Ready For Takeoff, But Still Bouncing Down The Runway

The recovery keeps gyrating like a dancing mummer: two steps forward, one step back, with some erratic twirls in between. The economy is likely to continue this bob-and-weave pattern, but the forward pitch should be enough to keep the recovery on track.

In the latest set of conflicting data, the economy's upward thrust came from gains in industrial output and business inventories. But housing produced a surprisingly strong drag in April. The foreign trade sector--a star contributor to the economy in 1991--is unlikely to offer much help this year, as a pickup in imports offsets growth in exports. As a result, trade will neither add to nor subtract much from future economic growth.

The mixed data are why some analysts think the Federal Reserve Board considered easing one more time when it met on May 19 to set monetary policy for the next seven weeks. But even with another cut in interest rates, it will take some time before the economy hits a smooth upward stride. More importantly, perhaps, job growth will have to pick up before consumers feel secure enough to boost their spending.

Certainly, the 17% plunge in housing starts in April, to an annual rate of 1.12 million, was a signal that the economy may need some more help (chart). The drop showed up in all types of housing and across all regions. In particular, starts of multi-unit projects fell 42.8%--the largest monthly decline in 29 years of record-keeping.

The drop in apartments, though, was less jarring than it first seemed. Multi-unit starts had soared 73.4% in March, so the April reading simply returned apartment building back to a lower, more sustainable pace. Apartments are in oversupply in many regions, so the construction of new projects will be modest this year.


April's decline in single-family homes is much more worrisome to the outlook. The 10.6% drop was the second in a row in a sector that has been a vital energy source in this recovery. The question now is whether the housing upturn took a breather or hit a brick wall in April.

Homebuilders, at least, remain upbeat. Members of the National Association of Home Builders report that sales and buyer traffic in May fell only a bit from their very high April levels. And 38% of builders expect single-family home sales to be good for the next six months, while only 12% expect sales to be poor. Even sales of townhouses and condominiums are expected to improve slightly into the fall, says the NAHB.

The swing in interest rates is another reason to believe that April was only a pause. The falloff in single-family starts was probably caused by rising mortgage rates. The average rate on a 30-year fixed mortgage stood above 9% in early April. That's high enough to push some consumers out of the housing market.

Now, however, according to HSH Associates, mortgage rates are back to 8.68%. That's the lowest rate since late January. Lower borrowing costs mean that demand for homes should revive. Indeed, during the week of May 8, applications for mortgages for home purchase rose for the first time in two months.


Even as homebuilders were catching their breath in April, the industrial sector was forging ahead. Output at the nation's factories, mines, and utilities rose by 0.5% for the month. That was the third consecutive gain in activity, helping industry to recoup almost all of the losses of the fall (chart). In coming months, the industrial rebound should be helped by the need to rebuild business inventories, and by modest growth in exports.

Factory output was up 0.5% in April, after a 0.4% rise in March. Auto makers helped to lift total production in April. New cars were assembled at a 5.9 million annual rate, up from 5.2 million in March. But other factories are also buzzing. Makers of furniture, paper, and business equipment--especially computers--all increased output by more than 1% in April.

Producers of construction supplies saw their fourth consecutive rise in output with a 0.6% advance in April. Makers of glass, wood products, and plumbing equipment are benefiting from the housing recovery.

Starting off the second quarter, industrial production stands a strong 4% above its first-quarter average, at an annual rate. And if the latest survey from Dun & Bradstreet Corp. is an indication, industrial output should be able to make further gains in coming months.

According to a D&B survey of 1,000 companies, manufacturers saw improvement in business conditions in April, with good news in production, unfilled orders, and exports. The D&B reading of expectations for the coming three months remained unchanged in April, after four consecutive monthly increases. In particular, the high readings of expectations about new and unfilled orders bode well for future increases in output.


The gains in output haven't overburdened factories yet. Capacity utilization for all industry rose to 78.7% in April, from 78.4% in March. And factories used 77.7% of capacity in April, up from March's 77.5%. Operating rates have inched up by nearly one percentage point since hitting a nine-year low in January. This rise means that industry is on the mend, but capacity is not nearly tight enough to send warning signals about inflation.

Factories should get a little boost this summer if businesses feel the need to build up inventories in response to better sales. In March, stockpiles held by manufacturers, wholesalers, and retailers grew by 0.4%, after no change in February. But business sales were up by a slightly faster 0.5% in March, following a 1.5% jump in February. As a result, the ratio of business inventories to sales fell slightly to 1.49--the lowest reading in 1 1/2 years (chart).

Retail inventories expanded by a large 0.8% in March, but some of that buildup may have been intentional, in anticipation of Easter shopping in April. Indeed, retail sales jumped by 1% for that month, suggesting some decline in store inventories.

Moreover, the government's annual revisions to retail sales, to be released during the week of May 26, should show consumers shopped more than it first appeared. The Commerce Dept. says that the level of retail sales over the past year will likely be revised higher, so retailers may feel more confident about stocking more goods.

American products are not the only items packed into retail warehouses, however. Increased domestic demand is also drawing in goods from abroad. That means that import growth will accelerate at the same time that U.S. export gains are likely to be very subdued because of slumping economies abroad. So, foreign trade--which kept the economy from falling more than it did in 1991--won't be much help to the recovery this year.

Rising imports caused a wider trade deficit in March. The trade gap increased to $5.8 billion, from $3.3 billion in February. Imports were up by 4.5%, to $42.8 billion in March. But exports fell 1.8%, to $37 billion.

Recovery in the U.S. is once again opening the import spigot. Imports are running 11.1% higher than their pace of a year ago. That's faster than the 8.2% rise in exports over the past 12 months (chart). Import growth hasn't surpassed the gain in exports since 1989. But if domestic demand continues to grow--even modestly--this year, import gains will also increase.

Exports, meanwhile, will be hard-pressed to keep up with the faster pace of imports. That's because of recessions in some industrialized countries. True, U.S. companies have been successful in exporting to developing countries in Latin American and the Pacific Rim, but those gains are only modestly offsetting the stagnation in U.S. shipments to Europe and Japan.

Exports won't add as much to the economy as they did in 1991, but other sectors should take up the slack. A pickup in industrial output, a second wind in housing, and the rebuilding of inventories will provide the economy with a few new dance steps--and keep the recovery gliding along for the rest of this year.

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