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Weekly Economic and Financial Commentary

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Fourth Quarter Off to Weak Start

Mon, Nov 17 2008, 06:09 GMT
by Wachovia Research Team

Wachovia

U.S. Review

Fourth Quarter Off to Weak Start

This week had a relatively light schedule of economic reports but nearly every report confirmed more weakness in the underlying economy. The highlight (should that be lowlight?) of the week was the release of retail sales data that showed a 2.8 percent drop in overall retail sales in October (see graph at right). Although the sharp drop in gasoline prices in October contributed to the falling value of retail sales, it was not the entire story. Spending on autos and parts tumbled 5.5 percent, and most other categories of retail spending posted losses as well. Our forecast calls for real consumer spending to plunge more than three percent in the fourth quarter, which would follow the 3.1 percent decline in the third quarter, and the retail sales data for October give us little hope that the actual outturn will be stronger than we project.

Most major retailers have reduced their expectations for the holiday shopping season. Our own forecast calls for a slight decline in holiday sales, ranging somewhere between -0.5 percent and -2.0 percent (year-over-year changes) Hiring will be down this holiday season and discounts will likely be far more aggressive than in years past.

Speaking of hiring (or lack thereof), weekly first-time unemployment claims surged by 32,000 to 516,000 in early November (see top chart). The four-week moving average, which is our preferred way of looking at this volatile series, rose to 491,000, which is its highest level since the tail end of the 1990/91 recession. Actual layoff announcements have increased in recent weeks and we expect weekly first-time unemployment claims and the unemployment rate to rise significantly further. Indeed, we project that the unemployment rate, which currently stands at 6.5 percent, will approach eight percent by the middle of next year. With consumers worried about their jobs, the outlook for consumer spending is obviously not very bright.

Overall U.S. GDP growth has been supported over the past few quarters by strong export growth. Unfortunately, the latest trade figures that were released this week contained some disappointing news. As shown in the middle chart, the trade gap narrowed by $2.6 billion to $56.5 billion in September. However, the modest improvement in the trade deficit actually masks some disturbing trends in both imports and exports. Total imports of goods and services plunged $12.5 billion in September, the largest monthly decline on record. Although the collapse in oil prices caused the value of petroleum imports to tumble $6.9 billion, non-petroleum imports were off $5.2 billion, reflecting the underlying weakness in the U.S. economy.

Perhaps more disturbingly, exports nosedived $9.8 billion in September, also a record. Although the decline may have been exaggerated by the Boeing strike, which reduced output at the nation’s largest exporter, the losses in exports were broad-based. It appears that weak growth in the rest of the world is starting to show up at the U.S.’s doorstep in the form of slowing export growth. Indeed, as we discuss in the international section of this report, the Euro-zone, to which the United States ships about 20 percent of its exports, has slipped into recession. With most major foreign economies either in recession or about to enter one, U.S. export growth is sure to slow further.

In sum, it appears that the fourth quarter has gotten off to a very weak start. As noted previously, we project that real personal consumption expenditures will tumble more than 3 percent in the fourth quarter. Businesses are cutting back on capex plans, and inventories likely will be cut further. If, as we expect, real GDP falls at an annualized rate of 3.6 percent in the fourth quarter, it will be the sharpest quarterly contraction since the first quarter of 1982.

Global Review

It’s Official: Euro-zone Recession

Data released this week showed that real GDP in the Euro-zone declined 0.2 percent in the third quarter relative to the previous quarter, which translates into an annualized rate of decline of approximately 0.8 percent (see graph at left). If the unofficial definition of recession is two consecutive quarters of negative real GDP growth, then it seems apparent that the Euro-zone has slipped into recession.

Some individual countries in the Euro-zone released their individual GDP data this week. Among the largest individual economies the lone bright spot was France, where real GDP edged up at an annualized rate of 0.6 percent. Although investment spending posted its second consecutive quarterly decline, consumer spending continues to hold up reasonably well, growing at an annualized rate of 1.6 percent in the third quarter. However, the 7.1 percent rise in exports does not seem sustainable given weak growth in the rest of the world.

Indeed, most other Euro-zone economies, to which France sends about 60 percent of its exports, underperformed the French economy in the third quarter. Real GDP in the Netherlands was flat, and Spanish GDP fell at an annualized rate of 0.9 percent, the first contraction in the Spanish economy since at least 1995 (see top chart). In Italy, output fell at an annualized rate of 2.0 percent in the third quarter, which follows the 1.8 percent contraction in real GDP in the previous quarter.

The German economy turned out to be much weaker than previously thought. As shown in the middle chart, real GDP tumbled at an annualized rate of 2.1 percent in the third quarter, the sharpest decline since the first quarter of 1996. Although a breakdown of real GDP into its underlying demand components is not yet available, German statistical authorities said a big swing in net exports, induced by strong growth in gross imports and a sharp fall in gross exports, was partly responsible for the weakness in overall real GDP. The statistical authorities also said consumer spending rose during the quarter, which is somewhat surprising given the 1.6 percent annualized decline in real retail sales that occurred. Apparently, consumer spending on services held up fairly well in the third quarter.

A few months ago, the ECB thought that the most serious issue it faced was inflation. Indeed, the year-over-year rate of CPI inflation rose to 4.0 percent in both June and July, well above the two percent rate ECB policymakers consider to be consistent with price stability (see bottom chart). However, the ground has shifted underneath the ECB’s feet over the past few months. With the Euro-zone in recession and energy prices down sharply, inflation should be the least of the ECB’s worries at present.

The ECB joined other major central banks by cutting rates by 50 basis points on October 8, and reduced its policy rate by another 50 basis points last week. In our view, the ECB will take its policy rate down 150 basis points more by early next year as the recession deepens. As we discuss in our recent Monthly Economic Outlook, further ECB easing should cause the euro to trend lower versus the dollar in 2009.

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Published on  Mon, Nov 17 2008, 06:09 GMT