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Weekly Economic and Financial Commentary

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No, 2008 Wasn't Just A Bad Dream

Mon, Jan 12 2009, 10:28 GMT
by Wachovia Research Team

Wachovia

U.S. Review

No, 2008 Wasn't Just A Bad Dream

No, 2008 Wasn't Just A Bad Dream This week brought a whole host of reports confirming the fourth quarter was every bit as bad as advertised. Reports earlier in the week showed manufacturing activity continuing to contract in December and factory orders were exceptionally weak in the three months ended in November. Employment conditions also continued to worsen, with nonfarm employment falling by 524,000 jobs.

December's job losses were extremely widespread and brought the total loss over the past five months to over two million jobs. A total of over 2.5 million jobs have been lost since the recession began a little over a year ago. While the bulk of those earlier losses were in manufacturing and in housing-related industries, job losses have broadened and intensified.

Not only did employment weaken but the average workweek has also continued to shorten, as more and more businesses have chosen to reduce hours. Total hours worked plummeted at a 7.7 percent annual rate during the fourth quarter, which is consistent with our forecast calling for fourth quarter real GDP to decline at a 6 percent annual rate.

Fourth Quarter Job Losses Will Undermine The First Half of ‘09

The extraordinary cutbacks in nonfarm payrolls during the fourth quarter are likely to carry over into the first half of 2009. Various counts of layoff announcements, including the Challenger survey, show layoff announcements picking up toward the end of the year. Several companies, including Alcoa and Lenovo, have recently announced plans to trim payrolls in coming months, as sales and new orders weakened much more during the fourth quarter than expected. This past season's disappointing holiday retail sales are also expected to lead to widespread store closings, resulting in additional job losses.

With employment and hours worked down sharply in recent months, personal income will likely remain under pressure, which means lower interest rates and lower gasoline prices will provide less relief to shell-shocked consumers. The International Council of Shopping Centers reported that December chain store sales fell 1.7 percent year-to-year, amidst the worst holiday shopping season since 1970. The drop was not unexpected and many chains have announced plans to close underperforming stores and a few chains are shutting down entirely. With this new data, we estimate that retail sales fell 0.8 percent in December and that sales excluding motor vehicles declined just over 1 percent. Both declines are in line with our earlier forecast for fourth quarter GDP growth.

The current quarter is little more than a week old, but expectations for first quarter growth are already being ratcheted down. The major domestic motor vehicle producers announced extended plant shutdowns for January, which will pull industrial production down sharply and also lead to a sharp drop in inventories. There has also been a string of disappointing announcements by major companies, such as Alcoa, Intel and Wal-Mart. Most reported disappointing sales and have further reduced expectations for sales and earnings for the new year. With earnings coming under pressure the talk of a new bull market will likely prove short-lived and capital spending plans will likely be cut back further.

November factory orders data show non-defense capital goods orders plummeting at a 28.0 percent annual rate over the past three months. The drop will likely result in even weaker capital spending during the first quarter. Another surprise this week was nonresidential construction held up a little better than expected in November. The strength likely reflects projects started well before the onset of the credit crisis. Many firms are likely rushing to finish projects before their funding dries up. We have no doubt that commercial construction is headed much lower in 2009.

Global Review

Bank of England Eased Further

In a widely expected move, the Bank of England cut rates by 50 bps this week (see chart at lower left). In explaining the decision to reduce the main policy rate to only 1.50 percent, the lowest rate in the Bank’s 315-year history, the Monetary Policy Committee (MPC) noted the sharp downturn in economic activity in the fourth quarter, not only in the United Kingdom but in most other economies as well.

Indeed, recent data confirm the MPC’s grim assessment of the current state of the U.K. economy. Industrial production tumbled nearly seven percent in November relative to the same month last year, the sharpest rate of contraction since 1980. Unfortunately, manufacturers appear not to have fared much better in December. As shown in the top chart on page 4, the manufacturing PMI remained mired in deep contraction territory in December. Although the service sector PMI edged up a bit last month, it too remains at a very low level, and the construction PMI continues to plumb new lows. Speaking of construction, a widely followed index of U.K. house prices fell 2.5 percent in December relative to the previous month. Since peaking in late 2007 the index of house prices has dropped 17 percent, nearly as much as the 20 percent cumulative decline that occurred in the early 1990s. Little wonder that consumer confidence has collapsed. By our reckoning real GDP probably dropped at an annualized rate of roughly four percent in the fourth quarter, which would be the sharpest contraction since the early 1970s. Our forecast also projects that British real GDP will continue to contract for the next two quarters.

The bad news then is that the United Kingdom appears to be mired in a deep recession at present. If there is a glimmer of hope it is that the British authorities are responding to the crisis. For starters, the Bank of England has cut rates aggressively. (The main policy rate has been reduced by 350 bps since early October.) In addition, the government has taken steps to stimulate the economy via fiscal policy. Pre-announced public capital expenditures have been brought forward and the value-added tax was reduced by 2.5 percentage points. Although the British stimulus package is not as large as the program that the incoming Obama administration is putting together, it is a step in the right direction.

Another stimulative factor for the U.K. economy is the recent depreciation of sterling. As shown in the bottom chart, the British pound has weakened about 10 percent on balance versus the euro since mid-July. It’s depreciation against the U.S. dollar totals 25 percent over that period. Everything else equal, currency depreciation should help to shore up U.K. net exports.

Whither the British pound? We look for sterling to depreciate a bit further against the dollar over the course of the year as the Bank of England cuts rates further. However, we expect the pound will continue to grind higher vis-à-vis the euro in the months ahead. Whereas the Bank of England has been very proactive in cutting rates, the European Central Bank has not been as aggressive. Therefore, the recession in the Euro-zone may linger longer than the downturn in the United Kingdom.

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Published on  Mon, Jan 12 2009, 10:37 GMT