(Archived Content)
When we met three months ago, the economy was in the early stages of a slowdown whose eventual resolution was difficult to judge. It was obvious that there was increased downside risk for the economy, but equally obvious that there were important elements of continuing strength. Now, three months later, that somewhat uneasy balance between strength and weakness still persists.
Strength can be said to have predominated in the first quarter Gross Domestic Product results reported at the end of last week -- certainly in the headline number -- with real growth rising to 2 percent annual rate from 1 percent in the final quarter of last year. It is even more impressive that auto sales which fell so precipitously late in the fourth quarter of last year recovered so quickly in the first quarter of this year. Coupled with cuts in production, auto and light truck inventories have been brought back into a more normal relationship with sales. Inventories early in the first quarter were averaging in the 90 to 100 day supply range and have since been reduced to the 60 to 65 day range generally regarded as closer to optimal.
While rapid resolution of the auto inventory problem is surely a sign of strength, the sluggish pace of inventory adjustment in the high-tech area in the early months of this year can only be regarded as a sign of weakness. High-tech inventories accumulated at a record rate for that industry in the fourth quarter of last year and in book-value terms even a little more than for autos. The difference is that auto inventories have quickly been reduced into better alignment with sales while high-tech inventories have not. High-tech inventory accumulation slowed in January and February at the manufacturing level but shipments slowed even more and inventory levels still appear to be excessive.
One reason that the auto inventory adjustment has gone more smoothly is that the industry sells its product largely, although not exclusively, to consumers where demand has been well maintained. The high-tech industry is heavily engaged in business-to-business transactions where demand has faltered at least temporarily. Real personal consumption expenditure has been remarkably unaffected by the recent slowdown, rising at nearly a 3 percent annual rate of growth in the fourth quarter and at a little more than a 3 percent rate in the first quarter. In marked contrast, business capital spending on information-processing equipment and software rose at a 10 percent annual rate in the fourth quarter and fell at about a 6-1/2 percent annual rate in the first quarter. Strength in consumption and weakness in business capital spending, particularly in the high-tech area, is becoming an increasingly important feature of the current economic situation.
Continuing strength in consumer outlays and growing weakness in capital spending is explained to some degree by recent developments in the wage-productivity-profit area. During the second half of last year, hourly compensation (wages plus benefits) for the nonfarm business sector rose at about a 6-1/2 percent annual rate in nominal terms and productivity grew at a little above a 2-1/2 percent annual rate, leaving nearly a 4 percent rise in unit labor costs. During the same period, the implicit price deflator for nonfarm output (the prices on average that corporations charged) rose by only about 1-1/2 percent, down from a 2-1/2 percent rate of increase in the first half of the year. In other economic environments, corporations might have passed through the increase in unit labor costs in the second half of the year with inflationary consequences. In the recent environment with very little corporate pricing power -- aside from some energy sectors -- the inevitable result has been a severe squeeze on unit profits and some increased uncertainty as to the outlook for capital spending. Comprehensive wage-productivity-profit data are not available yet for the first quarter, but from all indications much the same pattern has persisted.
Private consensus forecasts for the economy remain relatively optimistic. The Blue Chip consensus of 50-some economists at major corporations, financial institutions and academic research organizations provides a useful summary. Their growth projections have been scaled down considerably in the light of recent developments. For example, the consensus projection for real growth over the four quarters of this year was 3.5 percent last September, 3.0 percent last December and 2.0 percent by this April. That 2 percent path consisted of a slow start with only a 0.9 percent rate of growth in the first quarter, in contrast to the higher 2 percent figure released last week, followed by gradually firmer growth during the balance of the year, reaching a little more than a 3 percent rate by the fourth quarter.
This and similar private forecasts, such as that released last week by the National Association of Business Economists, are inherently plausible. There has not been much sign of the cumulative type of economic weakness which might drive the economy sharply lower, and some signs that the economy may already have bottomed with growth still positive. So a cautiously optimistic view of near term economic prospects seems to be warranted. Caution is still indicated because economic strengths and weaknesses are closely balanced with downside risk not yet completely removed from the picture.
Recent high-frequency statistical readings, some of them more forward looking than the comprehensive first quarter Gross Domestic Product results, may provide additional perspective on the near-term outlook.
- The Conference Board's index of leading economic indicators continues to trend downward, but in a gradual fashion more consistent with slow growth than anything worse.
- Both the Conference Board's index of consumer confidence and the University of Michigan's index of consumer sentiment suggest an increasingly cautious attitude on the part of consumers.
- The Conference Board's quarterly survey of business confidence plunged to a very low level at the end of last year, but had rebounded considerably by the end of the first quarter. The assessment of current conditions was still depressed but expectations for business conditions over the next six months had improved relative to the previous survey.
- Weekly initial claims for unemployment insurance continue on an upward path. This suggests that even with the continuation of slow to moderate growth on an economy-wide basis, labor markets may soften somewhat further.
- Both new and existing home sales rose in March with mortgage rates hovering near a relatively low 7 percent. It may be significant that at the end of the first quarter both the housing and auto markets -- traditionally where any serious cyclical weakness might be expected to emerge -- remained relatively strong.
That is a summary of recent economic developments and the near-term economic outlook.