As far as the economy goes, the new year may not offer much to celebrate—at least for a while. The fallout from the subprime debacle is still hitting the financial markets, and the investment climate for 2008 remains touch-and-go. That's because of the uncertainty surrounding the two biggest risks in the outlook: a credit crunch that would put a broad squeeze on spending by both businesses and consumers and a continued sharp decline in home prices that would pinch households even further.
The latest data, while far from reassuring, are not dire. They suggest the economy is slowing sharply from its 4.4% average annual clip, in 2007's middle two quarters. But they also allay some recession fears. Worries that real gross domestic product posted an outright decline in the fourth quarter, perhaps signaling the onset of a recession, have abated. Sluggish growth of 1% or 2% now looks likely, and a big round of thanks for that buoyancy goes to U.S. consumers.
Despite $3-per-gallon gasoline, falling home prices, and tighter credit, the broadest gauge of inflation- adjusted outlays for both goods and services rose 0.5% in November, and consumer confidence ticked up in December. Even if December buying holds steady or dips slightly, as recent lackluster reports on store sales suggest, fourth-quarter spending still will grow close to the 2.8% annual rate of the third quarter, providing a major pillar under overall growth. Many analysts had feared outlays would stagnate or even drop.
Housing is another story. Through November, housing starts had fallen 30%, at an annual rate, from their third-quarter average. That means residential construction is guaranteed to subtract a full percentage point or more from the quarter's economic growth. Moreover, November sales of new homes plunged 9% to a 12-year low. Starts still have further to fall, relative to sales, before builders' inventories get closer to their typical levels. That may not happen before midyear, and house prices, down sharply for existing homes in October, will take much longer to bottom out.
Yet what poses the greatest danger to the economy over the next few months may be neither housing nor consumers but the business sector. The combination of stronger exports and weaker imports once again contributed to positive fourth-quarter growth, but companies seem increasingly concerned about activity here at home. If companies get a bad case of the jitters about weak future demand and tighter financial conditions, they might sharply rein in their expansion plans. Job gains and the income they have generated have been the key to consumer resilience in recent months.
The latest signs raise a caution flag, especially the report from purchasing managers in manufacturing noting sharply worse business conditions in December. New orders for capital goods, outside of defense and commercial aircraft, fell in November for the second month in a row. These orders represent commitments to the future and, as such, are a good gauge of business confidence. Overall plant and equipment investment in the fourth quarter appears to have slowed for the second consecutive quarter. In the past there has been a tight correlation between capital spending and hiring.
As for jobs, the upward trend in new unemployment claims since August, when the financial market turmoil erupted, is not comforting. Weekly jobless claims data from mid-December to mid-January tend to be volatile due to holidays and weather, but they are averaging 343,000 in December, and the average is up in every month since August. Also, the total volume of claims has risen sharply in recent weeks, suggesting that a growing number of the newly jobless are not finding work.
While fears of a disastrous fourth quarter have faded, the real test is shaping up to be the first quarter of 2008. The economy will have to get past that challenge before the outlook for the remainder of the year can start to look a little brighter.