The Economy's Quickening Pace
When it rains, it pours. Data reports issued on Jan. 18 added to the growing list of releases showing a better-than-expected trajectory for the U.S. economy as the New Year gets under way. The market's expectations of any near-term easing by the Federal Reserve are now quickly dissipating with each new upside surprise in key sectors such as housing and labor—and prices for wholesale and consumer goods.
Though we are cautiously keeping our gross domestic product (GDP) estimates at 2.7% for both the 2006 fourth quarter and the 2007 first quarter, as the inventory correction in the factory sector works its way through the economy, we are likely to reach the end of this adjustment during the current quarter. And the drain on growth from declines in residential construction through 2006 looks poised to moderate significantly in the first quarter and to flatten out by the middle of the year.
Here is Action Economics' rundown of the key reports released Jan. 18:
Philadelphia Fed index: This regional gauge of economic activity improved to 8.3 in January from a revised -2.3 in December (-4.3 previously), maintaining its up-and-down pattern since the summer. Among the components, prices paid dipped to 11.9 from 19.0 (revised from 20.6) as price pressures slowed for a sixth consecutive month. Prices received were 11.6 after edging up to 8.9 (revised from 9.9). New orders climbed back into positive territory, rising to 1.3 from -0.9 (revised from -2.4). Employment was 7.9, vs. a revised 7.5 (7.9 previously).
These data are much stronger than expected, and together with the improvement in recent data almost across the board, suggest the economy is on healthy footing. We will raise our forecasts for other key sentiment indicators for January—to 53 for the Chicago purchasing managers' index and to 52 for the Institute for Supply Management's manufacturing index—but will keep our ISM nonmanufacturing forecast at 56.
Consumer price index: The December overall CPI increased 0.5% (median 0.5%), while the core index, which excludes food and energy prices, rose 0.2% (median 0.2%). The energy aggregate rebounded 4.6%, led by an 8% gain in gasoline prices. Food prices were flat, despite the upside risk from both the producer price index (PPI) and food exports price index. The core aggregate was held back by a 0.2% decline in new vehicles and a subdued 0.1% gain in medical care.
The report left year-over-year core inflation in December at the same 2.6% rate as in November, and we expect this measure to remain at 2.6% in January if we get another 0.2% core gain. The year-over-year inflation bounce to 2.5% from 2.0% in November should be followed by a pullback to 2.0% in January, if this month's gain is held to 0.1% by current weakness in energy prices.
In total, the mix of CPI gains, the upside surprises in the December PPI report, and the trade price figures for the month all combine to provide an ongoing irritant to the Fed's efforts to bring the various inflation indicators comfortably back in line with its objectives. We will assume a 0.4% overall and 0.2% core gain for the December personal consumption expenditure (PCE) chain price indexes, an inflation gauge favored by the Fed.
Housing starts: Housing starts rose 4.5%, to a 1.642-million-unit annual pace in December, from a downwardly revised 1.572 million rate in November (1.588 million previously). Permits rebounded 5.5%, to a 1.596-million rate (November was revised up to 1.513 million from 1.506 million). Strength in starts was in multifamily, up 42.1%, while single-family starts fell 4.1%.
These figures are now firmly in the camp of housing indicators that are bouncing through yearend, following a more mixed pattern in November of strong starts but lean permits.
We expect construction spending to be flat in December, following the 0.2% drop in November. And we will assume that the quarterly GDP subtractions via residential construction should start to moderate in the first quarter toward the -10% area, after a 20% rate of decline expected in the fourth. The residential construction component looks poised to be fairly flat by the middle two quarters of this year, hence removing this GDP drain from the mix as the year progresses.
Initial jobless claims: Initial claims fell another 8,000, to a notably lean 290,000 in the second week of January—which is also the Bureau of Labor Statistics' survey week for compiling the monthly employment report—following a 27,000 decline, to 298,000 in the first week of January. Continuing claims bounced by a hefty 120,000, to 2.53 million, following a revised 21,000 drop in the prior week, to 2.41 million.
The initial-claims figures have prompted an upward revision in our nonfarm payroll estimate for January's employment report to 150,000, which brings this figure right in line with the 152,000 average monthly gain in 2006, though below the notable strength in payrolls of 154,000 in November and 167,000 in December.
Claims are averaging 294,000 thus far in January, though holiday distortions often extend through the first two weeks of the New Year, so we should be cautious in interpreting either this pattern or the surge in continuing claims. The lean start to the month, however, is reminiscent of the sharp and surprisingly permanent downswings seen in the level of claims at the start of each of the last two years.