| BUSINESSWEEK ONLINE : JULY 17, 2000 ISSUE | ||||||||
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| BUSINESS OUTLOOK
U.S.: It's Too Early to Call the Soft Landing a Success Are consumers really cutting back--or was the spring slowdown a blip? When deciding whether the Federal Reserve is finished hiking interest rates this year, keep two words in mind: tentative and preliminary. Those were the Fed's own adjectives when describing the recent signs of slower growth. Until the central bank is convinced that the slowdown is definite and sustainable, policymakers will keep their fingers on the trigger. The latest data continue to add evidence that the economy in the second quarter slowed considerably from its revised 5.5% annual rate gain in the first quarter. Real consumer spending has risen just 0.2% in each of the past three months, and housing activity is weaker (charts). Even the nation's purchasing managers reported an easing in production and employment over the course of the quarter. But other data argue that demand by consumers and businesses could come roaring back in the second half. Real household incomes are growing at a solid clip, and nonresidential construction added to growth in the second quarter. In addition, export orders remain strong, as foreign economies pick up steam. The data's ambiguity is why the Fed is not ready to call it a day. Bear in mind that the U.S. economy probably exceeded its potential growth limit for at least three quarters, so real gross domestic product doesn't just have to slow, it may have to slow by a good amount and for a few quarters to wring out any prices pressures already threading through the economy. Only when those pressures have eased can the Fed declare the soft landing a success. But instead of slowing, inflation is beginning to stir a bit, according to revisions to one set of price data. EVEN SO, consumers remain the key to slower growth and Fed policy. To that end, the Fed has to be happy about the May spending data. Real consumer spending rose just 0.2%. Purchases of durable goods were especially weak, falling 1.1%, the third drop in a row. Blame motor-vehicle sales for that falloff. Auto makers had offered generous incentives in the winter. Once those ended, car sales weakened. Vehicle sales in the second quarter were about 5% below their first-quarter pace. Not surprisingly, auto makers are responding with new incentives that may lift vehicle sales this summer. Spending on nondurables and services grew at healthy rates in May, reflecting the increase in buying power coming from healthy income gains. In fact, household earnings are growing fast enough to support spending increases that are probably a bit bigger than the Fed prefers. Real aftertax income advanced by 0.4% in both April and May. Inflation-adjusted incomes are on track to grow at an annual rate of about 3 1/2% in the second quarter from the first, even as real consumer spending struggles to increase 3%. That would mark the first time in 1 1/2 years that incomes grew faster than spending in a quarter. So far, the recent small pickup in inflation has not yet cut into the still-solid growth of real incomes or spending. The Commerce Dept.'s revision to the personal consumption deflator, an inflation measure closely watched by the Fed, shows that overall consumer prices rose 2.5% in the year ended in the first quarter. Excluding food and energy, core prices were up 1.7%. While both inflation rates are mild, they have accelerated since mid-1999. And look for the jump in gasoline prices in June to lift overall inflation and cut into household purchases of other goods. In fact, the rise in pump prices may be a bigger drag on overall real consumer spending this summer than the past six Fed rate hikes have been. THE BIG QUESTION is whether households are serious about cutting back, or was the spring slowdown just a flirtation? Consumer fundamentals on job growth and pay gains argue that consumers have the wherewithal to rev up spending in the second half. However, there is the gas price-related drag on spending. Plus, policymakers can take heart in the fact that the financial markets are no longer giving spending the extra oomph they once were. The equity markets, as measured by both the Dow Jones industrial average and the broader Wilshire 5000 index, have been moving sideways since March and only the Wilshire is above its year-ago level. But stock prices will have to weaken considerably in order to dissipate the wealth effect completely. In the bond market, the gyration in yields means that higher long-term rates are beginning to crimp the biggest of all household purchases: houses. New single-family home sales fell 0.2% in May, to an annual rate of 875,000. Sales have fallen for three of the last four months and are clearly off their high rates of late 1998 and early 1999. The decline in home sales is already showing up in the construction data. Overall spending on construction edged up just 0.1% in May, with all the strength concentrated in commercial projects. Outlays for residential buildings fell 0.4%, the second consecutive decline. The slowdown in housing will also affect manufacturing output since consumer outlays for home-related goods should also begin to cool off. Those outlays total as much as new home construction in the GDP data, and manufacturers are already reporting some softening in orders for household durable goods. IN FACT, THE INDUSTRIAL SECTOR is seeing a slowdown in domestic orders in general, according to the National Association for Purchasing Management. The purchasing managers' index slipped to 51.8% in June, from 53.2% in May. The index for overall orders fell to 50.6% and now stands almost 10 points lower than it was in February (chart). The purchasers' index covering prices paid continued to ease up. But supplier deliveries stayed at a relatively high level, indicating that businesses are still taking a while to fill orders. However, the NAPM report did offer some suggestions that economic growth may not be slowing as much as the Fed would like. The purchasers said that the average PMI for the first six months of 2000 corresponds to real GDP growth of 4.4%. That's faster than the 4.1% increase in 1999, and is still too hot for the Fed's liking. In addition, the index for export orders remained high. That suggests that foreign demand continues to increase and should take up some of the production slack opened up by slowing domestic spending. And in a separate report, the NAPM said that its nonmanufacturing index bounced back in June. It rose to 64%, from 61.5% in May. Luckily for policymakers, inflation, though rising, remains weak. So the Fed can conduct policy without the heightened sense of urgency that often leads to policy mistakes. That said, the Fed will continue to watch the economy very carefully. As long as signs of a slowdown stay ''tentative,'' policymakers' vigilance will remain a certainty. By JAMES C. COOPER & KATHLEEN MADIGAN _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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RELATED ITEMS U.S.: It's Too Early to Call the Soft Landing a Success CHART: Visible Signs of a Consumer Slowdown CHART: Housing Is Down from Its Recent Peak CHART: Less Demand Slows Industrial Activity INTERACT E-Mail to Business Week Online | |||
