It's easy to be pessimistic right now. Important data are headed south, and there was a note of urgency in the Federal Reserve's surprise interest-rate cut. Stock prices have given up all of their post-rate-cut surge. Investors are still fretting about profits. And some of Wall Street's top economists are concluding that the economy is already in recession.
Although things may look bleak, don't join the funeral procession just yet. In fact, given the Fed's aggressive and preemptive action on Jan. 3--and its strong hint that more is on the way--now is the time to look up from the valley of slow growth to better economic times in the second half. Moreover, the trek through the first half may not be so treacherous.
Consider the December employment report. Job growth and hours worked have softened, reflecting a cooler pace of domestic demand. However, weakness in manufacturing is skewing the overall results (chart). And the unusually steep drop in factory hours worked in December reflects the severe winter weather, especially in the Midwest, which cut into the month's industrial production.
To be sure, the data of the next few months will not look especially encouraging. The seeds of this slowdown were sown by the Fed's rate hikes of 1999 and 2000, the drop in stock prices, and the rise in energy prices, all of which drained consumer and business buying power. Those drags on growth won't go away anytime soon, especially given the recent spike in natural gas prices. But so far, the reality of the economy's weakness has not matched the downbeat perceptions of households, businesses, and investors.
THAT'S THE BIGGEST PROBLEM for the outlook right now, because sentiment is so important to profit expectations and the stock market, and stock prices have never been so important to consumer and business spending. The threat of a vicious downward spiral in economic activity will continue to hang over the economy until data and attitudes clearly perk up.
For consumers, future trends in sentiment will depend greatly on the state of the labor markets. That's why the sluggish job growth for December suggests faltering consumer confidence this quarter. But the job data are not signaling a broad economic collapse. Private-sector payrolls grew by a mere 49,000 jobs in December, but manufacturing payrolls plunged by 62,000 last month, while private service-sector payrolls increased by a healthy 127,000.
The manufacturing layoffs are not surprising given that the factory sector is in recession. But the weather was also a factor. The average factory workweek shrank by 48 minutes in December, to 40.4 hours. That's the largest decline since the blizzard of January, 1996. The workweek doesn't fall that much in a recession--only during strikes, storms, and other unusual circumstances.
Inclement weather also hit December construction, the Labor Dept. said. And to some extent, retail activity was hurt as well. Indeed, retail buying in the first week of January bounced back quite strongly, based on store surveys. Snow may also skew the first-quarter data. After two mild winters, normal seasonal conditions could make the data look poorer than warranted.
NONETHELESS, there is hope that the manufacturing downturn will be short-lived, not only because the Fed has moved decisively but also because excess inventory accumulation should be corrected quickly (chart).
Technology and globalization have combined to change the inventory cycle that once plagued manufacturing and magnified economic swings. First, computers have streamlined inventory management, assuring that unintended buildups of goods are smaller and more quickly eliminated at less cost to economic growth. That factory activity has fallen off so fast suggests that any inventory problem is being rapidly addressed. Second, the U.S.'s dependence on imports has a beneficial side. When U.S. demand falls, an increasing amount of the excess stores builds up overseas. So the pain of the inventory correction inflicted on production and employment is partly shifted to foreign producers and away from U.S. manufacturers.
Inventory-related cutbacks in output and jobs in the auto industry and related sectors are a big part of the manufacturing sector's weakness. Auto inventories began to build up as demand slowed. In the first quarter of 2000, sales of light vehicles averaged a record annual rate of 18.2 million. By the fourth quarter, sales were down to a still respectable 16.2 million.
But overproduction meant a lot of vehicles were left parked on dealers' lots, leading to layoffs and plant closings. The biggest declines in December factory payrolls occurred in motor vehicles and parts, rubber and plastics, and metals. If demand rebounds--and lower interest rates and incentive programs will help--then the auto industry's drag on growth will wane.
OUTSIDE OF MANUFACTURING, the situation is more sanguine. In the broader service sector, job growth has slowed, but the gain averaged 109,000 jobs per month in the fourth quarter. That's down from 158,000 in the first three quarters, but it's not bad. Also, service payrolls suffered a 78,000 plunge in temporary workers. That was the biggest decline on record, and it's difficult to determine how many of those jobs were layoffs of contingent workers in the factory sector.
Total hours worked in the private-service sector actually accelerated in the fourth quarter, another sign that activity there is still healthy. But the drop in hours worked in the goods-producing sector caused a small decline in overall worktime. That means all of the economy's growth last quarter came from productivity.
The long-run pickup in productivity, though, could eventually hurt household confidence. If the economy's sustainable growth rate has risen to the 3.5%-4% range, then the unemployment rate will rise at a higher rate of economic growth. That is, a slowdown to, say, 2% growth will generate much more unemployment than that growth rate would have in the early 1990s, when sustainable growth was closer to 2.5%.
True, the December jobless rate held at a low 4%. But the recent jump in initial claims for jobless benefits and the rise in the unemployment rate for those claimants suggest that joblessness will begin to increase soon, perhaps as early as January (chart).
But there is room for optimism. Housing is holding up, buoyed by low mortgage rates, and appears to have contributed positively to fourth-quarter economic growth. Oil prices are down from their highs of last year, and energy costs are likely to ease after the winter. Most important, policymakers have made it clear they stand ready to help the economy. And if the Fed is leading the pack, the journey through the valley of gloom may not be so dire or so long as the pessimists fear.