This Summer's Growth Will Hardly Be Overheated

If you're looking for a way to beat the summer heat, take a cue from the U.S. economy: Just slow down and take it nice and easy.

Much of the data show that growth is cooling off. The leading indicators have gone nowhere for the second month in a row (chart). The second-quarter pace of consumer spending fell sharply. Construction did rebound from its weather-depressed performance in the first quarter, but higher interest rates will put a chill on some new projects in the second half. And with domestic demand a bit more laid-back, factories are gearing down a notch, as well.

It's not that the economy is wasting away in Margaritaville. On the contrary. During the past year, growth has averaged about 4%, pumped up by the 7% surge at the end of 1993. In the first quarter of 1994, growth moderated to 3.4%, says the Commerce Dept.'s final reading of real gross domestic product, which was revised up from 3%. Second-quarter GDP looks to be about 3%, and that moderate pace, or a bit less, should prevail in the second half.

If that scenario plays out, the economy's headway will be sufficient to generate about 2 million jobs this year, enough to keep consumers spending and factories humming. But growth will not be so hot as to fire up inflation, and that will please the Federal Reserve and hearten the financial markets.


Right now, though, manufacturing is not bustling the way it was a few months ago. Order books are not filling up as fast, production lines are running more slowly, and factories are still keeping inventories and payrolls on a short leash, as consumer demand for cars, trucks, and other durable goods has eased back a notch.

Factory orders for both durable and nondurable goods rose 0.6% in May, after a 0.2% increase in April. But so far in the second quarter, order growth has fallen well below the pace in each of the two previous quarters.

Some of the slippage in manufacturing reflects a seasonal slowdown in autos, as carmakers shut down production lines to retool for the new model year. Vehicle output should pick up in the third quarter, as the changeovers are made, especially since spot shortages of some popular models have trimmed Detroit's inventories to very low levels.

In fact, overall factory inventories are extremely tight in relation to demand. Stock levels rose 0.5% in May, the fourth increase in the past five months, but shipments also rose 0.5%, leaving the ratio of inventories to shipments at a historically skimpy 1.39. However, that low reading says more about manufacturers' improved inventory control than it does about the inadequacy of current stock levels to meet demand.

Activity in the factory sector remained solid in June, says the National Association of Purchasing Management, but its growth rate did ease a bit. The NAPM's composite index edged down to 57.5% from 57.7% in May. The index has been about flat since January, suggesting that growth is no longer picking up the way it was in the second half of last year.


The NAPM's report did contain an inflation warning, however. Its index of prices paid rose to 73.5%, the highest percentage of companies reporting price increases in about six years (chart).

At the same time, the percentage of companies reporting a slowdown in delivery times remained near a six-year high, a sign that several industries may be close to their capacity limits. By and large, the same industries that showed slower deliveries also reported higher prices.

But it's not as worrisome as it sounds. The NAPM's price measure is a diffusion index, meaning that it measures the breadth of price increases among industries, not their magnitude. Also, the hikes are concentrated in raw materials, mainly reflecting the recent runup in commodity prices.

Whether these hikes ever reach consumer inflation is still an open question that will not be answered until 1995. But even this summer, the consumer price index bears watching because of the government's new seasonal adjustment process. Compared with past patterns, the readjustment tends to moderate CPI increases in the winter, but it may well amplify them this summer. June data are due on July 13.

Of course, one sector of the economy is enjoying the summer heat: construction. Builders suffered this winter, especially in the East. But even with interest rates rising, building bounced back in the second quarter, and it should add a kick to the quarter's real GDP growth. Real construction spending rose 0.9% in May, and so far in the quarter, outlays are rising at a 8.7% annual rate, following a 2.9% drop in the first quarter (chart).

However, don't expect construction to be a big lift to growth in the second half. New building contracts, a leading indicator of building outlays, are down nearly 14% so far in the second quarter, compared with the first-quarter level. New contracts rose 4% in May, although residential deals fell 2%, according to the F.W. Dodge Div./ McGraw-Hill Inc.


Consumers may also be less of a contributor to growth in the second half. After three quarters of 4%-plus spending growth, consumers may have deserted the shopping malls in favor of the beach.

In fact, shoppers started to rein in their spending in the spring, despite solid income growth. Personal income rose 0.6% in April and in May. And after a bigger-than-usual tax bill cut into disposable income in April, real aftertax earnings jumped 1% in May. That means real income grew at a healthy 3.9% rate in the first two months of the second quarter.

Despite this extra money, consumer spending fell 0.6% in April and rose just 0.2% in May. As a result, real outlays are nearly flat so far in the second quarter. June spending will have to rebound by a huge 1.1% to push outlays up by a modest 2% rate for the quarter. And even that pace would be one of the slowest in this expansion.

A strong June push isn't out of the question. Some Eastern states experienced one of the hottest Junes on record, which probably increased spending on summer clothing and other hot-weather items, such as air conditioners. The Johnson Redbook Report noted that sales at department stores and chain stores increased 3.5% in June from May.

Car dealerships didn't do as well, however. Sales of U.S.-made cars and light trucks stood at an annual rate of 12.3 million in June, from 12.6 million in May. Softer vehicle demand reflects some spot shortages of models and the overall slowdown in durable-goods spending, which fell 1.4% in May, the second decline in a row (chart).

Besides vehicles, demand for appliances and furniture is also tapering off. The higher cost of credit, the slowdown in housing, and the absence of mortgage refinancings are all cutting into spending. So, too, after two years of double-digit growth in durable-goods purchases, households have satisfied most of the pent-up demand from the 1990-91 recession.

Instead of buying cars and carpeting, consumers are adding to their nest eggs. Personal savings as a percent of disposable income rose to 4.7% in May, from 3.9% in April. The savings rate is now at its highest in more than a year. And with job and income growth healthy, consumers can save more while still keeping their spending on the rise.

A steady but slower uptrend in consumer spending ensures the economy is cooling off. For those worried about simmering inflation, slower growth will take some of the sting out of the dog days of summer that lie ahead. For the rest of us, a pitcher of margaritas should do the trick.

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