U.S. Review
The Bottom Falls Out
Fourth quarter real GDP declined much more than previously reported, with the new preliminary figures showing output tumbling at a 6.2 percent annual rate. The advance estimate, released last month, had put the decline at a less severe 3.8 percent rate.
The 6.2 percent decline in fourth quarter real GDP marks the largest quarterly drop since the first quarter of 1982, which occurred in the midst of the long and deep 1981-82 recession. That downturn was, up until now, the longest and deepest since World War II.
The large downward adjustment to fourth quarter growth was due to larger declines in consumer spending, export, and business fixed investment. Inventories also declined by nearly $20 billion during the quarter, which means that final sales fell at an even larger 6.4 percent annual rate.
Nominal GDP, which is essentially revenue growth for the entire economy, fell at a 5.8 percent pace in the fourth quarter, which is the sharpest drop since 1958. Falling revenues at businesses and governments are one big reason why employment has fallen so hard.
First Quarter Growth Will be Weak as Well
While we do not expect final domestic demand to be as weak as it was in the fourth quarter, it remains disturbingly weak. Our most recent estimate for first quarter real GDP called for a decline at a 6.7 percent annual rate. This was before the fourth quarter numbers were revised sharply lower. We update our forecast the week after the employment numbers are reported and our next forecast will be published on March 11. Right now, it looks as though first quarter real GDP will be just about as weak as the fourth quarter was. The composition will be much different, however, with inventories falling much more rapidly and consumer spending probably not plunging as much as it has in recent quarters.
Most of the early 2009 data is disappointing to say the least. Home sales have still not found a bottom, even though they hit new lows for this cycle and, in the case of new homes, the modern era. Sales of new homes plunged 10.2 percent in January and sales for December were revised lower and now show a 14.7 percent drop.
The winter months are the low season for home sales, so these sales numbers carry a little less weight than they would if they occurred in April or May. That said, consumers appear to be in no mood to make major purchases in any way, reflecting the growing desire to shore up their balance sheets and rebuild savings. Sales of existing homes fell 5.3 percent in January to a 4.49 million unit pace, the lowest pace in this cycle. New incentives for first-time homebuyers included in the Economic Stimulus Package may provide a slight boost to home sales later this year but sales will not turn up in a major way until employment conditions improve.
There were also a number of regional manufacturing surveys released this week and all pointed to continued weakness in the factory sector. The Chicago Purchasing Managers’ survey rose 0.9 points in February to 34.2. Despite the increase, this key business barometer remains exceptionally low. Moreover, the employment series plummeted 9.6 points in February to 25.2, which is the second lowest reading ever. On the positive side, production rose five points in February but that came off of an extremely low January figure. New orders were essentially unchanged at 30.6. Virtually every key component remains well below the key 50 breakeven level, except supplier deliveries. Clearly the factory sector is nowhere near turning the corner just yet.
The labor markets also do not appear to have bottomed out. First time claims for unemployment insurance surged in mid-February, suggesting that we will see another outsized decline in nonfarm payrolls and further increase in the unemployment rate.
Global Review
No More Yen for Yen?
After winning the honor of the world’s strongest currency in 2008, the Japanese yen has recently lost its footing. Indeed, the greenback fell more than 20 percent versus the Japanese currency over the course of 2008, and most other major currencies dropped even further. As shown in the chart at left, however, the dollar strengthened about eight percent versus the yen during February and most other major currencies posted gains as well. What’s suddenly wrong with the yen?
The short answer is that the Japanese economy has fallen off a cliff, pulling the currency with it. Real GDP in Japan plunged at a jaw-dropping annualized rate of 12.7 percent in the fourth quarter. Unfortunately, data released this week showed that the carnage continued in January.
As shown in the top chart, industrial production in January was down nearly 30 percent (year-over-year), which is partially a reflection of the unbelievable 39 percent decline in export volumes that has transpired over the past year. Japan is a major supplier of capital goods equipment to the rest of the world, especially to other Asian countries, and the sharp falloff in global trade has taken a toll on Japanese exports. In addition, the previous strength of the yen has no doubt contributed to the sharp decline in Japanese exports.
With exports collapsing, the Japanese trade balance, which had been in the black since 1980, has turned into a deficit over the past few months (see middle chart). Although the overall current account balance, which includes more items than the merchandise trade balance, is still in the black, the surplus in December fell to a 13-year low. At the rate that exports are plummeting, it seems like only a mater of time before Japan registers a current account deficit.
It is the chronic current account surplus that helps to explain the strength of the yen last year. When investors become risk averse, as they have done to an extreme over the past year, capital tends to flow from the borrowing nations (i.e., countries with current account deficits) to lending nations (i.e., those with current account surpluses). However, Japan is rapidly falling out of the latter category. Moreover, the deep recession – some would say depression – that is underway in Japan has caused returns on Japanese assets to become very unattractive. Foreign investors have turned into net sellers of Japanese stocks and bonds while Japanese portfolio investment abroad has picked up. The combination of a rapidly shrinking current account surplus and a pick-up in net capital outflows has led to yen depreciation recently.
Yen Will Probably Continue to Trend Lower
The Japanese yen has lost a fair bit of ground in a relatively short period of time, so some retracement is bound to occur sooner or later. However, we look for the yen to weaken further on a trend basis in the quarters ahead. Japan will probably remain in a deep recession throughout most of the year, which will cause the economy to experience a mild case of deflation again (see bottom chart). Consequently, the Bank of Japan will keep rates as low as possible for as long as possible. Rock-bottom returns in Japan should contribute to further yen depreciation.
