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U.S.: THOSE MANIC MARKETS WON'T CALM DOWN ANYTIME SOONStrong data are reviving old fears about Fed tighteningThe economy was supposed to slow down in last year's second half. It did, but only for one quarter. Now, the same worry that arose last summer is starting to resurface, especially on Wall Street: Will excessive growth in an economy already near full employment fuel future inflation and spur interest rate hikes by the Federal Reserve? It's a legitimate question. After slowing to a 2.1% growth rate in the third quarter, down from a 3.3% first-half pace, the economy appears to have sped up again in the fourth quarter, back into 3% territory. Consumers spent with more gusto, partly because December consumer confidence was at a seven-year high. That buying rebound, along with stronger foreign demand, is spurring a pickup in manufacturing, as suggested by the nation's purchasing managers. And while lower long-term interest rates are buoying housing, the big surprise has been business construction, which has surged in recent months (charts). True, a couple of one-time fillips appear to have boosted the fourth quarter, and their effects may reverse in the first quarter. But right now, the trends in much of the data strongly argue that nearly all of the risk in the consensus forecast of 2.1% growth in the first half of 1997 is on the side of stronger-than-expected growth. THAT'S A PROBLEM because the fourth-quarter acceleration places growth over the four quarters of 1996 at about 3%. And with the labor markets and plant capacity already stretched thin, the economy cannot grow above its long-term trend of about 2 1/4% for long without kindling wage and price pressures. That's why the recent spate of strong data has caused unusually high volatility in the financial markets, especially for bonds. The yield on the benchmark 30-year Treasury bond rose back to 6.78% on Jan. 7, after having fallen to 6.35% on Dec. 3. Along the way, the Dow Jones industrial average has seen several 100-point swings--even on the same day. Wall Street's nervousness reflects the fear that 3% growth will strain the economy's resources further in 1997--and lead to Fed tightening. And the latest reports only fuel those concerns about the outlook. First, consider consumers. Their spending rebound last quarter should not have been surprising, given strong labor markets and income growth. That's a big reason why their spirits are soaring. The Conference Board's index of consumer confidence surged to an expansion high of 113.8 in December, led by an appraisal of current conditions that was near a record high. One recent downer for consumer spending was the dip in December car buying. Sales of domestic and foreign cars and light trucks slipped to an annual rate of 14.5 million last month, from 14.9 million in November. Still, the quarterly average was only slightly below that of the third quarter, and sales of nondurable goods and services have been strong. Consumers are also buying homes. Despite the summer backup in mortgage rates, sales of both new and existing homes have remained surprisingly strong, and now the decline in mortgage rates from their summer highs will buoy demand into 1997. Sales of new single-family homes surged 14.2% in November, to an annual rate of 772,000. It was the largest monthly gain in 3 1/2 years. Homebuilders' take on market conditions perked up in December for the first time since May. THE REALLY BUSY construction companies, though, are those putting up business projects. Overall construction outlays rose a robust 1.8% in November, after adjusting for inflation, following a 1.4% advance in October and a 1.2% jump in September. Outlays for new homes have held up, and government projects have been strong, but the private nonresidential sector has supplied the real power. From July to November, nonresidential outlays posted the strongest four-month growth since 1984. The surge has been led by commercial buildings, mainly offices, hotels, and stores. Its roots are in a healthy economy, strength in financial services, and the end of the commercial building drought that weighed heavily on builders when the 1980s' boom turned to bust. Industrial building has also been strong, as has institutional construction, including schools and hospitals. For now, the boom has added some unexpected oomph to fourth-quarter economic growth. Whether that momentum can be maintained in the first quarter will depend on the weather, since heavy December and January flooding threatens to wash away parts of the West. But the high level of contracts for nonresidential projects closed in the second half of 1996 suggests that building will resume later on. THE MOMENTUM in the factory sector also looks pretty sturdy. To begin with, orders are strong. Durable goods bookings, while volatile, are trending higher, and orders for nondurable goods are especially strong. They rose 0.8% in November, after a 1.6% jump in October. Bookings for nondurable goods are now growing at a pace similar to that seen in 1994, when the overall factory sector was really cooking. Moreover, factory inventories are extremely thin. Stock levels rose 0.4% in November, but shipments increased 0.9%, pushing the ratio of inventories to sales down to 1.38, the lowest on record (chart). With inventories low, output gains should continue in the new year. In particular, car companies liquidated their stocks at yearend. After being a drag on industrial output in the fourth quarter, car production is scheduled to provide a lift in the first quarter. The nation's purchasing managers also suggest that manufacturing is building up steam again. The purchasing managers' index of business activity rose in December to 54%, from 52.7% in November. A reading above 50% means that industrial activity is on the rise. The December level was the highest since June, and new orders for the month looked strong. Purchasers also noted that export orders held at a high level. The index of foreign bookings averaged 55.9 in the second half, up from 51.9 in the first half, suggesting that exports are picking up. Indeed, surging exports in October led to a sharp narrowing in the trade deficit, which provided a boost to economic growth last quarter. However, the trade gap has shown a tendency in recent years to narrow at yearend, only to widen again in the first quarter. So that source of strength could reverse in early 1997. But bad weather and seasonal quirks in the trade accounts aside, the economic data are starting to tell a consistent story of renewed growth at a speed that's greater than the economy can handle without straining its available resources. Before Wall Street can settle down, it will have to see convincing evidence that growth is falling back to a more modest pace.
By JAMES C. COOPER & KATHLEEN MADIGAN
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Updated June 15, 1997 by bwwebmaster
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