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BusinessWeek: January 10, 2000 |
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Business Outlook: U.S. Economy
U.S.: Consumers Keep Stoking the Economy's Fires The Fed's challenge: Slowing spending without killing growth altogether
Why? Up to now, the Fed has been content to allow the economy to run free, confident that strong productivity growth and weak global conditions would restrain U.S. inflation. But the Fed's thinking is changing. That's evident from the hawkish tone of its statement after its Dec. 21 policy meeting, along with the apparent urgency evident in the recently released minutes of the Nov. 16 meeting, when policymakers put through an interest-rate hike for fear of losing the opportunity later amid Y2K concerns. The bond market is latching on to the Fed's new mind-set (chart). As of Dec. 28, the yield on the benchmark 30-year Treasury bond had risen to a two-year high of nearly 6.5%. The credit markets are building in expectations of at least two more quarter-point rate hikes into the structure of rates. And based on recent surveys, some Fed watchers believe that even more hikes than that may be necessary to prevent inflationary pressures from building. At its last meeting in 1999, the Fed registered its concern that "increases in demand will continue to exceed the growth of potential supply." That was the Fed's clearest statement to date that the economy is growing too fast for its own good. The bottom line: If growth doesn't slow, the Fed will raise interest rates further until it does. THAT'S WHERE CONSUMERS come in. Households show no sign of dialing back their spending habits, and the economy will not cool off until consumers do. For all of 1999, consumer spending appears to have grown in excess of 5%, enough to account for almost all of the economy's growth. Consumer outlays, before inflation adjustment, rose 0.5% in November, and weekly surveys suggest very strong December buying. Inflation-adjusted spending in the fourth quarter may not be much slower than the third quarter's 4.9% pace. And housing demand remains at a high level: November sales of existing homes jumped 6%, to an annual rate of 5.09 million. As a result, real gross domestic product last quarter could end up posting another gain in excess of 4%, on top of the upwardly revised third-quarter advance of 5.7%. One drag on growth at yearend was foreign trade, as shown by the widening in the October trade deficit to a record $25.9 billion. Household euphoria is powering the spending spree. The Conference Board's confidence index makes it clear that consumer optimism about the economy is the highest in a generation (chart). The index jumped to 141.4 in December, from 137 in November. Assessments of both the present situation and expectations six months down the road rose. Households seem to have shrugged off any worries that the Y2K date change on the world's computers will adversely affect the economy. And the upbeat spirits are grounded in strong consumer fundamentals. As Lynn Franco, director of the board's Consumer Research Center put it: "Healthy paychecks, continued low inflation, and continued job opportunities will keep the economic expansion on its record-breaking course." VERY SIMPLY, almost anyone who wants a job has one, a situation that will not be changing anytime soon. The Conference Board said that a record 51.5% of households report that "jobs are plentiful." Initial claims for unemployment benefits through mid-December are running at the lowest levels seen since the mid-1970s, and the jobless rate appears to be headed below 4%. Strong labor markets are powering healthy gains in income. Personal income rose 0.4% in November, and during the past year real household earnings have grown a strong 3.5%. Even so, real spending over the past year has risen by a more rapid 5.5%. As households continue to increase spending faster than their incomes are growing, the trend in the personal savings rate remains down. The rate averaged just 2% in the three months ended in November. That's a record low, and down sharply from 3.7% a year earlier and from 4.4% the year before that. Households are bridging the gap between income and spending by depending increasingly on wealth gains. Consequently, past stock market increases will continue to spill over into 2000 spending behavior. But Wall Street's effect on consumers may complicate the Fed's decision-making. Policymakers know that tightening too hard could expose household finances to a double whammy of higher interest rates and flattening stock prices. But the Fed may have no choice but to tap on the brakes again as long as demand continues to rev up. AND ONE KEY SIGN that the economy is firing on all cylinders is the growing momentum in manufacturing, as the global recovery augments already strong domestic spending and as businesses feel the need to build up their inventories, which have become skimpy relative to demand. Factory orders tell the story. New bookings for big-ticket durable goods, such as home-related items and business equipment, jumped 1.2% in November, after declining in both September and October. The gain would have been nearly 2% if not for a falloff in aircraft orders, which can be volatile from month to month, skewing the overall result. Based on a six-month moving average, the trend in orders is clearly up. Moreover, the trend in new orders for capital goods is also up strongly, suggesting little slowdown in business outlays for new machinery and equipment. New orders are coming in faster than factories can ship out goods. So the backlog of unfilled bookings, excluding aircraft, is increasing rapidly (chart). That means industrial production should post good gains in the new year, sopping up some idle output capacity. Low utilization rates in manufacturing, partly reflecting the Asian crisis and its aftershocks, have been a big reason why goods inflation in the U.S. has remained so low. For 2000, the Fed is facing the challenge of pulling off a soft landing for the expansion. That is, the Fed must find the level of interest rates that will slow the economy but not cause it to crash. It's a tricky maneuver. The last time the Fed attempted it was five years ago. The result: Growth slowed to 2.2% in 1995 from 4.2% in 1994. Let's hope the Fed shows the same piloting skills in 2000. Return to top | |
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