Q3 Real Retail Sales Weakest in Nearly Three Decades
Nominal retail sales dropped 1.2% in September putting the third quarter decline at annualized rate of 4.0%. Using the Consumer Price Index of commodities to adjust for inflation, a rough approximation, real retail sales tumbled at an annualized rate of 12.5%, the largest drop since the second quarter of 1980 when real retail sales dropped at an annual rate of 16.4% (see chart 1). It is nearly certain that consumer spending (good and services) in the third quarter will post the first decline since the fourth quarter of 1991, which raises the probability of a contraction of real GDP in the third quarter.
Inflation, a Lagging Economic Indicator, Appears to Have Peaked
The Consumer Price Index (CPI) held steady in September after a 0.1% drop in August. On a year-to-year basis, the CPI rose 4.94% in September vs. a 5.4% jump in August, which is probably the peak reading for inflation in the current business cycle. The 1.9% drop in the energy price index held back the overall inflation index.; recent declines in energy prices suggest a further moderation in inflation. The energy price index appears to have reached its peak in July 2008 (29.25% yoy increase), with the year-to-year gain in September at 23.1%. Food prices move up 0.6%, putting the year-to-year increase at 6.2%, following a 4.9% increase in food prices increased in 2007. Continued growth in world wide demand for food is likely to result in higher not lower foods prices in the future.
The core CPI edged up 0.1% in September, which translates into 2.47% year-to-year increase in September, after registering a 2.54% jump in August (possibly the peak.). In September, price declines for cars (-0.7%) and clothes (-0.1%) were more than offset by higher prices for shelter (+0.3%), recreation (+0.2%), and education (+0.1%).
Conclusion – Inflation and inflation expectations are no longer a threat that will prevent the Fed from lowering the federal funds rate again. However, given that the economy is projected to show a recessionary path in the months ahead, the current low federal funs rate does not stand in the way of robust economic growth but the operation of the credit machine is the major problem. A resumption of lending to businesses and consumers is necessary for a broad economy recovery.
– Inflation and inflation expectations are no longer a threat that will prevent the Fed from lowering the federal funds rate again. However, given that the economy is projected to show a recessionary path in the months ahead, the current low federal funs rate does not stand in the way of robust economic growth but the operation of the credit machine is the major problem. A resumption of lending to businesses and consumers is necessary for a broad economy recovery.Even After Excluding Strike and Weather-related Impact, Factory Activity Remains Significantly Weak
Factory production plunged 2.8% in September vs. a 1.0% drop in August. The sharp drop in factory activity in September is partly related to Hurricanes Gustav and Ike. The output of mines fell 7.8%, as crude oil and natural gas operations in the Gulf of Mexico were suspended because of the hurricanes. The output of utilities advanced 2.2% following a 3.1% drop in August. According to the Fed, the impact from hurricanes on total industrial production in September is about 2-1/4 percentage points. In addition to reductions in oil and gas extraction, hurricane-related shutdowns of petroleum refineries and petrochemical producers also contributed to the overall decline in industrial production, while other factories affected by power outage also played a role, albeit a smaller one. The Boeing strike accounted for an estimated 1/2 percentage point to the overall decrease in industrial production.
Factory production fell 2.6% in September, with the quarterly decline of 5.6% as the largest drop since the first quarter of 2001. Sectors excluding aircraft and mining also posted declines in production -- consumer goods (-1.4%), business equipment (-7.0%), construction supplies (-1.5%), and materials (-3.4%). Production in the auto industry moved up 1.9% in September vs. a 11.3% drop in August. Output of the high-tech sector advanced only 0.5% in September, after a 0.1% gain in August.
The operating rate of the factory sector fell to 74.5% in September, the lowest since October 2003, and it is consistent with readings seen during prior recessions.
In related news, the Federal Reserve Bank of Philadelphia’s factory survey shows extraordinarily weak conditions.
Initial Jobless Claims: New High for Insured Unemployment Rate
Initial jobless claims fell 16,000 to 461,000 in the week ended October 11. The drop in the number of applicants filing for unemployment insurance was largely due to a 21,249 decline in Texas following a similar sharp increase in the prior week. These temporary disruptions aside, the main message is that firms are reluctant to hire. Continuing claims, which lag initial claims by one week, rose 40,000 to 3.711 million. The insured unemployment rate (Continuing claims/Covered employment) increased to 2.8% from 2.7% in the prior week. The new cycle high for the insured unemployment rate of 2.8% was last seen in October 2003 (see chart 9).
Mexico: The First Ripple From the US Financial Crisis
With financial markets now under constant watch and the industrialized economies broadcasting bearish news on a daily basis, a country such as Mexico is easy to overlook. However, it might just be worth noticing that while most people are concerned about how the dollar is faring, some attention should be paid to what goes on south of the border with the peso.
A telling sign of relative economic strength in the US is workers’ remittances to Mexico. This figure, tracked on a monthly basis, serves as both a barometer of the US economy and as a nice proxy for the quarterly current account figures in Mexico. Regarding the latter, remittances accounted for 2.35% of GDP in 2007 and provide a stabilizer to the external balances when the US is doing well. When the US economy slows, however, not only does Mexico sell fewer goods north of the border, but fewer dollars come south – which can be a problem for the current account balance.
Remittances fell by 12% year on year in August (the sharpest drop since the series started) and 4% in January-August 2008. Last year was not a particularly great year for Mexican expatriates as growth in money sent home remained static. Now, this sharp drop suggests harder times ahead, and perhaps even liquidity concerns down the road if this key source of support narrows further.
We forecast that US import demand will soften significantly over the next 12 months, which will negatively impact Mexico’s balance of payments situation. Also, the marked drop in oil prices will be another hit to export earnings looking forward. It would indeed be hasty to suggest that a balance of payments crisis is looming for Mexico, but it is worth remembering that when the waters in the US get choppy, they have a nasty way of spilling across the Rio Grande. And considering the breadth and magnitude of the current financial crisis, it may be a good time to reassess Mexico’s near-term outlook.
