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The Chill Could Last Right Through The Spring


Business Outlook

THE CHILL COULD LAST RIGHT THROUGH THE SPRING

There's a recovery in the economy's future. The Federal Reserve has planted the bulbs. The Administration and Congress are throwing in some fertilizer. But if you're trying to count the crocuses breaking through the ground, forget it. They're not there yet.

Yes, housing is recovering, but that's not new. Homebuilding has been in a modest upturn for a year, and lower interest rates and tax giveaways will help out. Exports are growing, but that's old news, too.

The real keys to a cyclical turnaround are stronger labor markets, a pickup in domestic demand, and better evidence that the Fed's past easings of monetary policy are sufficient to spark a general upturn in business. In these three areas, the signs are still lacking.

New claims for jobless benefits remained high in January, and job worries continue to depress measures of consumer confidence. Commodity prices, a sensitive indicator of changes in demand, still have not shown the early-recovery bounce that they typically do. A recent surge in lumber prices, however, probably does reflect some new strength in housing.

As for consumers, spending tanked at the end of 1991, and initial January readings look poor. Car sales weakened further last month. And although some retailers say sales are up from a year ago, that's probably because buying during the gulf war was so dismal.

With consumers out of action, manufacturing is losing momentum. New factory orders are falling, and the nation's purchasing managers report that industrial activity began the year with no signs of growth (chart).

LONG

RATES

POSE A

THREAT

All this bad news does not write off the recovery. But it does suggest that getting there could be difficult and take longer than the consensus forecast of a spring turnaround implies.

The index of 11 leading indicators, which is supposed to foretell the economy's future, seems to say as much. It fell 0.3% in December, the second consecutive decline. The index has posted only one slim gain since July.

At least one of those leading indicators, the M2 money supply, looked more encouraging in January. M2 fell sharply at yearend, but a surge during January suggests that the weakness was more technical than fundamental. However, M2 continues to grow at the lower end of the Fed's 2.5%-to-6.5% target range. Until money grows faster, doubts will remain about the ability of past cuts in interest rates to spur the economy.

Fed Chairman Alan Greenspan said in congressional testimony on Feb. 4 that the central bank expects previous rate cuts to generate a sustained recovery beginning in the second quarter. He also hedged his forecast. He said that assessing the outlook right now is "extraordinarily difficult," and that the Fed is "continuing to evaluate whether some additional insurance in the way of further monetary ease would be appropriate."

Most assuredly, the economy will need more help if long-term interest rates keep rising. The backup in long rates, coming without any concrete signs of recovery, threatens to kill off the upturn at its roots. Low rates are critical to housing and to the restructuring of the debt-laden balance sheets of consumers and businesses.

The huge financing needs of the U.S. Treasury remain the biggest prop under long rates. At its quarterly refunding announcement on Feb. 5, the government pleased the bond market with its smaller-than-expected financing needs and its onetime cut in the proportion of 10-year and 30-year bonds. However, the market was disappointed that Treasury had no plans for a permanent reduction in its dependence on long-term financing.

ARMS CUTS:

AT WAR

WITH

RECOVERY

Defense cutbacks could be another stumbling block for the recovery. Real military outlays fell last quarter at a 15.4% annual rate. That is the sharpest quarterly decline since the pullout from Vietnam in 1973.

The drop is equivalent to a full percentage-point decline in real gross domestic product, and secondary impacts on incomes and spending will show up in later quarters. Moreover, the cutbacks have only begun.

Less defense spending is just one more drag that the manufacturing sector can do without right now. The auto industry and its suppliers are already hurting, and factory orders generally are slumping. Durable goods orders dove 5% in December, to $117.7 billion. Monthly bookings are volatile, but the December decline was broad, and the three-month average shows that orders are trending downward again (chart).

In addition, new bookings are coming in slower than shipments are going out, which is depleting the order backlog. Unfilled orders fell 0.5% in December, the fourth consecutive decline. The backlog dipped to the lowest level in more than two years. With both new and unfilled orders falling, factories have little incentive to boost either their production or their payrolls.

Manufacturing remained in decline in January, according to the National Association of Purchasing Management. The NAPM's index of industrial activity held steady at the December level of 47.4%, and a reading below 50% indicates that manufacturing is in recession. Orders and output posted no growth in January, says the NAPM, and employment continued to fall.

INCOMES

ARE UP

--BY A FEW

DOLLARS

The problems that manufacturing faces in early 1992 stem directly from the consumer retrenchment of late 1991. Adjusted for inflation, real outlays fell 0.4% in October, barely rose in November, and didn't grow at all in December. For the quarter, real spending on goods and services declined at an annual rate of 1.1%.

That weakness was concentrated in goods purchases. Outlays for goods plunged at a 5.2% annual rate in the fourth quarter. The severity of that slide is comparable to that of the 6.6% drop registered during the fourth quarter of 1990--the worst quarter of the recession.

The slump in car buying accounted for some but not all of last quarter's weakness in goods purchases. And car sales continued to be a drag on outlays in January (chart).

New domestically made autos sold at an annual rate of 6.1 million in late January. Although that was better than the 5.7 million pace at mid-month and the dismal 5.3 million showing early in the month, January sales stood at a paltry 5.9 million--a shade lower than in December.

Home buying may well be a different story in January. Although sales of new single-family homes fell 6.6% in December, to an annual rate of 522,000, purchases last month probably picked up in response to sharply lower mortgage rates, and the promise of favorable tax treatment will probably lure some first-time buyers later on.

However, nothing can kill a housing recovery like higher mortgage rates. The average rate for 30-year fixed loans has risen by half a percentage point, to 8.83% for the week ended Jan. 30, from 8.31% in the week ended Jan. 10 (chart). That's back to where rates were in early November, when sales weren't so hot.

Fixed mortgages are more expensive because of the general rise in long-term rates and also because the wave of refinancings has pumped up mortgage demand, allowing banks to charge more.

The housing recovery is sure to lift home-related purchases of goods, but a full-blown turnaround in consumer spending will not happen until employment and incomes improve in a big way.

Personal income did rise a strong-looking 1% in December, but a host of onetime influences boosted the gain. Excluding a jump in farm subsidies, special payments of jobless benefits, and bonuses for auto workers, incomes rose only 0.5%. And inflation stole 0.3% of that.

In the third and fourth quarters of last year, real aftertax income rose at annual rates of only 0.3% and 0.5%, respectively. It's little wonder that consumers are not yet in a position to lead this economy into a recovery. If consumer fundamentals do not show marked improvement by March or April, you can forget about a spring recovery and start hoping for a summer turnaround.JAMES C. COOPER AND KATHLEEN MADIGAN


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