A Cold Shoulder From Shoppers Is Creating A Chill

Spring is in the air. But just as the weather is warming up, the economy is showing clear signs of cooling down. Through February, retail sales have posted three shaky readings in a row. The factory sector is surrendering some of its momentum. And the job markets are losing their oomph.

The big debate right now is: How much is growth tapering off, and will the slowdown continue? So far, a sudden shyness among consumers is the main reason for the economy's paler cast, as higher interest rates take their toll on demand (chart). But the outlook for the other third of the economy, especially capital qpending and exports, remains largely undimmed.

The data's softer, noninflationary tone has delighted Wall Street. That, plus the evidence of moderating growth found in the Federal Reserve's latest regional economic survey, almost assures that the Fed will eschew another rate hike at its Mar. 28 policy meeting. The prospect that Fed policy is on hold has pushed the yield on the benchmark 30-year Treasury bond to below 7.4%, the lowest in nine months. And stocks continue to strengthen, even as the dollar remains weak.

THE FIRST-QUARTER DROP-OFF in the pace of consumer spending looks especially sharp. Retail sales plunged 0.5% in February, the first decline in 10 months. And even though the January gain was revised from 0.2% to 0.6%, sales so far in the quarter, adjusted for inflation, have not grown at all from their fourth-quarter level. Keep in mind, though, that the monthly sales data are quite volatile and subject to big revisions, and Commerce will make an annual revision on Mar. 20.

Although the recent dip in consumer demand probably exaggerates the underlying trend, the slower pace of spending is likely to continue. That's because job growth for this business cycle has peaked. Even with February's strong 318,000 rise in payrolls, monthly job gains have averaged 282,000 during the past six months, down from 333,000 in the previous six months.

Moreover, initial jobless claims have been trending higher since last fall. During the first week in March, the four-week average of claims rose to 340,000, the highest in seven months.

It follows that income growth also will slow, which will continue to moderate the trend in consumer spending. Households are increasingly dependent upon income gains to finance purchases, since their use of credit is subsiding in the wake of last year's borrowing binge, and higher interest rates are placing greater demands on their incomes.

Sales declines in credit-sensitive goods accounted for much of the drop in February retail sales, but the weakness was widespread. Not only did cars, furniture, and building materials each post sales losses, purchases of nondurable goods also fell, with an especially steep decline in apparel.

THE SOFTNESS in consumer buying is working its way back to the manufacturing sector. Industrial production at factories, utilities, and mines rose 0.5% in February, pushed up by a surge in utility output as winter weather returned to normal.

Factory output alone increased only 0.4%, after a 0.2% gain in January. That's well below the average monthly rise of 0.9% during the fourth quarter. Strains on capacity also have eased a bit since December. The factory operating rate remained at 85.1% in February, a tick below December's level.

Although a rate that high is usually associated with building price pressures, producer prices of finished goods remain tame. The producer price index rose 0.3% in February, the same as in January, and excluding energy and food, the core PPI also increased 0.3% in February. The only sign of faster-rising prices is in intermediate and crude materials, but most businesses are having little success in passing those increases forward.

Not surprisingly, the slowdown in industrial output mostly shows up in consumer goods, especially furniture, appliances, and clothing--the same items that consumers left in retail stores in February. However, output of capital goods remains robust (chart), reflecting both the ongoing boom in equipment spending at home and continued strength in demand abroad.

With consumer demand losing steam at a faster pace than output, some businesses are holding more inventory than they want. Inventories in manufacturing, wholesaling, and retailing jumped 0.9% in January, though sales rose only 0.1%. The biggest problem is cars. Auto dealers' stocks surged 3.2% amid flagging sales. In response, carmakers have announced cuts in their second-quarter production schedules.

Rising inventories will add to economic growth in the first quarter, but that kind of strength won't lead the Fed to hike rates. If demand fails to perk up, excessive inventories will slow output further, and retailers will have to cut prices to move merchandise.

THE FEBRUARY JOB NUMBERS also argue against another rate increase. The report was a mirror image of the data in January. Back then, the top-line number looked weak, but the details showed continued strength. In February, just the opposite was true: The big job gain blew the doors off most expectations, while the jobless rate fell back to 5.4%, from 5.7%. But all of the underlying numbers were more subdued.

Factory jobs last month rose just 27,000 after gains of more than 40,000 in each of the previous four months. Hours worked fell 24 minutes, to 34.5 hours in February, and the factory workweek slipped from 42.2 hours, to 42.1 hours.

Taken together, the January and February reports suggest that the labor markets are starting to look a bit cooler. So far in the quarter, overall hours worked--the combined effect of jobs and the workweek--are rising at an annual rate of only 2.8%. That pace is down from 5.1% in the fourth quarter. Most important, a shorter workweek usually precedes less hiring.

Moreover, job growth in February was more narrow than in January. The percentage of industries that added workers fell to 57.9% last month, from 62.4% in January. The Labor Dept. said many of the new jobs were in temporary employment, computer services, and recreation, as more normal temperatures in February boosted hiring at ski resorts.

What especially heartened the financial markets was the news that, despite the strong hiring, wage growth hardly budged (chart). The average nonfarm wage was flat in February, at $11.31 per hour. And with hours down, average weekly pay fell more than $4.50, to $390.20. Slimmer February paychecks may well be part of the story behind the month's drop in retail sales.

Although consumer spending seems to be gliding down to a more sustainable pace, the key to a successful soft landing for the economy may lie in how much the rest of the economy slows. But in the first quarter, at least, the downshift by consumers looks to be sharp enough to offset the gains by other sectors.

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