U.S. Review

The Worst May Be Behind Us

The combination of a slightly stronger tone to the financial markets, long overdue changes in the accounting rules, and economic news that ranged from no worse than expected to slightly better than expected, has unleashed the first significant bit of optimism we have seen since the onset of the financial crisis. While this marks a change, the recession is clearly not ending. The absolute worst of the downturn is probably behind us, with the fourth quarter of last year and first quarter of 2009 probably marking the largest declines in real GDP.

There is still plenty of bad economic news in the pipeline. The March employment data were awful as expected. Nonfarm employment declined by 663,000 jobs. Revised figures show that payrolls declined by 86,000 more jobs than first reported in January. That month now shows a decline of 741,000 jobs. Job losses are extraordinarily broad based, with virtually every industry other than education and healthcare posting employment declines. The largest losses continue to be in manufacturing and construction, where close to half the 5.1 million overall job losses have been.

Manufacturing and Construction Remain The Weakest Links

With job losses so heavily concentrated in manufacturing and construction, states with outsized exposures to these industries have seen some of the largest increases in the unemployment rate. One notable area of the weakness is the Carolinas, where the unemployment rate has recently risen into double digits. North Carolina, which had 13.0 percent of its workforce employed in manufacturing when the recession began, saw its unemployment rate rise to 10.7 percent in February. The state has lost 174,000 jobs since the recession began with just over one-third of the losses occurring in the factory sector. Other large manufacturing states have also seen unemployment sky-rocket.

Construction employment declined by 126,000 jobs in March and is down some 1.0 million since the recession began. Up until recently nearly all of those losses have been in residential construction, with the bulk of the decline occurring in states where housing overheated the most, including Florida, Arizona, California, Nevada and Georgia. Commercial construction is now beginning to weaken in a major way, and job losses there should be more evenly distributed throughout the country but will not be nearly as large as residential cutbacks have been.

While manufacturing and construction have accounted for the largest share of job losses, they are hardly alone. Layoffs have been extraordinarily broad based throughout this recession, with even recession resistant areas like state and local government being hard hit. Some of the biggest problem areas in the service sector include business services, the financial sector, retailing and the hospitality industry, which are all reeling. The diffusion index which measures the number of industries increasing employment, remains mired near modern era lows at just 22 percent.

Aggregate hours worked fell at a 1.0 percent annual rate during March and plunged at an 8.7 percent annual rate during the first quarter. By comparison, hours worked fell at a 7.4 percent pace in the fourth quarter. The sum of aggregate hours and productivity growth is a good proxy for real GDP growth. The latest numbers indicate that we should see a huge drop in the first quarter. On the surface this implies we will see a larger drop in the first quarter than we did in the fourth quarter. The actual decline in real GDP will probably be somewhat smaller that in the fourth quarter, however. The trade deficit has shrunk dramatically in recent months, largely due to a dramatic decline in imports. Our early look at first quarter real GDP calls for a decline of five and half percent. Declines in subsequent quarters should be much smaller.


Global Review

Is a Bottom in Sight?

Stock markets in most countries enjoyed strong rallies this week. Some news agencies have attributed the rally to growing speculation that the world economy is stabilizing. Is that claim wishful thinking or is there any evidence to support that statement?

In our view, “stabilizing” is a strong word. It implies that a bottom in economic activity has been reached. Rather, it may be more appropriate to say that an inflection point may have been reached. That is, global economic activity continues to contract, but at a less rapid rate than previously.

Let’s start with the good news. As shown in the chart at the left, the manufacturing PMI in China moved above “50” in March. That is, the index crossed the demarcation line that separates expansion in the manufacturing sector from contraction. Soon after credit markets locked up last autumn, the Chinese government announced plans to accelerate infrastructure spending and it relaxed credit restrictions that were put in place when inflation was seen to be a problem last year. These stimulus measures may be one of the reasons that manufacturing activity in China appears to be expanding again.

Korea has extensive trade ties with China, and data released this week showed that Korean industrial production (IP) rose 6.8 percent in February relative to the previous month. The outturn for February, which was much stronger than expected, follows the 1.6 percent rise in Korean IP in January. Taiwanese production rose 3.3 percent in February relative to the previous month, and Brazil has also managed to put together two consecutive monthly increases in industrial production so far this year.

Europe Continues to Contract, However

The economic news out of the United Kingdom has been a bit better as well. The manufacturing PMI posted a decent increase in March (see middle chart), and the service sector PMI also rose (see bottom chart). However, both indices remain below the demarcation line that separates expansion from contraction. Thus, the PMIs suggest that British economic activity continued to contract in March, albeit not quite as rapidly as in February. Moreover, the comparable indices in the Euro-zone, which is roughly five times as large as the British economy, showed very little increase in March. Therefore, it seems likely that economic activity in the Euro-zone continued to contract at a sharp rate in March. In that regard, the ECB’s decision to cut rates by only 25 bps this week, rather than the 50 bps that was widely expected, caught many investors flat-footed.

In sum, we believe it would be premature to say that global economic activity is “stabilizing.” As noted above, “stabilization” implies that activity has bottomed. In our view, it would be more accurate to say that an inflection point may have been reached. That is, many economies continue to contract, but not as sharply as in the fourth quarter when economic activity went into freefall. This slowing in the rate of contraction is a step in the right direction. To paraphrase an ancient Chinese proverb, which probably is appropriate in light of recent Chinese economic data, “a journey of one thousand miles begins with a single step.”