Around the end of this year, as weaker consumption and business investment combine with plunging foreign trade, the slowdown in the economy we have long foreseen will result in a “growth recession.” But by the second half or third quarter of next year the U.S. economy will resume its growth. It will not be an outright recession that we will face as we approach the New Year but a reduction in our rate of economic growth. That will dominate the first half of next year as the economy’s pace slows below 1 percent, unemployment picks up from 4.5 percent and moves toward 4.9 percent, and profits continue to fall.
By the second half, however, reacting to lowered interest rates and settling global concerns, the U.S. economy should resume a real growth trend of 2 to 2.5 percent growth, thus averting an outright recession. Overall, the growth for the entire year will average 1.5 percent, while profits rise 2.2 percent, compared with 2.5 percent reduction this year.
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While the stock market continues its volatile reaction to rising financial risks and falling profits, the Standard & Poor 500 remains some 10 to 15 percent overvalued relative to falling earnings prospects this year. A more ominous development in the marketplace was the abrupt reversal in August of investments in equity mutual funds, the worst monthly outflow in history. After eight years of steady monthly inflows, often at record levels, investors began taking their money out of the mutual funds, breaking record set during the stock market crash of 1987. For reasons that are not clear the updated figures on that market are lagging behind what is normally available, as when there is a positive investment flow.
Economic indicators and trends
Latest indications show the economy being harmed more profoundly and rapidly than even we envisioned. Underscoring these events, the Fed (Federal Reserve Bank) made two rapid-fire cuts in the funds rate, pushing it down to 5 percent a couple of months sooner than we had anticipated.
First off, employment last month eked out a mere 69,000 gain and the unemployment rate ticked up to 4.6 percent. Manufacturing employment resumed its decline, falling 30,000 on faltering foreign trade, off 152,000 since March. Construction jobs fell 20,000 as heated building activity topped out and bad weather interfered in some regions. The upshot here is that, after the agreement that ended the General Motors auto strike helped to push up August jobs about 310,000, by September the depredations of falling foreign trade and leveling domestic demand reasserted its braking effects on employment, effects that will persist into 1999.
Confirming the foreign origins of our current economic weakness, the U.S. trade deficit swelled to $16.77 billion in August, a record level of red ink. Reflecting both fallen exports, off 0.3 percent, and soaring imports, up 2.2 percent, the deficit will clearly sap considerable strength from our GDP (Gross Domestic Product) for the next several quarters.
Other indicators confirmed the weakened state of the manufacturing sector and fingered foreign trade and the run-out of correcting inventories as the main culprits. The National Association of Purchasing Management (NAPM) reported the total NAPM index contracted for the fourth consecutive month in September. NAPM survey respondents said their main concerns focused on Asia and its effect on the domestic economy, namely, cheaper imports, reduced exports, and currency instability. Inventories continued to liquidate, dragging down performance. Trade negatives overwhelmed other positives in the economy, as export orders fell for the ninth consecutive month.
Reflecting the NAPM survey, industrial production took an uncharacteristic fall last month, declining 0.3 percent. Following on the 1.6 percent surge in August that accompanied the GM strike’s end, the declines were nevertheless widespread beyond the auto and auto-related sectors. So another indicator shows the economy lagging even after the strike effects ended as slumping exports and increased import competition undercut manufacturing production. In a startling development, September’s production data closed a quarter that showed no growth, its weakest performance in over seven years, namely at the end of the last recession!
The weak production performance also cut capacity utilization for the
third consecutive period, to a level of only 81.1 percent last quarter, a five-year low. This at once undercuts inflation pressures further, but it also undermines incentives for investment spending, until recently a main impetus for GDP growth. High flying consumer confidence lost altitude in September. With the slumping stock market and impeachment worries rife, consumer confidence retreated toward year-lows in September while the important expectations index collapsed to nearly a two-year low.
Next in the litany of weakness is the slowing trend of retail sales through September, not surprising given falling consumer confidence: Even though auto sales surged 1.1 percent in the aftermath of the GM strike, last month’s level of auto sales was some 3.5 percent below the pre-strike level of June. And non-auto sales have slowed to just a 0.3 percent quarterly pace for the three-month periods ending both August and September.
The strong housing sector retreated further. September housing starts slipped 2 percent to a still-healthy 1.576 million annual rate; yet that marked a four-month low. Latest data, for August, showed home sales, both new and existing, each fell some 4 percent vs. July. Despite mortgage rates at decade’s low levels, new home sales in August were at the second-lowest rate of the year. Latest inflation readings confirm its nonexistence.
First off, hourly wages hardly rose last month, again blunting the 12-month trend just below 4 percent. The September survey showed the NAPM price index fell for the ninth straight month. And the rate of deflation in NAPM purchase prices actually dropped further, registering 34.4 for the lowest reading for the purchase price index since 1949!
Pacific blues and Fed policy
In the Pacific Basin, while still another country slipped into recession — this time New Zealand — better news came with Japan’s announcement of a $516 billion fund to save its critically ill banks. Long awaited, this move in conjunction with the Fed’s sudden expansive policy, encouraged regional equity markets. Lower Fed rates even provided the cover to allow some troubled countries to cut interest rates, a policy that higher U.S. rates had prevented because of currency considerations.
Brazil’s financial troubles also occupied the G-7 and International Monetary Fund over the past month. Potentially good news here had the IMF proffering a $30 billion line of credit to forestall the toppling of Latin America’s biggest economy. Reacting to the growing financial crisis as we anticipated, the Fed cut the funds rate a quarter-point at the Sept. 29 meeting of the FOMC. But in a surprise move between meetings, on Oct. 15 Chairman Alan Greenspan cut the funds rate another quarter-point, to 5 percent, and lowered the discount rate a like amount, to 4.75 percent. To combat the global crisis, the Fed now seems embarked on a frankly reflationary policy, which should steepen the prospective yield curve more quickly than we had expected.
Hampered by ongoing hedge fund liquidations, bond market illiquidity has seized-up the corporate and credit sectors, even threatening business investment. Indeed, yield premiums between lower grade corporate bonds and Treasuries have soared in recent weeks to spreads not seen since early 1987. The yield spread between BAA corporate bonds and the 10-year Treasury bond soared above 260 basis points last week, the widest risk premium in eleven years.
The G-7 nations also called for coordinated rate cuts and the creation of a new international authority that would act to avert future financial crises of the current sort. As The Times of London put it in an October 5 article on the Group of Seven communiqué, “Fear of a meltdown in world stock markets and a decline into 1930s-style economic depression has pushed the world’s leading finance ministers into making an unprecedentedly strong demand for an urgent and coordinated response to the current turmoil.”
In this environment, the Fed likely will cut the funds rate another half-percent over the next few months, to supply immediate liquidity that may unwind gracefully the current high degree of risk aversion in the capital markets.
