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Steadfast Shoppers Keep The Expansion Rolling


Business Outlook: U.S. ECONOMY

STEADFAST SHOPPERS KEEP THE EXPANSION ROLLING

That constant beat you hear is the footsteps of consumers marching to the latest sale or to their real estate agent's office. Even in the first half, when the economy started to look feeble, consumers were right there--with wallets open, ready to help businesses pare down excess inventories and stave off recession. And from all recent signs, households will remain steadfast in the second half.

For one thing, job jitters, so prevalent earlier in the expansion, have diminished. Income growth, while less robust because of slower job growth, remains supportive. Credit is flowing generously through the banking system. All this is giving consumers a good feeling about the coming months--enough so that more and more of them this summer are shelling out big bucks for new houses (charts).

Consumer spending last quarter was even stronger than first thought, resulting in an upward revision to economic growth. Real gross domestic product rose at an annual rate of 1.1% in the second quarter, according to the Commerce Dept.'s latest numbers, up from the originally reported advance of 0.5%.

As it turns out, consumer outlays rose a sturdy 3.4% instead of 2.5%. Consequently, overall demand by consumers, businesses, and government increased 2.5%, higher than the 2.1% gain reported earlier.

A healthy pace of consumer spending is helping businesses to trim their top-heavy inventories. Excluding the farm sector, business stockpiles rose a bit less in the second quarter than first estimated--up $31.9 billion instead of $32.9 billion--but that was far below the first-quarter's $49.1 billion advance.

Although that slower growth was a big drag on the economy last quarter, leaner stockpiles and continued spending are laying the groundwork for better economic growth in the second half.

BUT DON'T LOOK FOR a return to last year's brawny performance. Consumers are in good shape--but not that good. First of all, the economy is not creating as many jobs this year as in 1994. Second, the cyclical surge in housing and durable goods last year exhausted a lot of spending power and pumped up debt loads. Also, the 1996 federal budget will be a drag on the economy. Moreover, the Federal Reserve's rate hikes, which ended in February, are still squeezing activity.

Even the Fed thinks so. The minutes of its July 5-6 policy meeting, released only recently, show that nearly all members viewed policy as "somewhat restrictive." Only one of the 12 members of the policy committee voted against the July 6 quarter-point cut in interest rates. Given that breadth of sentiment and given that the economy seems most likely to continue along a modest growth path, chances for another small cut at the Sept. 26 meeting remain alive.

The Fed's willingness to cut interest rates a bit may have played a part in keeping consumers feeling upbeat. Consumer confidence, although down a shade in August, held at a fairly high level. The Conference Board's index dipped to 101, down from 101.4 in July. Historically, a level around 100 is a strong reading.

Households are feeling better about the future. Although they gave a more downbeat assessment of present conditions, they rated prospects six months from now much higher than they did in July. This expectations component of the overall confidence index is more closely correlated with spending patterns.

FAITH IN THE FUTURE, especially when combined with this summer's lower mortgage rates, is a key reason why home buying has been so strong. Sales of existing houses jumped 5% in July, to an annual rate of 3.99 million. That was the third consecutive increase and the highest level in more than a year.

Sales of new houses are also up for the third month in a row. From an annual rate of 712,000 in June, they edged up to 715,000 in July, also the highest in more than a year. Since hitting a three-year low of 575,000 in February, sales have grown the strongest in the West and South. The gain in the Midwest has been more modest, and homebuying in the Northeast is actually down some 20%.

It's very likely that this year's surge in homebuying is about to top out, however. That's because the gains in recent months reflect declines in mortgage rates earlier in the year. By mid-July, the average rate on a 30-year fixed-rate mortgage had fallen to 7.41%, according to the Federal Home Loan Mortgage Corp. Since then, rates have risen to 7.88% by late August.

That level of rates is still consistent with a healthy pace of sales, but unless rates start falling again, there is nothing to spur further gains. Indeed, mortgage applications to buy a house had surged 44% from early January to early June, but since then they have dropped 14% by mid-August. That pattern suggests that housing demand is now falling off and that home-sales data this fall will look weaker.

Still, sales of new houses this summer have been sturdy enough to generate new building activity that should continue into the fall. Builders' supply of unsold new homes had reached a 7.2-month supply, relative to the pace of sales, but the July inventory stands at a more comfortable 6 months.

WHEN HOUSING DEMAND is at a high level, it bodes well for sales of home-related durable goods. And sales of such big-ticket items as furniture and appliances have indeed strengthened this summer, helping stores to wrestle their inventories into better shape.

In the process, though, hard-goods manufacturers have taken a hit. Orders taken at durable-goods factories fell 1.7% in July, and since reaching their recent peak in January, they are down nearly 5%.

But the weakness in orders has been concentrated in the transportation sector, especially the auto industry. Excluding bookings in transportation, orders are only 1.3% below their January level. Rising orders for electronic equipment, reflecting strong capital spending in that area, have helped to buoy the total.

Moreover, excluding the transportation sector, unfilled orders are growing (chart). That means many durable-goods industries have plenty of work in the pipeline, and once Detroit's production picks up again, as it is slated to do in coming months, the overall factory sector will show more bounce.

Detroit accounted for much of the weakness in July durable-goods orders. But that largely reflected inadequate seasonal adjustment for the plant shutdowns during the month. For that reason, August orders are likely to look stronger. August car sales also appear to be bouncing back from their weak July showing, also reflecting seasonal quirks.

Thanks to consumers' relentless support, the economy's inventory adjustment is running its course quickly and will probably be complete by the end of the third quarter. After that, as long as households keep beating a steady rhythm, the expansion should keep on marching well into 1996.BY JAMES C. COOPER & KATHLEEN MADIGAN


Steve Ballmer, Power Forward
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