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Hope. The silver lining on the economic horizon appears to be getting brighter: Equities succeeded in defending their recent gains, and some forward-looking sentiment and leading indicators are showing initial “signs of life”. That is fueling our expectation that the economy will stabilize in the course of the second half of this year. But this is still nothing more than hope!
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Disappointment. The hard near-time data continue, however, to tell a different tale: The slump in global industrial production appears unrelenting, businesses are scaling back their investments, and consumers are saving more. The latest decline in retail sales in the US also removed some of the luster from the good start to the year and is a heavy burden for the current quarter (pages 2-4).
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Emergence of a floor. This interplay of surprisingly good and disappointingly bad numbers will remain with us for several more months to come. It is, however, not atypical for a phase of transition, which replaces that of the economic downturn. It is, of course, no guarantee of an economic recovery (soon)!
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Confidence. What nevertheless gives us reason to hope involves the economic stimulus and liquidity programs running into the billions. But they also harbor considerable risks (including, but not limited to, ballooning government debt, pages 5-7). Furthermore, the “upswing” in 2010 will be very meager. So far, it was private consumption that has always led the US out of a crisis (cf. chart below). Consumer spending will, however, most probably only plod along.
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Further topics:
– Central & Eastern Europe: Still difficult times ahead (page 8).
– Scandinavia: The deep fall of the former poster countries (page 11).
– Data outlook: German business climate improves, US home sales to stabilize (page 14).
– Market outlook: EUR and govies tending sideways (page 20).
Private consumption has not yet bottomed
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US retail sales were down sharply in March. Nevertheless, we expect that private consumption expenditures rose in the first quarter.
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For technical reasons, the March slump in retail sales is a greater burden for the current quarter anyway. Therefore, private consumption is likely to post a renewed decline this spring.
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While the negative impact of the struggling labor market on disposable incomes is being cushioned by fiscal programs, households are still suffering from strong erosion of their asset positions.
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The adjustment to falling net worth and to an environment where access to credit remains difficult will continue to weigh on consumption growth even after the end of the recession. The most important engine for a strong economic recovery is, therefore, missing.
Harsh reality
US retail sales were down an unexpectedly strong 1.1% in March after still posting solid gains in January (+1.9%) and February (+0.3%). The decline in March was particularly shocking as it came completely unexpected – both we and the consensus had expected an increase of ¼%-½%. The main reason for this miscalculation was the development of car sales. A few weeks ago, automakers had reported a 9% jump in unit sales for the month of March. A similar increase in sales of car dealers would have more than offset the weakness in other sectors. But instead of the anticipated strong increase, auto dealers reported a 2¼% decline in sales, thereby exacerbating the negative development in other sectors.
Consumption rose in the first quarter
Despite the decline in March, the less volatile core group of retail sales ex cars, gasoline and building material increased at an annualized 3¼% in Q1 as a whole. That suggests private consumption rose by just over 1% per annum during this period (cf. chart in the next column).
Such an increase is also indicated by monthly consumption data available so far for January and February, which in real terms were an annualized 1¼% above the Q4 average. This rise was triggered by a strong increase in demand for durables; real consumption of nondurables and services was, in contrast, little changed (cf. chart).
Disposable income rising
At first blush, the rise in consumption expenditures at the beginning of the year flies in the face of the macroeconomic environment. First, the US economy has lost more than five million jobs since the beginning of the recession – two million of them in the first quarter alone. Second, households had to contend with an immense slump in their net worth. In the last 1½ years, households’ net wealth has fallen by close on USD 13 trillion. That is equivalent to about 1½ times annual income. Since mid-2007, households have, therefore, worked de facto for “nothing“.
But while the miserable situation on the labor market caused compensation of employees to fall at an annualized 3% between November and February, disposable income managed to rise by 4¾% during the same period (cf. chart). Support came from three factors: First, pay raises for federal civilian and military personnel; second, cost-of-ling-adjustments to several federal transfer payment programs; third, a considerable reduction in nonwithheld income taxes (which include taxes on dividends and interest income), based on projections of lower final settlements and higher refunds.
Fiscal measures will continue to support disposable income in the current quarter. April marks the beginning of the Making Work Pay program. By the end of the year, this program will probably increase disposable income by a total of USD 60 bn via lower taxes. Furthermore, the government will start to mail out USD 250 checks to more than 50 million households in early May. The total volume of this measure is more than USD 13 bn. In the second quarter alone, the Making Work Pay program and the mailing out of the 250 USD checks will lift disposable income by an annualized USD 100 bn. That is equivalent to the average income of about two million employees.
Burden for the current quarter
In contrast to disposable income, private consumption probably won’t be able to rise again in the current quarter. Given the weak economic environment, the increase in consumption in the first quarter must after all be seen as a correction of the exceptionally weak fourth quarter, when real consumption expenditures posted their strongest decline in 28½ years. Many households cut back on their holiday shopping or postponed purchases until January; possibly to get even better deals. As a result, retail sales fell 3.1% in December and rose 1.9% in January. But this special effect has now expired, and the fundamental weakness of the US economy is shining through once again. In this context, the strong March decline in retail sales is a greater burden for the second quarter than for the first (see box).
One engine for the recovery is missing
Alongside the weak labor market, whose impact on incomes is being cushioned to some extent by fiscal policy, households are still suffering from the erosion of their net worth. Despite the recent stock market rally, the S&P500 has fallen another 11½% since Q4. That translates into a wealth loss of more than USD 1¼ trillion. Furthermore, home prices have continued to plummet, and given the high excess inventories of properties on the market there are currently few if any indications that the slump in home prices will taper off soon. Roger Altman, Deputy Treasury Secretary under President Clinton, recently cited the ongoing erosion of net worth as one of three reasons why the coming recovery will be different, i.e. weaker, than normal.1
Accounting for roughly 70% of GDP, private consumption is the most important component of aggregate demand. For that reason, household expenditures also always play an important role in economic upswings (cf. chart). In the first year after the last three recessions (1981/82, 1990/91 and 2001), private consumption contributed on average 2¾ percentage points to GDP growth; all other GDP components, in contrast, added only ¾ of a percentage point.
Given the problems plaguing households, consumption will probably also post only a moderate increase after the end of the current recession. For the second half of the year we expect growth of 1%, and for 2010 an increase of close on 1½%. The most important engine for a strong economic recovery is, therefore, missing.
