Economic Highlights for the week ended February 1, 2008

Economic Week In Review: Fed Cuts Key Rate Again, GDP Growth Slows

Vanguard 2/1 - In a noteworthy week, the Federal Reserve Board lowered its short-term interest rate target by half a percentage point—the second reduction in eight days—to shore up the weakening U.S. economy. In other economic news, GDP growth slowed in the fourth quarter, new-home sales continued to slide, and construction spending declined. For the week, the S&P 500 Index rose 4.9% to 1,395 (for a year-to-date total return of –4.9%), and the yield of the 10-year U.S. Treasury note fell 1 basis points to 3.60%.

Fed Delivered Another Pick-Me-Up – FOMC January 30 Announcement

Vanguard 2/1 - Following on the heels of last week's surprise three-quarter-point cut in the federal funds rate, the Federal Reserve Board's Open Market Committee (FOMC) lowered its target rate to 3.0%—a drop of 0.5%—on Wednesday. Noting recent indications of a deepening housing contraction and softening in the labor markets, the FOMC stated that the additional rate cut "should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain." The FOMC also noted that inflation—which is expected to moderate in the coming quarters—needs to be monitored carefully.

Bear Stearns 1/30 - The Fed, in emphasizing its willingness to address downside risks to growth from here, leaves the door open for further rate reduction at the March FOMC meeting.Unless the economic data show enough strength to shift market expectations on rates, we see the Fed cutting the funds rate to 2½% at the March 18th FOMC meeting.  The problem with this strategy is that it is likely to boost inflation pressures over the next year and we stand by our macro strategy themes of a steeper yield curve, a weaker dollar, and buying inflation protection.

New-Home Sales Continued To Slide - December

Vanguard 2/1 - Sales of new homes decreased more than 26% in 2007, the steepest drop since record-keeping began in 1963. The housing market showed no sign of stabilizing. December new-home sales fell 4.7% to 604,000 units (annualized)—the slowest month since February 1995. Inventory continued to build; at the December sales rate, it would take 9.6 months for all unsold new homes to be purchased. While the $219,200 median price of a new home in December was down 10.4% from one year ago, the median price for all of 2007 eked out a 0.2% gain over 2006. The Standard & Poor's/Case-Shiller home-price index—a separate measure of home prices in 20 metropolitan areas—declined in November for the eleventh consecutive month.

Durable Goods Orders Were Much Stronger Than Expected In December

Vanguard 2/1 - An unexpectedly robust increase in December's new orders for durable industrial products—up 5.2% in the largest monthly increase since July—provided some relief from other gloomy economic indicators. Military aircraft and parts orders more than doubled and most sectors gained, reflecting strong overseas demand. Orders for core (non-defense) capital goods excluding aircraft—a key barometer of business investment—increased 4.4%. Partly mitigating the good news was a 1.1% increase in business inventories and a 2.5% increase in unfilled orders, which have risen in 31 of the last 32 months. Both measures now stand at the highest level since the data series began in 1992. For the year, new orders increased 1.0%, the poorest showing since 2002.

Bear Stearns 1/29 - The strength in this report was broad based, but given that this is a volatile series and given the weakness in the ISM in December, it is too soon to say that manufacturing is recovering from its recent doldrums. 

Consumer Confidence Fell In January, But Jobs Assessment Strengthened

Vanguard 2/1 - The Conference Board's index of consumer confidence surrendered last month's modest gain and retreated to 87.9 in January from December's upwardly revised 90.6. While consumers were slightly more positive about the current business climate, their short-term outlook turned more pessimistic. Overall, confidence has trended downward since July, although January data was collected before both the Federal Reserve Board's January 22 surprise rate cut and the announcement of plans for an economic stimulus program.
Bear Stearns 1/29 - The jobs components of this report point to an improvement in consumers' perceptions of the labor market as the percentage of consumers judging jobs as being "plentiful" rose to 23.9% from 23.6%, while those viewing jobs as being "hard to get" fell to 20.1% from 22.7%.  Thus, the net jobs "plentiful" less "hard to get" index rose to 3.8% from 0.9%.

Weak GDP Growth As Economy Slowed Down – 4Q2007

Vanguard 2/1 - As anticipated, growth in the total output of U.S. goods and services slowed during the fourth quarter, to only 0.6% (annualized)—a steep decline from 4.9% growth in the third quarter. New-home building plunged an annualized 23.9%, the largest quarterly decrease in more than 20 years, and exports rose only 3.9%. The Commerce Department's estimate of real GDP growth for all of 2007 was 2.2%, the weakest showing since 2002, when the economy was recovering from recession. Residential investment declined 16.9%, and the slowdown extended beyond the weak housing market (to equipment and software, for example), adding to concerns about a recession.

Bear Stearns 1/30 - The surprise in this report was a $3.4 billion decline in real inventories in the fourth quarter, which subtracted 1.3% points from GDP growth.  Real final sales rose 1.9% in the fourth quarter, about in line with our forecast.  For the year as a whole, real GDP rose 2.5%.

A 23.9% plunge in real residential investment subtracted 1.2% points from fourth-quarter growth.

An auto-related decline in inventories was the major factor in a weaker-than-expected GDP report.  The weak headline number should provide the Fed with some cover from the economic data to satisfy market expectations to cut the funds rate by 50 basis points today (January 30).

Disappointing News On The Job Front – January Payroll Report

Vanguard 2/1 - In the first monthly decrease since August 2003, nonfarm payrolls unexpectedly fell by 17,000 in January (versus expectations of adding 75,000 jobs), another possible recession indicator. Construction and manufacturing shed jobs, but health care continued to add positions. While the retail trade sector was little changed overall, job losses among clothing and general merchandise stores indicated consumers were tightening their belts as the housing slump and high energy prices continued.

Bear Stearns 2/1 - December payrolls were upwardly revised to 82,000 from 18,000, November employment was downwardly revised to 60,000 from 115,000 (a net upward revision of a negligible 9,000).

The unemployment rate fell to 4.9% in January from 5.0% in December as the labor force fell 42,000 (household employment rose only 37,000 in January).

A decline in payrolls is one of the factors that typically indicates that the economy is in recession.  However, given the size of the statistical adjustment for net business creation and lack of corroboration of this payroll reading by the ADP survey, we will have to wait for the February report before drawing a conclusion on whether the economy has slipped into recession. 

ADP Employment - January

Bear Stearns 1/30 - The January ADP employment report showed a stronger-than-expected 130,000 gain in private payrolls in January.  December ADP employment was downwardly revised to 37,000 from 40,000.

Within ADP employment, service-providing jobs rose 141,000, while goods-producing employment fell 11,000 (the fourteenth consecutive monthly decline).  Manufacturing employment was flat in January after eighteen consecutive monthly declines.

Initial Claims for Unemployment – week ended Jan. 26

Vanguard 2/1 - In other employment news, first-time filings for unemployment for the week ended January 26 increased more than expected to 375,000 (the highest level since October 2005, post-Hurricane Katrina), but filings at this time of year tend to be volatile.

Employment Costs Rose Steadily – 4Q2007

Vanguard 2/1 - A key barometer of compensation trends—the Employment Cost Index—increased 0.8% in the fourth quarter, the same pace as in the first and third quarters and a sign of relatively low wage-based inflation pressures. Wages and benefits grew at similar rates. For the year 2007, civilian compensation costs rose 3.3%, the same as in 2006.

Personal Income, Spending, And Savings Increased In December

Vanguard 2/1 - Personal and disposable income both rose 0.5% in December—a plus for cash-strapped consumers. Consumer spending—which represents about 70% of GDP—increased only 0.2%, well below November's revised 1.0% increase; inflation-adjusted spending was flat, reflecting a lackluster holiday season. Consumers saved 0.2%of their disposable income (compared with no savings in November). For the year, 2007 spending grew 5.5%, the slowest rate since 2003.

The core personal consumption index (excluding food and energy)—a barometer of inflation watched by the Federal Reserve—increased 2.2% in December 2007 over December 2006, outside what is considered to be the Fed's comfort zone of 1%–2%.

Chicago Purchasing Managers’ Index Fell To 51.5 In January

Bear Stearns 1/31 - The Chicago purchasing managers' index fell to 51.5 in January from 56.4 in December.

Weakness was broad based as new orders fell to 44.7 in January from 56.7 in December, production plunged to 51.3 from 62.0, and employment declined to 47.0 from 49.3.

Inflation indicators in this report show sharply rising price pressures as the prices paid index soared to 81.7 in January from 67.4 in December, while supplier deliveries slowed sharply as the vendor performance index rose to 61.7 from 48.7.

This report highlights potential stagflation themes with sharply slowing manufacturing activity in the Midwest combined with a significant further pickup in inflation pressures.

ISM Manufacturing - January

Vanguard 2/1 - January's ISM Index—a monthly survey of purchasing managers by the Institute of Supply Management—improved to 50.7 from a revised 48.4 in December. While the latest index is just above the threshold level of 50 (readings below 50 generally indicate the manufacturing sector is declining), manufacturing is likely to remain soft at least in the near term, particularly given the inventory build associated with the durable goods report.   

Bear Stearns 2/1 - This report and the December durable goods data suggest that manufacturing activity is growing at a slow pace in early 2008 rather than contracting as appeared to be the case in late 2007.  This report, however, also underscores cost inflation pressures. The leading indicator in this report, new orders, remains weaker than current production.

U of Michigan Consumer Sentiment - January

Bear Stearns 2/1 - The University of Michigan's consumer sentiment index was downwardly revised to 78.4 in January from the previously reported 80.5 (up from 75.5 in December).  Current conditions are now reported at 94.4 in January versus 91.0 in December, while expectations increased to 68.1 from 65.6 in the prior month.

One-year inflation expectations held steady at 3.4% in January, while five-year inflation expectations eased to 3.0% from 3.1% in December (both unrevised from the preliminary sentiment report).

Consumer sentiment continues to deteriorate, but long-term inflation expectations remain stable.  This report provides no obstacle to a Fed rate cut in March.

Construction Spending

Vanguard 2/1 - Construction spending in December decreased 1.1% from November, more than analysts predicted. The soft housing market was reflected in a 2.8% drop in private residential construction, but private nonresidential spending—including offices and communication facilities—rose 1.3%. In the public sector, spending fell 1.5%.

Bear Stearns 2/1 – In addition, November construction spending was downwardly revised to show a decline of 0.4% from a previously reported 0.1% increase.  Over the last year, total construction spending has fallen 2.3%.

There is no new information in this report. Residential construction continued to plunge at the end of 2007, while nonresidential investment remained robust.

The Economic Week Ahead: February 4 – February 8

Vanguard 2/1 - While the groundhog briefly takes center stage, he may quickly be overshadowed by another relatively full slate of economic news next week—kicked off by Monday's announcement of factory orders, which should provide a more complete picture than this week's durable-goods orders. The ISM non-manufacturing index (Tuesday), productivity and costs (Wednesday), consumer credit (Thursday), and wholesale trade figures (Friday) complete the roster.