Research Dept. News
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Monthly Report, num 310 - February 2008
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International review - United States
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United States: fear of recession
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United States grows by 2.5% in fourth quarter which means a substantial slowdown in economic activity.
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A month ago the economy was going through a narrow defile between fear of lower growth and rising inflation. The strength of domestic demand in the third quarter raised doubts about the former. But, when president Bush declared that the economy needed a shot of vitamins in the arm when announcing a package of fiscal measures totalling 145 billion dollars and the Fed drastically reduced its intervention rate, this all suggested that the doubts had decreased and that the risk lay in the sharpness of the slowdown or even the recession.
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The United States is expecting a poor start to the year, with the likelihood of recession included, and the key lies in the performance of private consumption. The low level of savings, the drop in housing prices, the tightening of credit terms and the higher cost of energy could leave in a weak state the factor that has been acting as the main support of economy in the United States and the world, given that, through its imports (that is, its trade deficit) has absorbed the excess savings of the emerging economies, of Japan and, to a lesser extent, of Europe. Monetary policy was ready to act but in view of such pressures it was necessary to provide rapid specific fiscal stimulus so that not everything would fall on low interest rates because, among other things, this could add upsets in the dollar exchange rate.
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Retail sales slowing down and perception of current situation grows worse.
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The gross domestic product (GDP) moved up 2.5% year-on-year in the fourth quarter. There were notable drops in retail sales. Excluding cars and petrol, which are highly volatile, retail consumption in December grew by 3.7% year-on-year, 1.3% discounting price increases. Also running along these lines was the consumer confidence index from the Conference Board given that the slight rise shown (to the level of 88.6 points) was due to a slight correction of the drastic drop in prospects the month before. A significant point is that this weakness has been turning into the perception of the present situation which went from 115.7 points to 108.3, a level similar to the low in October 2005 following hurricane Katrina.
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Manufacturing executives more pessimistic while those in services see things more calmly.
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Some dark clouds are also appearing in what seemed like strength at the beginning of the year, namely the firm state of non-financial companies. Latest results published suggest a drastic drop in profits and this logical change of attitude is reflected in the index of business activity put out by the Institute for Supply Management. In the manufacturing sector the index dropped from 50.8 to the 47.7 points level, below 50 which indicates that pessimistic responses were in the lead with a clarity not seen since the start of the war on Iraq. In services, things look somewhat better although the index dropped from 54.1 points to 53.1. By component, prices generally are close to the 70 points level while in manufacturing we note weakness in employment and a sharp drop in new orders. In services, prices are holding, although just barely, in the optimistic range.
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Construction undergoing sharp slowdown with home prices down 6.7%.
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The housing market continues well on the downward track. On the supply side, the storm is growing worse with a much deeper drop than during other cycles. Housing starts dropped more sharply in December losing 14% compared with November with a total drop of 38.2% year-on-year which reduces this activity to less than half that operating in 2005. The sharpness of the drop in supply is having its effect on growth but, with housing investment representing 4.5% of total GDP in current dollars, the most troubling aspect is what it implies regarding the scenario construction companies have for the real estate market and therefore for private consumption, that equals a decisive 70.0% of GDP. Sales of existing housing were down 20.0% year-on-year in November while new housing dropped by 34.4%. The slowdown in the Case-Shiller index for housing prices was also sharper with a loss of 6.7% year-on-year in October.
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The pass-through of the weakness in the housing market and the tightening of private consumer credit terms is taking place through three channels, to which a fourth may be added. First, there is the wealth effect for the fact that, as consumers feel they are not as wealthy as a result of the drop in the prices of their assets, the restrict their spending. There is also the lower capacity to find finance using equity of diminishing value as collateral. Thirdly, the tightening of borrowing terms not only affects those who have a low credit rating but all other households seeing that those who hope to buy a house are obliged to save more in order to make the down-payment. Finally, the higher price of oil, while it may not affect the non-energy components of the CPI, through increased spending on petrol, does reduce the funds available for other goods and services.
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Employment slowing down while unemployment rate rises to 5%.
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The labour market had a poor month in December with only 18,000 new jobs added to the economy and an unemployment rate that went from 4.7% to 5.0% of the labour force. The most notable, however, continues to be the persistence of a more moderate downward trend than in previous slowdown cycles of the economy. This is adding some fuel to consumption but increasingly less given that in the past 12 months an average of 111,000 jobs have been created each month, half what was normal at the beginning of 2006.
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Inflation holds above 4% while correction of deficit must wait.
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The December consumer price index (CPI) maintained a rise going to 4.1% year-on-year. The core component (the general index less food and energy) rose slightly with the increase going from 2.3% to 2.4% year-on-year. The increase in inflation must be seen as a bad spoke in the wheel in the implementation of expansionist monetary policies than as the start of an upward spiral in prices. The speed with which the economy can advance without creating inflationary pressures has been reduced and the Federal Reserve must preserve its anti-inflation reputation in order to keep being effective. Both producer prices and the underlying index (excluding the inflationary and volatile home rentals) are showing a scenario that is less removed from price stability.
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On the foreign front, things are taking longer than expected. The trade balance in goods and services in November showed a deficit of 63.12 billion dollars, an increase of 8.0% year-on-year which cannot continue. Exports rose by a robust 13.0% but it was the boost in imports (with a rise from 9.1% to 11.4%) that caused the growth of the deficit.
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