Markets & Finance

Reports Show We're on Solid Ground


New data portray good overall growth for the economy, though the factory sector is being hurt by an inventory correction

Reports on U.S. employment, consumer sentiment, and factory inventories and shipments released on Feb. 2 all reinforce the view that the economy is posting solid growth overall as we enter the new year, but with an ongoing inventory correction that is taking a toll on the factory sector.

Here is Action Economics' rundown on the reports:

Employment: U.S. job growth got off to a slower than expected start for 2007. The January employment report released on Feb. 2 showed the headline nonfarm payrolls figure rising 111,000 in the month, a moderation from December's upwardly revised 206,000 (from the 167,000 previously reported). November's payroll growth was also subject to a big revision, bumped up to 196,000 from 154,000.

The January jobs data were weaker than expected, though combined with the big November and December boosts, they suggest a healthy trajectory overall.

The unemployment rate rose to 4.6% in January from 4.5%, as civilian employment posted only a 31,000 gain, following a string of outsized increases through 2006. Average hourly earnings rose 0.2% after a 0.4% increase in December (revised from 0.5%), hence also falling short of expectations. The workweek slipped to 33.8 from 33.9 hours.

Among employment categories, manufacturing shed 16,000 workers. Construction employment rose 22,000, though this was probably a function of better weather. Service employment was up 104,000, and government employment climbed 14,000. The revisions to the back months make the labor market look stronger, despite the softer than expected January numbers.

For January, the workweek drop, payroll and earnings shortfall, and weak civilian employment figure all suggest downward spin on the remaining data for the month. We now assume only a 0.2% personal income gain in January that will still leave disposable income poised for a 4.4% growth rate in the first quarter, with the gain due largely to the strong fourth quarter close. This should translate to a 3.1% rate in "real" terms.

We now project a 0.3% industrial production drop for January, with factory sector weakness and a further 0.5% utility drop owing to the mild U.S. winter, and a 6.6% drop in vehicle assemblies following gains in November and December.

Hours worked are poised for 1.9% growth in the first quarter, despite the lean January data, again thanks to the strong trend through December that will match the fourth-quarter rate. As such, we will keep our 2.5% first-quarter gross domestic product (GDP) estimate intact.

We already expect the 3.5% fourth-quarter GDP gain to be knocked down to 3.1% in the next revision because of expected construction and inventory adjustments, and the result would be a 2.8% GDP growth trend through the two quarters that is quite close to our assumptions before the advance GDP report was released on Wednesday.

Michigan Sentiment: The final University of Michigan consumer sentiment index for January slipped to 96.9, vs. the big jump to 98.0 for the preliminary reading (91.7 in December). The current economic conditions index was revised to 111.3 from 112.5 (108.1 in December). The economic outlook index was 87.6 vs. 88.7 for the preliminary (81.2 December).

The report revealed downward bumps that still left solid levels, given the surprising pop in the preliminary figures. Strength in surveys of confidence through January is now fairly uniform, as illustrated by the similar surge in the Conference Board's consumer confidence index to 110.3 on the month, and comparable gains in other confidence measures.

Generally, falling gasoline prices, soaring stock prices, low interest rates, a tightening labor market, and surging income with record bonus payments are continuing to boost these survey readings.

Factory Goods: Factory orders rose 2.4% in December after a revised 1.2% increase in November (0.9% previously). Durable orders were revised to 2.9% from 3.2% initially. Nondefense capital goods orders excluding aircraft rebounded a solid 3.1% after a 1.0% decline. Factory shipments surged 1.4%. Inventories were up another 0.1%. The inventory-shipment ratio fell to 1.22 from 1.23.

The factory report for December signals a downward bump in fourth-quarter factory inventories, and we expect further downside surprises from the optimistic Commerce Dept. assumptions for the remaining December inventory data as well.

Our December business inventory forecast now sits at 0.4%, which is below the Commerce Dept.'s surprisingly high 0.6% assumption but still above the 0.2% we had assumed in formulating our original 2.7% fourth-quarter GDP forecast.

The Fed Outlook: We continue to assume that the Federal Reserve will maintain its rate-hike pause as long as it fears downside economic risks from housing sector "pass through.". If housing stabilizes through the second quarter, however, the Fed will be positioned to rethink how restrictive a stance should be maintained through the later years of this expansion. In that context, our best guess remains that the desired Fed funds rate target will ultimately lie above, rather than below, the current 5.25% rate.

Englund is principal director and chief economist for Action Economics.

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