U.S.: Bundle Up And Wait For The Thawby
The recent grim economic reports show a sea change from a few weeks ago. True, at the end of 1995, the economy was taking on a softer feel. But suddenly, the data have all the firmness of Jell-O, and recession worries are cropping up. All this is bound to complicate Federal Reserve policy, and it threatens to elevate the economy to a key election issue.
On the surface, the January reports clearly look recessionary. Payrolls plunged, joblessness rose, purchasing managers sounded glum, and consumer confidence nose-dived (charts). Amid higher commodity prices, even the inflation news is not all good.
But below the tarnished patina, the numbers were skewed by January's winter storms and the second government shutdown. In particular, the Labor Dept. took its employment survey during the week of the blizzard. And given the record cold that gripped much of the nation in early February, the numbers may not show much bounceback until March.
The weak data can't all be blamed on the weather, though. Consumers have increasing debt to pay off, and the manufacturing sector is genuinely soft. Many factories are cutting back because of excessive inventories--particularly in the auto industry.
On balance, the economy's growth rate seems likely to have slipped from the third quarter's healthy 3.2% annual pace to less than 2% in the fourth quarter. Moreover, since 1995 ended with a whimper and the weather and the shutdown started the first quarter at such a low level, the winter economy could be hard-pressed to show any growth at all.
LOOKING TOWARD THE SPRING, though, there is nothing to suggest that the economy cannot resume growing at least moderately. Prior to January, the labor markets were generating income gains sufficient to support trendlike growth in consumer spending. Through early February, the pattern of initial jobless claims points to continued modest growth in payrolls.
An improving trade deficit, fueled by a sharp slowdown in imports relative to exports, will also support growth. The trade deficit for goods and services fell to $7.1 billion in November, from $8.2 billion in October. Improvement in the trade gap, by itself, is on track to add about a percentage point to fourth-quarter growth in real gross domestic product.
Moreover, capital spending is slowing down, but it will continue to grow much faster than the overall economy. The inventory adjustment begun last year is probably about over. And the Fed has started to ease monetary policy by cutting short-term interest rates.
In short, there are none of the classic imbalances that could set in motion the recession process, in which falling economic activity begins to feed on itself, causing the economy to spiral hopelessly downward.
What remains key to the growth--as opposed to recession--scenario is lower long-term interest rates. Rates will have to remain at 6% or below to assure support for housing and other important credit-sensitive sectors. But spooked by the budget fiasco, and most recently by a record Treasury refunding and inflation worries from gold and commodity prices, the bond market has kept the yield on the 30-year Treasury above 6.1%, even after news that payrolls tumbled in January.
THE WEATHER'S IMPACT on jobs last month was as obvious as a six-foot snow drift. Payrolls dove by 201,000 employees, the largest drop since the 1990-91 recession. Jobs had grown by 212,000 in November and 166,000 in December. Payrolls of service producers, which had grown by an average of 147,000 per month in the second half of 1995, dropped by 141,000 in January. And the workweek fell 36 minutes, to 33.7 hours, the largest decline on record.
The losses in jobs and hours worked were a quantum leap from those predicted by back-of-the-envelope models based on known data such as initial claims, the purchasing managers' employment index, and the Conference Board's help-wanted advertising index.
Moreover, a strike of building maintenance workers in New York, plus five weather-sensitive industries, accounted for 82% of the January job losses. Those industries--restaurants, amusement parks, private education, trucking and warehousing, and temporary-help agencies--make up only 12% of the total nonfarm jobs in the Labor Dept.'s survey of 349 industries.
Other distortions embedded in the numbers are harder to dig out. At least some of the 72,000 drop in manufacturing payrolls also reflected the weather, as well as government contract work lost by many private-sector companies. The factory workweek shrank by nearly 1 1/2 hours, to 39.8. That was one of the three largest monthly declines in the postwar era.
HOWEVER, NOT ALL OF THE SOFTNESS in manufacturing can be blamed on snow. The National Association of Purchasing Management's composite index of industrial activity weakened further in January, to 44.2% from 46% in December. The index has been below the 50% mark--the dividing line between growth and decline in the factory sector--for six months in a row, and last month's reading was the lowest in nearly five years. Weather and the shutdown may have played a part in the drop in production and jobs, but the plunge in January orders seems less likely to be distorted.
One problem: Auto makers are wrestling with inventories which had swelled to an 83-day supply at the start of the month; 60 days is normal. In January, total vehicle sales fell to an annual rate of about 14 million, after an incentive-fueled surge to 16 million in December.
Although that two-month average is respectable, auto makers have to hold their output below sales so they can trim inventories. That process will be a drag on first-quarter industrial production and economic growth. Looking toward spring, however, fewer vehicles on car dealers' lots will allow output to resume growing.
But if the economy avoids a recession in 1996, does that mean inflation has nowhere to go but up? The runup in materials prices and gold prices rising above $400 an ounce suggest that market-scaring idea.
Commodity prices, measured by the Knight-Ridder/Commodity Research Bureau's futures index, hit a seven-year high recently. Also, the Labor Dept.'s final look at 1995 inflation shows that the core consumer price index, which is a better indicator of inflation's underlying trend, accelerated slightly last year for the first time in five years (chart).
If anything, the blizzard ensured that the economy is growing below its noninflationary trend of about 2%, using the new GDP measure. That precludes any large or lasting pickup in inflation. In fact, much of the recent rise in commodities reflects surges in the prices of grains and gold. Industrial materials are softening.
The upcoming news on the economy is bound to be bad. But consider this the groundhog phase of the slowdown. In six weeks, the economy's outlook will look much warmer.