat in August, and real aftertax earnings were down slightly, strong gains in both June and July mean that third-quarter income still scored a good gain. The bad news for retailers is that shoppers still head for the sale tables first.
For manufacturers, the pickup in consumer demand is allowing inventories to adjust more quickly, paving the way for faster production and hiring.
In fact, that shift may already be occurring, according to the September survey of the National Association of Purchasing Management. The NAPM's overall index edged up to 48.3% in September from 46.9% in August. The index is still below the 50% mark, indicating the factory sector remains lackluster.
However, the sluggishness can be traced to a big drop in the inventory index, which fell from 45.2% in August to 40.8% in September, the lowest reading in nearly four years. The NAPM said that its other indicators of factory health--output, new orders, and employment--picked up in September. A busier factory sector in September is also indicated by the BUSINESS WEEK production index. Also, the NAPM's index of prices paid fell for the eighth month in a row.
OF COURSE, CONSUMER SPENDING is not the sole reason to expect the economy to pick up steam. Business investment and housing also added to growth in the third quarter and should help out in coming quarters as well. Business equipment investment showed some weakness in the third quarter. But after growth rates averaging 18%, a pause is not unusual.
However, businesses are spending more on new construction. Total new outlays for building projects slipped an unexpected 0.2% in August, but that followed jumps of 0.9% in June and 1.6% in July. Even after adjusting for prices, construction staged a comeback in the summer (chart). Most of that bounce came from commercial real estate projects, especially retail space.
In addition, home buying has held up surprisingly well, given the tight stance of Fed policy, and that demand has kept homebuilding afloat. New single-family home sales fell 9.6% in August to an annual rate of 710,000. But the drop reflected a strong revision in the July sales rate from 715,000 to 785,000.
So far, the third-quarter new-home sales pace is far above the second-quarter rate. That has helped to clear out the supply of unsold homes--another example of inventory adjustment within the economy.
While the monthly numbers have looked a bit uneven--a key reason why the markets have roller-coastered--the summer data echo the spring. The economy may not look too exciting, but as most economists will tell you, there's not much reason to worry, either.