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Weekly Economic and Financial Commentary

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Headwinds Intensify

Mon, Jul 14 2008, 08:45 GMT
by Wachovia Research Team

Wachovia

U.S. Review

Headwinds Intensify

Economic activity still appears to be holding up at a pace that is consistent with at least modest economic growth. This week had a relatively light economic release schedule but the reports that were released tended to come in stronger than expected. Major reports include the ICSC chain store sales figures, which came were up 4.3 percent year-to-year. Chain store sales are clearly being bolstered by tax rebates. Most of the impact has been at discount stores and warehouse clubs. Department stores and most specialty apparel chains reported declines for the month. Furniture sales were absolutely awful. The major electronic chains and home improvement centers did not report sales. We suspect spending has held up at electronics chains, which should be one of the largest beneficiaries from rebates. Home improvement stores may also see another strong month for the same reason, with tax rebates trumping the drag from the housing slump.

First-time claims for unemployment insurance fell sharply during early July. Jobless claims probably are not as good as the drop suggests.

The Heat Is On

Weekly jobless claims tend to bounce around quite a bit during the summer months, as the labor department often has some difficulty seasonally adjusting annual plant shutdowns for model year changeovers at the domestic auto manufacturers. We could easily see a gain next week that matched this week’s decline.

Friday morning brought more good economic news. The nation’s trade deficit narrowed much more than expected during May, falling to $59.8 billion. The improvement was even greater after adjusting for inflation. In real terms, the trade gap fell $3 billion to $43.6 billion. All of the improvement was in energy, where higher prices appear to be curbing the appetite for imported oil. Non-petroleum imports actually increased during the month. The improvement in the trade deficit means second quarter real GDP may come in much stronger than expected. If the real trade gap remains at its current level next month, trade will add about 2 percentage points to second quarter real GDP. Our current forecast, which calls for a 2.2 percent rise in second quarter GDP, assumes only a 0.5 percentage point improvement from trade. Later in the morning, the University of Michigan released its consumer sentiment index for July, which showed its first gain (albeit small) since January.

All of this better than expected economic news did little for the financial markets. Rumors about the viability of the two largest government sponsored mortgage firms along with a resurgence in oil prices sent stocks much lower at the start of trading on Friday. Treasury Secretary Hank Paulson attempted to cool off some of those rumors by making a statement of support for Freddie Mac and Fannie Mae later in the morning, but concerns about the financial sector continue to be a major wildcard for the economy. Right now the risk appear to be greatest for shareholders but disruptions in the secondary market for home mortgages will also likely lead to an even wider spread between mortgage rates and the 10-year Treasury. This is the last thing an already stressed housing market needs right now, if affordability comes back down, look for the housing woes to extend even further.

While equities swooned, especially in the financial sector, on Friday morning crude oil extended Thursday’s gains and reached new all-time intraday highs. The early part of the week had brought a fleeting hope that some of the energy price pressures the economy was facing would diminish in coming weeks. Another round of energy price increases could again lead economists to lower forecasts for economic activity late this year and into 2009.

Global Review

Singapore GDP: Slower Global Growth?

Data released this week showed that real GDP growth in Singapore slowed to only 1.9 percent in the second quarter, the slowest year-over-year rate of growth since the third quarter of 2003. Singapore is small. There are only 4.6 million residents in the city-state and GDP is only $160 billion, making it a bit more than 1 percent the size of the U.S. economy. However, the reasons for the large slowdown in Singapore may tell us something about the state of the global economy in the second quarter.

Let’s drill down a bit into Singapore’s GDP. Growth in construction industries slowed a bit from 16.9 percent in the first quarter to 15.2 percent in the second quarter, and the service industries saw their growth rate edge down from 7.6 percent to 6.9 percent between the first two quarters of the year.

However, the year-over-year growth rate in the goods producing industries, which represents about 30 percent of GDP, tumbled from 12.7 percent in the first quarter to -5.6 percent in the second quarter. Domestic spending appears to have downshifted a bit in the second quarter, which probably contributed to the weakness in goods producing industries. For example, growth in the volume of retail sales slipped from a year-over-year growth rate of 4 percent in the first quarter to 1.5 percent in April, data for May and June are not yet available. However, the external environment also contributed to the marked slowdown in Singaporean GDP growth in the second quarter.

With an export-to-GDP ratio that exceeds 200 percent, Singapore is one of the most open economies in the world. And as shown in the top chart, growth in Singapore’s non-oil exports has slipped into negative territory. Because most exports are manufactured, the downturn in Singapore’s goods producing industries in the second quarter probably reflects recent weakness in export growth This is yet another indication that growth in the rest of the world is slowing.

Not only is the Lion City experiencing slower economic growth, but it is suffering from higher inflation as well. As shown in the middle chart, the CPI inflation rate in Singapore has jumped up to 7.5 percent, the highest rate in 26 years. Yes, the 9 percent rise in food prices over the past year has had a disproportionate effect on overall CPI inflation, and the increase in the goods and services tax last summer, which will drop out of the year-over-year calculations in July, contributed to the rise in inflation. That said, non-food prices in Singapore, as in most other Asian economies, appear to have accelerated over the past year.

Because Singapore is such an open economy, the Monetary Authority of Singapore (MAS) manages the trade-weighted value of the Singapore dollar. As shown in the bottom chart the Singapore dollar has strengthened about 35 percent versus the U.S. dollar since the beginning of 2002. Due to the rise in inflation recently, the appreciation of the currency is in Singapore’s interest. However, we believe the MAS will slow down the rate of the currency’s appreciation now that real GDP growth is showing signs of slowing.

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Published on  Mon, Jul 14 2008, 08:53 GMT

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