Growth May Drop to Below-Trend Rate in Second-half Even As Recession Talks Fade

Fri. August 29, 2008; Posted: 05:40 PM

(RTTNews) - Last week saw some semblance of strength emerging in the economy following the release of a couple of positive economic readings. The second quarter GDP growth was revised up to 3.3% due to stronger exports and less inventory reductions. The narrower trade deficit added three percentage points to GDP growth, offsetting the 1.5 percentage point deduction brought about by inventory depletion. Consumer spending growth was also revised upwards. However, economists are less sanguine about the performance in the second half of the year, as global growth that has solidly supported U.S. growth even amidst the domestic downturn is now showing signs of weakness.

Housing data continued to be confounding, offering little visibility towards a housing market recovery. However, last week's housing market reports pointed to some degree of stabilization. The National Association of Realtors' existing home sales report showed a 3.1% monthly increase in existing home sales in July to a seasonally adjusted 5 million annualized unit rate. On the other hand, existing home sales for July were down 13.2% year-over-year. Inventories at the end of July rose 3.9% to an all time record high of 4.67 million homes, representing an 11.2-month supply at the current sales pace.

The national median price of existing homes fell 7.1% to $212,400 from a year-ago. Regionally, sales increased in the West (up 9.7%), Northeast (up 5.9%) and Midwest (up 0.9%), while sales edged down 0.5% in the South.

Meanwhile, the Commerce Department's new home sales report showed a 2.4% monthly increase in new home sales for July to an annualized rate of 515,000 units. However, the previous two months' sales were revised down, resulting in a net reduction of 46,000 for the previous two months. The median sales price of new homes was down 6.3% year-over-year in July. Meanwhile, inventories of new homes edged down to a 10.1-month supply rate. Regionally, new home sales jumped 38.9% in the Northeast and rose 9.9% in the West. On the other hand, sales in the Midwest and South fell 8.2% and 2.5%, respectively.

Consumer sentiment seems to be taking a turn for the better after several months of poor showing. The Conference Board's consumer confidence index rose 5 points in August to 56.9, marking the second consecutive months of gains. While the expectations index increased 10.1 points to 52.8, the current conditions index declined 2.6 points to 63.2. Much of the optimism is traced back to the recent pullback in energy prices. The fledging recovery in consumer sentiment was confirmed by the University of Michigan's consumer sentiment index, which rose to 63 in August from 61.2 in July.

The minutes of the August 5th FOMC meeting showed that most members were of the view that the next move in interest rates will be towards the upside. However, the members don't seem to share a unanimous view about the extent and timing of the policy move. The FOMC expects weak growth for the rest of the year before it recovers modestly next year. Additionally, the members expect weak consumer spending due to difficult, credit, labor and housing market conditions. While most members expect headline inflation to slow in the coming quarter, the core inflation rate is expected to edge down during 2009. Given the fact that some of the members do not view the current policy stance as particularly accommodative, the FOMC is most likely to remain on hold this year.

However, the personal income and spending data for July came in weaker-than-expected. Personal income fell 1.1% due to a smaller payout in July than in June. Although personal spending rose 0.2%, the real spending when adjusted for inflation declined 0.4%. Additionally, the core PCE deflator increased 0.3%, pushing up the year-over-year rate to 2.4%.

The data points received last week shed some light on the growth scenario going forward. According to Wachovia Securities, the economy may expand by around 1% in the second half of the year. Trade, which provided much of the boost to growth in the second quarter, may contribute less in the third and fourth quarters. Additionally, consumer spending is also expected to contribute less to growth in the coming quarters. The firm estimates personal consumption expenditure to decline at an annual rate of 0.7% in both the third and fourth quarters.

However, there is some upside risk to the estimate due to a pullback in gasoline prices and the possibility of an increase in auto sales due to the incentives announced in late August.

Going by the surprisingly strong durable orders goods report for July, one can expect business fixed investment to pick up. Orders for non-defense capital goods orders, excluding aircrafts, rose 2.6% in July, rendering the annual rate to 13.5% over the past three months.

What does this scenario imply for monetary policy action? The central bank is likely to stand pat on interest rates, as it is left with the option of facing the double-trouble of below-trend growth and above-target inflation.

Although the upcoming week is a holiday-shortened week, there are a few key first-tier economic reports that could sway the markets. Traders may look forward to the release of the Labor Department's non-farm payrolls report on Friday to gauge the strength of the labor market, especially at a time when personal income has been showing softness. Additionally, the markets could also focus on the results of the ISM's manufacturing and services sector surveys.

Additionally, some degree of importance may also be attached to the Commerce Department's construction spending report for July, factory goods orders report for July, the Labor Department's final second quarter productivity and costs report, and the regularly scheduled weekly jobless claims and oil inventories reports.

Going by the mixed messages relayed by the regional manufacturing surveys, one cannot expect much change in the ISM's manufacturing purchasing managers' index. Wachovia expects the employment index to retreat in August after the sharp spike in June and act as a drag on the headline index. That said, the prices paid index may pullback due to a moderation in commodity prices.

Meanwhile, the Labor Department's non-farm employment report is likely to show an eighth straight month of job declines. The job losses are likely to be severe, given a sharp climb in weekly unemployment claims in the recent reporting weeks. However, much of the increase in the weekly claims is seen as a side effect of the extension of the federal government's unemployment benefits program. Meanwhile, the unemployment rate is likely to hold steady around 5.7%.

Construction spending may show another month of declines, primarily due to the softness in single-family housing starts. However, we could soon see a turnaround, as residential construction has been becoming less of drag on the growth.

Monday

The U.S. markets are closed on account of the 'Labor Day' public holiday.

Tuesday

The Commerce Department's construction spending report to be released at 10 AM ET on Tuesday is expected to show a 0.4% decline in spending for July.

Construction spending eased 0.4% in June from the previous month to a seasonally adjusted annual rate of $1.08 trillion. Year-over-year, spending declined 5.9%. Private and public construction spending fell at a monthly rate of 0.4% and 0.2% respectively. Within private construction, spending on residential construction declined 1.8%, offsetting the 0.8% increase in non-residential construction.

The results of the manufacturing survey of the Institute for Supply Management, which are based on data compiled from purchasing and supply executives nationwide, are due out at 10 AM ET on the same day. Economists expect the index to show a reading of 49.5 for August.

The purchasing managers' index for August eased 0.2 points to 50, barely remaining in the expansion zone. While the new orders index fell 4.6 points to 45, the production and the employment indexes climbed 1.4 and 8.2 points, respectively. Inventories remained in the contraction zone, with the inventories index falling 6.2 points to 45. The prices paid index, though retreating 3 points, remained elevated at 88.5.

Wednesday

The ADP National Employment report, which sheds light on non-farm private employment, is scheduled to be released at 8:15 AM ET on Wednesday. The report is usually released two days prior to the Labor Department's employment report.

The Commerce Department is due to release its report on factory goods orders for July at 10 AM ET on Wednesday. Orders for manufactured goods are likely to have increased 0.4% in the month.

In June, new orders for manufactured goods rose 1.7% following a 0.9% increase in May. Shipments and unfilled orders also rose in the month, increasing 1.6% and 0.9%, respectively, while inventories rose 1%.

Meanwhile, durable goods orders report for July released last week showed a 1.3% increase in orders. Durables make up bulk of the factory goods. Orders rose 0.7% excluding transportation equipment. The readings were better than the consensus estimate that called for no change in durable goods orders.

The Federal Reserve is due to release its Beige Book, which is a compilation of anecdotal evidence on economic conditions from each of the 12 Federal Reserve districts, at 2 PM ET on the same day. The report is normally released about two weeks before the monetary policy meeting is held.

The Energy Information Administration is also due to release its weekly oil inventory report at 10:30 AM ET on Wednesday.

Crude oil stockpiles eased 0.1 million barrels in the week ended August 22nd to 305.8 million barrels, remaining in the middle of the average range for this time of the year. Gasoline inventories fell by 1.2 million barrels, while distillate fuel stockpiles remained unchanged. Refinery capacity utilization averaged 86.5% over the four-weeks ended August 22nd compared to 86.4% in the previous week.

Thursday

The nine-member monetary policy committee of the Bank of England is due to hold a two-day meeting ending Thursday to determine the near-term direction of monetary policy. Any change in the policy is announced at 7 AM ET on the same day.

At its August meeting, the Bank of England kept its benchmark interest rate unchanged at 5%. The decision was in-line with expectations, as economists expected the central bank to allow time for its previous policy actions to produce results.

The European Central Bank's Governing Council is scheduled to meet at 7:45 ET on Thursday to determine its interest rate policy. Any change in policy is announced immediately after the meeting, while a statement is read out at a press briefing about 45 minutes after the meeting, followed by a Question & Answer session.

The ECB also held interest rates steady at 4.25% at its August meeting after raising it by 25 basis points in July. The interest rate on the marginal lending facility was held at 5.25%, while the interest rate on the deposit facility was retained at 3.25%. The inflation rate in the euro zone region remains well above the central bank target of 2%. However, the bank may have been prompted to maintain rates due to evidence of slowing economic growth in the euro zone economies.

The U.S. Labor Department is scheduled to release its revised report on second quarter non-farm productivity and unit labor costs at 8:30 AM on Thursday. The consensus estimates call for a 2.9% increase in non-farm productivity.

The preliminary second quarter non-farm productivity report showed that non-farm productivity rose 2.2% compared with the previous quarter, slower than the expected increase of 2.5%. Productivity of the business sector rose 2.3%. However, manufacturing sector's productivity dipped 1.4%, dragged down by a 3.5% slump in the productivity of the durable goods manufacturing sector.

Unit labor costs of the non-farm business sector increased by 1.3% in the second quarter, while those of the durable goods manufacturing sector and non-durable goods manufacturing sector climbing at an annualized quarterly pace of 8.8% and 3%, respectively.

A Labor Department report on the number of individuals claiming unemployment benefits during the week ended August30th is scheduled to be released at 8:30 AM ET on Thursday.

The number of individuals claiming unemployment benefits declined 10,000 in the week ended August 23rd to 425,000 from the previous week's upwardly revised average of 435,000.

The four-week average that removes volatility declined 6,000 in the recent week to 440,250 from the previous week's revised average of 446,250. Continuing claims, which is calculated with a week's lag, increased 64,000 in the week ended August 16th to 3.3655 million.

The ISM is scheduled to release the results of its non-manufacturing survey at 10 AM ET on Thursday. The non-manufacturing index is likely to show a reading of 49 for August.

The services sector survey for August showed that the business activity index rose 1.3 points to 49.5, which suggested that the activity in the sector is contracting. The business activity and new orders indexes eased 0.3 and 0.7 points to 49.6 and 47.9, respectively. However, the employment and backlog of orders indexes increased 3.3 and 3 points, respectively. Towing in-line with the manufacturing survey, the prices paid index fell 3.7 points to 80.8.

Friday

The Labor Department is scheduled to release its monthly non-farm payroll report at 8:30 AM on Friday. The report sheds light on the number of paid employees working part time or full time in the nation's business and government establishments, the number of hours worked in the non-farm sector, the basic hourly rate for major industries and the number of unemployed as a percentage of the labor force. Economists estimate that the U.S. economy lost 70,000 jobs in August and look for an unemployment rate of 5.7%.

In July, the U.S. economy lost 51,000 jobs, which was lesser than the 75,000 job losses predicted by economists. The previous month's job loss was revised down to 51,000 from the originally reported decline of 75,000.

The unemployment rate rose to 5.7%, a tad higher than the 5.6% rate expected by economists. Average hourly earnings rose 0.33% to $18.06.

Among the sectors, the good producing sector lost 46,000 jobs, with the construction and manufacturing sectors losing 22,000 and 35,000 jobs, respectively. Meanwhile, the services sector lost 5,000 jobs. Retail trade and professional and business services lost about 17,000 and 24,000 jobs, respectively. The leisure and hospitality segment added 39,000 jobs.

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