U.S.: This New Year's Hangover Doesn't Hurt
The widely anticipated slowdown in the U.S. is still more forecast than fact. Indeed, yearend reports portray an economy headed into the new year under a full head of steam. Although the data are far from complete, fourth-quarter economic growth appears to have been quite good--on the order of 3% or more. That would follow the third quarter's revised 3.7% pace, which matched the growth rate in the first half.
Some of that momentum is carrying over into early 1999. Shoppers gave retailers a good holiday season, although it did not meet high expectations. Based on the low yearend level of initial unemployment claims, the labor markets still look tight. And factory orders show that capital spending on equipment is holding up. Manufacturing continues to suffer from weak foreign demand, but that was true all year. The trade deficit has nonetheless narrowed in recent months, but that may be a blip instead of a new trend.
However, maintaining 1998's powerful impetus throughout 1999 will not be easy. Last year, the obstacles to growth were all foreign-based, and potent domestic demand easily overrode them. But the coming year promises more homegrown challenges. As profit-starved companies seek to cut costs--and as recently announced layoffs become reality--growth in household income will slow and capital budgets will get squeezed. Also, foreign demand will remain in the doldrums, although the drag will be less intense. This scenario is not a recipe for recession, but it does present significant constraints on growth in 1999.
RIGHT NOW, CONSUMERS ARE STILL the economy's driving force. The two factors that drove spending throughout 1998 continue to fuel outlays: Strong labor markets are supplying wage growth, and accommodative financial conditions are offering low interest rates and a strong stock market. Until some cracks appear in these fundamentals, household spending will stay firm.
Certainly, households remain optimistic about the economy, although not as ebullient as they were in the summer (chart). The Conference Board's index of consumer confidence slipped to 126.1 in December, from 126.4 in November. Consumers' assessments about the current economic situation improved, but expectations fell. That's because households are getting worried about job prospects over the next six months.
However, the job markets still looked healthy at yearend. In mid-December, weekly initial claims for unemployment benefits dropped to 287,000, the lowest in almost a year and a half--and the second-lowest in an expansion now nearly eight years old. The four-week average of claims is actually falling (chart). New claims do tend to be low around the holidays, but these readings are below those at similar times in recent years.
In addition, income was still flowing freely to households in November. Personal income increased by 0.5% in the month, and after adjusting for inflation and taxes, consumer buying power still rose 0.4%. For the fourth quarter, real income is set to grow at a solid annual rate of about 3.5%.
BUT THAT INCOME FIGURE doesn't tell the whole story. Real "paycheck" income from wages and salaries, which comprises about three-fifths of total income, is on track to grow about 5.5% in the fourth quarter, about the same pace as for all of 1998. This measure of income reflects the year's excellent job growth, the acceleration in hourly pay, and very low inflation, and it has been a better indicator of spending. For 1998, consumer outlays will grow in excess of 5%, the strongest performance in any year since 1984.
Consumer spending appeared to have cooled off in November, as real outlays for goods and services posted no gain, but that's deceptive. Car and truck sales retreated from October's high level to a merely good showing in November. And warm weather caused a sharp drop in energy demand. Excluding those two factors, real spending rose a healthy 0.3%, led by purchases of furniture, appliances, and clothing.
Continued mild weather in December did hurt holiday sales of apparel. That was a key difference between good and great holiday receipts. Consumers flocked to stores just before and after Christmas looking for deep discounts, and they were not disappointed. Based on the trends of recent years, that bargain hunting is likely to continue into January, spurred on by the drop in oil prices, which means that households will be spending less of their income on heating bills this winter--and more on other items.
CONSUMER SPENDING ISN'T THE ONLY economic sector to end 1998 on a high note, though. Capital spending and foreign trade also look as if they contributed to real gross domestic product growth in the fourth quarter.
Orders for durable goods increased 1% in November, and 1.2% when the volatile transportation sector is excluded. Bookings for nondefense capital goods rose 2.2% in November, while shipments were up 1.2%, the third consecutive gain. These rising trends in capital goods come at an unusual time. Typically, expectations of slower demand prompt businesses to trim, not expand, their capital budgets.
What gives? Part of the explanation may be that companies are still investing in new computers and software to correct possible Y2K problems. Electrical machinery shipments have risen at an annual rate of 11.7% so far in the fourth quarter, and new orders are still rising.
Recently strong export gains suggest that foreign demand is also boosting the capital goods sector, but those gains are misleading. Shipments of aircraft, which tend to be volatile from month to month, helped to lift exports by about 3% in both September and October. As a result, the total foreign trade deficit for goods and services narrowed to $14.2 billion in October, from $14.4 billion in September and a record $16.7 billion in August. Exports are likely to fall off in coming months as aircraft shipments swing the other way.
One hopeful sign for the trade sector is that the deficit with Asia--which once was in a free fall--may have bottomed out. Data seasonally adjusted by BUSINESS WEEK show that the U.S. trade deficit with Pacific Rim countries in October was the smallest so far in 1998 (chart). And the overall trade deficit began the fourth quarter well below its third-quarter average.
Still, it may be too early to declare a turnaround in trade--especially with consumer demand in the U.S. still so robust. A hefty portion of those marked-down sweaters, electronics, and toys were made by foreign producers. And imports will continue to grow faster than exports as long as U.S. households continue their spirited buying trends. For now at least, the urge to shop shows no signs of waning.