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SEPTEMBER 27, 2004
U.S.: That Spring Slowdown? Just A Bad Dream After faltering in the second quarter, growth is rebounding nicely Back in the spring, the recovery was looking shaky. Growth in the economy was slowing as consumers struggled with high gas prices. Many businesses put their hiring plans on hold. And inflation, even outside of energy, was picking up, potentially putting the Federal Reserve in the fix of having to raise rates in a slowing economy. But that was then. Now it's all starting to look like little more than a bad dream. To be sure, residual effects of costlier energy, increased business caution, and a global slowdown still exert some downward pressure on the growth of consumer spending, business outlays, hiring, and exports. But more and more data for the third quarter suggest that consumer demand, industrial output, job gains, and overall economic growth are rebounding from their second-quarter dips. The data also show that inflation is cooling, a turnaround that's now helping the buying power of household incomes. Moreover, upward revisions to several key data in the second quarter suggest last quarter's slowdown was not as sharp as first thought. Given that June construction spending, exports, and inventories now look stronger than originally reported, several research units on Wall Street believe the Commerce Dept. will lift its estimate of second-quarter growth in real gross domestic product from 2.8% to around 3.4% on Sept. 29. WITH THE ECONOMY MOVING OUT of its soft patch and regaining "some traction," as Fed Chairman Alan Greenspan told Congress recently, the Fed is clearly on course to hike its target federal funds rate by another quarter-point, to 1.75%, at its Sept. 21 policy meeting. Indeed, with 4% growth in the second half looking more likely, similar hikes at the Fed's November and December meetings cannot be ruled out. Given that the Fed's favored measure of core inflation, which strips out energy and food, is running at 1.5%, even a 2% federal funds rate would imply an unusually stimulative policy. One important sign that the economy is getting back on firmer ground is the rebound in the industrial sector. Last year the upturn in industrial output was a key signal of renewed economic strength generally, and the same implication is most likely true now. Output in the nation's factories, utilities, and mines rose 0.1% in August, but that gain was depressed by a drop in utility output, reflecting unusually cool weather. Production in manufacturing alone increased 0.5% after a 0.9% gain in July, and growth from the previous year is now on a par with the rapid pace of output growth in the late 1990s.  Manufacturers are benefiting especially from the efforts of companies to restock inventories to levels that are better in line with the pickup in demand that began last year. Inventory growth, by itself, accounted for 1.2 percentage points of the first quarter's 4.5% advance in real GDP. And with more complete inventory data now in hand, the Sept. 29 revisions should show that stock-building contributed more to last quarter's GDP growth than the 0.7 percentage point now on the books.Also, the faster pace of inventory growth appears to be continuing in the third quarter. Businesses in the manufacturing, wholesale, and retail sectors increased their stock levels by 0.9% in July, on top of June's 1.1% rise, which was the largest monthly increase in 4 1/2 years. A key sign that businesses are serious about adding to their inventories is the upturn in the volume of commercial and industrial loans that began in June, after a steady 3 1/2-year decline. The pattern of C&I loans has always been highly correlated with inventory trends, because businesses rely on them to finance their stockpiles. IT'S EASY TO SEE WHY businesses are rushing to rebuild their inventories. First, the July ratio of inventories to sales, while up from its record low in March, remains at a level suggesting that stockpiles are extremely thin. So any worry about an unwanted inventory buildup that could depress future production is far from warranted. Second, as widely expected, most notably by Fed officials, the demand slowdown has proved transitory. Consider consumer demand. The Commerce Dept. reported that retail sales fell 0.3% in August, but the drop was concentrated in motor vehicles. Excluding cars, sales rose 0.2%. And the total July number was revised up to show an increase of 0.8%, instead of 0.7%. The gains probably extended into September, although hurricanes Frances and Ivan might skew the data for sales in the Southeast. Weekly store surveys for the week ended Sept. 11 showed improvement over the previous week. Real consumer spending will probably grow at an annual rate of about 3.5% in the third quarter. That would be twice the 1.6% second-quarter advance. Foreign demand also got off to a better start in the third quarter than it did in the second. Exports of goods and services jumped 3% in July, after falling in two of the previous three months. The gain in exports, coupled with a drop in imports, narrowed the trade deficit from a record $55 billion in June to $50.1 billion in July. Even so, the continued high price of oil and the need to replenish oil inventories in the U.S. mean that foreign trade will probably be at least a small negative for U.S. growth in the second half. In addition, high energy prices, along with China's goal of cooling its economy, has raised uncertainty about global growth, which could curtail demand for American-made goods. THE CHINA SLOWDOWN hasn't yet affected U.S. exports. So far this year, shipments to China and other Southeast Asian countries are rising faster than they did for all of 2003. But nations such as Thailand and Singapore are warning that the high level of oil prices is slowing growth and could continue to do so in 2005.  What may be more important to the outlook is how the foreign trade sector influences inflationary trends in the U.S. Already, global demand for commodities has pushed up prices of raw materials. Even excluding oil, import prices of industrial supplies are up 16.3% in the year ended in August. U.S. producers have not been able to pass along these price hikes to their customers. Producer prices for finished goods, excluding food and energy, were up only 1.5% in the same time period.In addition, slowing demand elsewhere in the world means foreign producers will want to gain further market share in the U.S., one of the few vibrant economies right now. Already, foreign companies are keeping their prices low, even with the weaker dollar. The latest import data show prices of imported consumer goods, excluding cars, up a tiny 0.6% in the year ended in August, while capital goods prices have fallen by 1.5%. Low inflation, of course, will allow the Fed to maintain its measured approach to rate hikes. Equally important, it should keep bond yields at relatively low levels. Attractive financing is just another reason to expect a rebound in growth in the second half.  By James C. Cooper & Kathleen Madigan
BW MALL
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