By Michael Englund
A heavy load of data releases in early August, 2002, brought the U.S. economic outlook into sharper focus. And the markets didn't like what they saw: Updates showing weaker-than-expected gross domestic product (GDP), personal income and consumption, and labor market conditions led many observers to conclude that the economy was poised to slide back into recession. Stocks plummeted, while investors flocked to the relative safety of U.S. Treasuries, pushing yields to record lows.
At S&P MMS, we think the recent statistical barrage showed that the chances for upside surprises for economic growth in the months ahead have been sharply reduced. Clearly, downside risk to the economy has increased to some degree, though the financial markets seem to have over-emphasized this prospect. But despite renewed warnings of negative wealth effects -- where falling stock prices crimp consumer spending -- the biggest potential negative for the economy remains the possibility of a sizable new terrorism shock.
SLIM CHANCE OF A CUT.
Prospects have changed only modestly for our view of the economy's growth trajectory through early 2003. The consensus forecast of slow-but-steady growth -- which always seems painfully at odds with the normal volatility in the quarterly GDP figures -- is still the most likely scenario.
What does this all mean for Alan Greenspan & Co.? Well, the Federal Reserve has been granted plenty of time to tighten policy, despite a solid growth rate and the inevitable need to eventually bring monetary policy back to "neutral." It looks as though Fed policymakers are going to remain on hold for an extended time, much like the 1992-94 period, given the recent data.
We at S&P MMS have shifted our call for a Fed policy tightening out to late in the 2003 second quarter from early in the first. Though there's a growing belief in the market that the Fed may actually be preparing to cut rates amid the weak data and sinking stock market, we see little chance of that happening.
From the mountain of data in the most recent reports -- the GDP report contained revisions stretching back to 1999 -- a few key insights can be gleaned. First, the recession in 2001 was more substantial than reported at the time. The mix of data in the GDP report now tells a more consistent story of an economy that was soft throughout 2001, rather than one with patches of weakness in different parts of the year for different components. Consumption weakness led the recession rather than lagged it, as is typical, and the cyclical downturn in corporate profits and fixed investment became more pronounced.
Secondly, the economy was weaker in the second quarter of 2002 than was previously thought, with no signs from the factory sector that a sharp acceleration in activity is imminent. Though business investment typically lags the economic cycle, the apparent outright weakening of the sector in the early July reports is problematic: It reduces the likelihood that any near-term surge in manufacturing will boost reported economic growth above market estimates. The lack of improvement amid a freefall in most inventory-to-sales ratios seems strange, though the widespread pessimism in the equity markets may explain some delay in corporate plans to ramp up production in line with the typical historical pattern.
Third, the dichotomy of strength in household spending and retail sales alongside massive weakness in business fixed inventory investment remains intact. The auto-sales data indicate a robust rise in spending in July, following solid figures in June. And the runup in the savings rate suggests that the strong sales trajectory has not prevented consumers from taking a more cautious approach to their own balance sheets.
REASON FOR CONCERN? Finally, the July data have revealed the mixed result of solid sales despite production weakness concentrated in the factory sector, so the sharp drop in the average workweek seen in the July jobs report is not quite as troubling. With strength in sales, production must follow.
The overall message from the early August, 2002, reports is that a soaring economy in the second half of the year with upside shocks to inflation is no longer a risk, as long as oil prices remain relatively stable. The economy is still likely to post healthy growth in the third and fourth quarters of a 3.5% to 4% annual rate, but the diverse mix of data, and the lack of meaningful job creation, will sustain ongoing concern in the markets of a double-dip recession.
Englund is chief market economist for Standard & Poor's/MMS International
Edited by William Andrews