Take A Deep Breath, Relax, And Forget The `R' Word

As the old saying goes, be careful what you wish for. You want a soft landing? It might just be on your doorstep. But as the data now clearly show, a soft landing means soft sales and hiring, and people are starting to get nervous.

A few economists are even using the "R" word, but recession worries right now are way out of place. The economy is in the middle of what is likely to be a short and sharp inventory correction brought about by the impact of the Federal Reserve's interest-rate hikes on housing and consumer spending. A similar correction resulted in a slowdown in 1986, after which the expansion went on its merry way.

As businesses wrestle their inventories into better shape relative to sales this spring and summer, industrial production will remain on the weak side and employment gains will continue to slow. But after the slowdown, the economy is more likely to pick up again than it is to spiral downward toward recession--although it will not regain its 1994 pizzazz.

Growth has plenty of supports to prevent a recession. For one: Falling long-term interest rates will buoy housing. The yield on the benchmark 30-year Treasury bond crashed through 7% on May 9 to close at 6.93%, the lowest in 14 months. Of broader importance, refinancing activity is already showing some early signs of activity, says the Mortgage Bankers Assn.

Also, business outlays for high-tech equipment and construction are strong and likely to remain so. And the drag on U.S. exports resulting from Mexico's recession will have run its course by the second half, when foreign demand elsewhere and the cheaper dollar will reignite export growth.

LIKE THE 1986 SLOWDOWN, the 1995 episode might well have a bonus: It could extend the expansion. Slower growth will keep pressure off wages and prices as it eases constraints on capacity and as it unwinds some of the recent tightness in the labor markets--already evident in the April job report (chart).

At first blush, those job numbers looked pretty ominous. The unemployment rate jumped to 5.8%, up from 5.5% in March, and payrolls actually shrank by 9,000, the first decline in more than two years.

To be sure, job growth is slowing, but the Labor Dept. pointed to "an unusual set of circumstances" that exaggerated the April weakness in payrolls. Because of seasonal quirks, the poor showing was in effect a payback for questionably large job gains in February and March. Also, the April dip included 32,000 striking supermarket workers in California.

Still, signs of slower growth were evident. The 48.7% of industries adding workers in April was the lowest in 21/2 years. Big job losers in the month were manufacturing, down 28,000, and construction, off 20,000. Temporary-employment services shed 21,000 temps, typically the first to go as business wanes.

The factory workweek fell a steep 36 minutes, to 41.3 hours. A shorter workweek usually precedes cutbacks in output and hiring. The drop in manufacturing hours suggests a second consecutive decline in industrial production in April.

So far this year, job gains have averaged 173,000 per month, down from nearly 300,000 during the second half of last year. Given the recent uptrend in initial jobless claims, job growth for the rest of the year seems likely to maintain a slower pace. Hiring will be sufficient to generate income for consumers, but the jobless rate may drift up a bit.

ONE KEY ARGUMENT for recession is that the Federal Reserve has already raised--or is about to raise--interest rates too much and thus drain the monetary blood from this expansion. Overtightening has always contributed much to past recessions.

However, the Fed's actions of the past 16 months were preemptive strikes against inflation. And the latest data on productivity and unit labor costs show that price pressures are almost nil. In fact, the slowdown in unit costs actually strengthens the case that the Fed's next move could be one of easing.

Productivity in the nonfarm business sector grew at an annual rate of 0.7% in the first quarter, on top of a revised 4% advance in the fourth. In manufacturing alone, output per hour worked jumped 3.6%. Over the past year, factory productivity has risen a steep 4%.

Growth in productivity in coming quarters will not look as strong. The cyclical forces that pushed up efficiency early in this expansion have pretty much run their course. But companies will remain committed to increasing efficiency, because rising productivity has kept a lid on unit labor costs and bolstered profits.

Unit labor costs--the cost per unit of output--rose at an annual rate of 3.4% last quarter, after falling slightly in the fourth. Over the past year, though, unit labor costs are up just 1.4%, while factory unit costs have dropped 1.5%. The puny growth in overall unit labor costs among all nonfarm businesses is about half the rise of inflation economywide. That gap means businesses are in a good position to make money even as sales volumes slip during the slowdown.

BUT WILL WORKERS make any money? A steady drop in consumer spending is another part of the recession thesis. So far, incomes are growing at a healthy pace. The torrid rise in credit, though, bears watching.

In April, hourly nonfarm wages increased 0.6%, to $11.39. That gain and a longer overall workweek pushed up weekly paychecks by 0.9%, implying that personal income rose in April. How much of that went to taxes remains to be seen when the Commerce Dept. reports the income data on June 1.

April spending doesn't look as encouraging, however. Early reports from retailers and a drop in motor vehicle sales suggest that consumer spending struggled to rise last month, after growing at an annual rate of just 1.4% in the first quarter.

But even though spending looks sluggish, borrowing doesn't. Installment credit grew $13.8 billion in March, after gains averaging $8.3 billion in the previous two months. The March surge was the biggest since August, and half the rise was in revolving debt, which includes credit cards. It jumped $6.7 billion.

As a percentage of disposable income, installment credit rose to 18% in the first quarter, the highest since the debt-crazed 1980s (chart). To be sure, some of the increase can be linked to convenience use of credit cards--balances that are paid off at the end of the month. But because retail sales have slowed so sharply, the rise may also say that consumers are trimming their monthly repayments of old debt.

If so, higher rates are squeezing some households. A recent survey by Western Union Commercial Services shows that "paying other financial obligations" is the reason most frequently given by delinquent borrowers.

As long as incomes grow steadily, though, consumers are unlikely to throw in the towel. Their spending will buoy the expansion this year, helped by capital investment and exports. Growth in those three sectors should keep the recession bears at bay.