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WEEKLY ECONOMIC COMMENTARY -- WEEK OF JULY 3, 2008
As the economy enters the mid-point of one of the most turbulent years in recent memory, it is approaching a fork in the road that splits into widely divergent possible paths. Policy makers are hoping that the road taken will provide a smoother ride than one navigated over the first half of the year, which was littered with a credit crisis, surging food and fuel prices, an intensified housing meltdown and a deteriorating job market, among other potholes. But the alternate route could be even more hazardous. At least in the first half of the year the economy continued to grow, albeit at a sharply reduced pace, thanks to the boost provided by tax rebates and solid exports. But if the headwinds from the first half remain as powerful in the second, the pillars that kept economy afloat so far will be overwhelmed.
Unfortunately, the opening act of the second half is not promising. For one, the oil dagger is piercing ever more deeply into the economy's heartbeat, soaring to over $145 a barrel in early July. With fuel at the pump now firmly ensconced north of $4 a gallon, motorists are spending an estimated $1.6 billion a day for gasoline, which translates into more than $50 billion for the entire month - the highest monthly bill on record. . How much of a possible depressant is that? Put simply, it just about equals the monthly rebate checks mailed out in May and June, which were arguably the major spending force during those months. The final check will be sent in the week of July 11 and the total will be considerably less than the monthly gasoline bill. So don't expect much strength, if any, to be reported for sales of discretionary products this month, as households will be pouring a significant fraction of their budgets into their gas tanks.
For another, the higher gasoline bill will be pressing against an ever-shrinking paycheck, reflecting a deteriorating job market that is crimping worker incomes. That was made abundantly clear in Thursday's employment report for June, which revealed another month of sizeable job losses, fewer hours worked and anemic wage gains. About the only positive aspect of the report is that it wasn't worse than expected. Economists on Wall Street predicted that the economy lost about 60 thousand jobs last month, almost spot on with the 62 thousand reported by the Labor Department. The financial markets, already reeling from skyrocketing oil prices, had braced for worse news, fearing that job losses could climb to triple-digits for the first time since 2003. With the erosion kept to "only" 62 thousand, the equity market staged a nice relief rally on Thursday, as the Dow Jones industrial average posted a respectable 73 point gain heading into the July 4 holiday.
But sifting through the numbers, there is really nothing to celebrate beyond the "it could have been worse" outcome. With the June figure, the economy has now shed jobs for six consecutive months, a string of losses seen only during recessions and their immediate aftermaths. The jobless rate after spurting a half percentage point to 5.5 percent in May held at that level in June, which is not a particularly encouraging development. The jump during the previous month was viewed as somewhat of an aberration because the household survey was taken late in the month, thus capturing a flood of students entering the labor force. It was thought that the spike would be corrected in June resulting in a slight pullback in the unemployment rate. The fact that no giveback occurred clearly suggests that students are having a hard time finding jobs.
Indeed, the fact that the jobless rate held steady despite more than 300 thousand students leaving the labor market indicates that workers elsewhere are feeling more of the pain. As it turns out virtually all key sectors of the workforce lost ground last month, although the cyclically sensitive industries , as expected, suffered the biggest losses. Construction workers continued to receive an avalanche of pink slips, as the worst housing slump in a generation threw another 43 thousand hard hats on to the unemployment rolls. That followed layoffs of 37 thousand in May and a whopping 99 thousand in April. To say that the ranks of construction workers pulling down paychecks are thinning would be an understatement. Since September of 2006, when it became apparent to homebuilders that the housing market was weakening, more than half a million construction jobs have vanished.
In manufacturing, where the job market has been buoyed somewhat by the strength in exports, conditions are also being overwhelmed by weakening domestic demands. After plunging by 23 thousand in May and 46 thousand in April, factory payrolls shrank by another 8 thousand in June. But manufacturing jobs were boosted by almost 6 thousand due to the end of a strike at a major auto parts maker. Despite the strength in export orders, industrial companies are purging workers at a faster pace than they did during the 2001 recession, and the support from exports should start to fade in coming months. As in the U.S., the oil shock is starting to take a toll on the growth rates of economies overseas, including such rapidly-growing developing countries as India and China. What's more, growth prospects in Europe are being further diminished by the inflation-fighting leanings of its policy makers. This week, the European Central Bank lifted its short-term target interest rate by a quarter-point, a move that had been widely expected.
That said, the overall job market is not deteriorating as rapidly as it usually does during recessions - at least not yet. During a typical recession, job losses average 150-200 thousand a month, including 181 thousand during the 2001 recession, which is more than double the 73 thousand average monthly decline so far this year. Of course, the jury is still out as to whether or not the economy is actually in a recession. But the job market is certainly following a recession pattern and we would like to think that the relatively modest pace of job losses so far is an indication that this cyclical downturn will not be as severe as in past recessions. Only time will tell if that turns out to be the case.
From our lens, the economy is either perilously close to or actually in the midst of a cyclical downturn, but one that is very dissimilar to previous ones. Indeed, even if the popular definition of a recession is not satisfied - i.e. two consecutive quarterly declines in real GDP - to most people, it certainly feels like a recession. That's clearly evident in just about every poll taken of households; according to the latest widely-followed surveys conducted by the University of Michigan and the Conference Board, household confidence is currently lower than the lowest points reached during each of the past five recessions. Simply put, if it walks like a duck and talks like a duck, then you are probably looking at a duck. But just as the proximate woes that are bringing on the current recession are inherently different from past recession catalysts, the internal dynamics of this downturn differ from past ones.
In particular, the labor market in 2008 may not suffer job cuts as deeply as those incurred in past recessions. But the pain this time is spreading far beyond the newly unemployed. The record number of home foreclosures and the steep decline in home values - the principle asset of most households - is threatening the financial security of a broad spectrum of the population. Households have already seen their net worth shrivel by $2.1 trillion over the six months ending in March and they will suffer another massive decline in the second quarter, with decimated stock portfolios reinforcing the decline in home values. What's more, most families are facing the pain of higher fuel and food bills. Not only is the aforementioned surge in the cost of gasoline squeezing budgets, households will soon have to brace for the shock of astronomically high home heating costs this coming winter.
So what lies ahead in the second half of the year? So far, consumer spending has held up remarkably well during what may be the first few months of a recession, thanks, in part, to the temporary assist provided by .tax rebate checks. However, the positive influence of the economic stimulus package is relatively small and will be short-lived. Once the last of the rebate checks are delivered in early July consumers, still facing the daunting headwinds of the housing depression, a weakening labor market and increasingly restrictive credit practices, will be hard pressed to maintain even the diminished pace of spending seen over the past three quarters. The wild card in the outlook for consumers is how they react to the delivery of the first of the winter heating bills that may be truly exorbitant. Our sense is that there are more downside than upside risks to our conservative spending projections for the second half of the year.
Not surprisingly, businesses have become much more cautious over the past year in response to weakening domestic conditions, credit market turmoil and the uncertain duration and severity of the housing slump. As a result, they have become much more focused on preserving margins and shoring up balance sheets than in expanding their businesses. The defensive stance of managers can be seen in the remarkable productivity gains over the past several quarters of anemic economic growth. As economic growth slowed in the fourth quarter of 2007 and first half of 2008, productivity growth would typically plummet. But, corporate managers, cognizant of the squeeze on profits caused by rising non-labor input prices have kept tight control of labor usage; by paring hours worked by more than the decline in output they have been able to sustain solid productivity gains. Additionally, purchasing managers have kept a tighter control over inventories and firms are scaling back capital spending plans until they get a clearer picture of how weak costumer demand will be in coming quarters.
Our sense is that the economy will be hard pressed to match even the tepid growth rate registered over the first half of the year. Thanks to aggressive policy moves by the Fed, the stimulus package by the administration and probably more policy intervention going forward, the probable recession will likely be shallower than past ones and the loss of jobs will not be as sharp. But the pain of this downturn is being felt much more broadly than in the past. You do not need to be unemployed to be late with a mortgage payment, or have your home in foreclosure proceedings. Credit worthy households and businesses are now routinely denied access to loans as financial institutions swing from absurdly easy credit standards to now onerously restrictive practices. What’s more, it is not only the unemployed who face sharply rising food and fuel costs. Simply put, the headwinds may not blow the economy into a severe recession – or even a recession at all – but they are battering a broad swath of the population that will leave the economy in a seriously impaired state for some time to come.