U.S. Review
A Double Dose of Reality
This week’s economic numbers may have finally brought an end to the green shoot rally. There is only so far “less bad” economic news can take us. A sustainable recovery will require things to actually get better. This week’s big disappointment was the weaker employment data. Nonfarm payrolls declined by a larger than expected 467,000 jobs and the unemployment rate rose 0.1 percentage point to 9.5 percent.
The other bad economic news is the inability of California, and several other large states, to come up with a working budget. California’s troubles are receiving the most attention and the state is reportedly set to begin issuing IOUs today, since it has run out of money.
The problems at state governments are the most severe in modern history. Taxes will either have to be increased or spending will have to be cut dramatically. Either way there will be more strains placed on consumers and the broader economy. The severe state fiscal imbalances are putting strains on parts of the economy that usually hold up well during recessions and raise the possibility of a second stimulus program later this year.
The Economy Really Needs Some Genuine Good News
While the economy struggled immensely, the first half of this year turned out to be no worse than widely feared. Moreover, the rate of deterioration in economic activity lessened considerably during the second quarter. Layoffs decreased, motor vehicle sales stopped falling and factory orders actually improved slightly. Real GDP almost certainly declined during the second quarter and our latest working estimate calls for real GDP to decline at around a three percent pace for the quarter. While that marks some improvement from the prior two quarters, the decline is still quite substantial.
June’s employment report marks somewhat of a reversal. Employment losses worsened during the month, with nonfarm payrolls falling by 467,000 jobs. Federal government job losses increased, reversing a gain a few months earlier tied to the temporary hiring of Census workers. State and local government payrolls were little changed in the month, with gains in education offsetting job losses in other areas. Private payrolls declined by 415,000 jobs, with losses across nearly every industry. The heaviest losses continue to be in manufacturing and construction but employment is also falling in the service sector, particularly in financial services, retail trade and at temporary staffing companies. The average workweek also dropped another tenth of hour in June, suggesting that a turnaround in employment is still quite a way off. Businesses typically work their existing workforce longer before they commit to hiring more workers. Even then, businesses typically first turn to temporary staffing companies for workers before they add permanent staff.
The decline in the average workweek combined with the huge drop in nonfarm payrolls produced a 0.8 percent drop in aggregate hours worked. Hours worked declined at a 7.9 percent annual rate during the second quarter, compared to a 8.9 percent drop in the first quarter. Given our forecast for real GDP to decline at around a three percent pace, the drop in hours worked suggests that productivity growth improved significantly during the quarter.
The unemployment rate rose 0.1 percent in June to 9.5 percent. While that represents a 26-year high, the increase in the unemployment rate was less than feared. The labor force declined by 155,000 in June. Apparently, fewer people chose to look for work this summer than usual. Both the labor force participation rate and employment population ratio declined by 0.2 percentage points during the month. Weaker employment conditions are weighing on consumers’ minds and were the major factor in June’s weaker than expected consumer confidence figures.
Global Review
Is Japan Recovering?
Data released this week showed that the Tankan index of Japanese business sentiment rose from a reading of -58 in March to -48 in June (see graph at left). The index is widely followed by market participants because it is fairly correlated with Japanese GDP growth. If the past relationship between the Tankan index and the year-over-year growth rate continues to hold, then the latter probably improved somewhat from the steep 8.4 percent contraction registered in the first quarter. Indeed, Japanese real GDP quite possibly rose on a sequential basis in the second quarter following double-digit declines in each of the past two quarters.
“Hard” data also suggest that the economy has bounced. Industrial production rose for the third consecutive month in May (see top chart on page 4). Yes, production is still down 30 percent relative to May 2008. The Japanese economy fell into a very deep hole late last year/early this year, and it is still in that hole. However, Japanese IP has risen 14 percent from its low in February. Does recovery begin when you finally emerge from the hole or when you begin to climb from the bottom of the hole? Most economists would say the latter suffices for recovery.
Among G-7 countries, the contraction in GDP in the first quarter of 2009 was the deepest in Japan, so how in the world can anybody talk about recovery? Among respondents to the Tankan survey, large manufacturers, which tend to be more exposed to exports than smaller manufacturers and non-manufacturers, reported the most improvement. Although the volume of exports is down more than 30 percent on a year-over-year basis, real exports are up about 13 percent over the past few months (middle chart). Therefore, much of the recent bounce in the Japanese economy appears to be related to foreign sources. Exports to the United States appear to be stabilizing. The Chinese economy is clearly growing again and shipments to China, which account for 15 percent of Japanese exports, have risen about 30 percent over the past few months.
In contrast, domestic demand in Japan remains sluggish. As noted above, small manufacturers and non-manufacturers, who tend to be more dependent on domestic spending than their large manufacturing counterparts, reported much less improvement in the Tankan survey. Indeed, retail spending has been flat to slightly down since the beginning of the year. Employment in May was off two percent relative to the same month last year, and unemployment has risen to the highest rate since Japan crawled out of its last recession in the early years of this decade.
A deep recession and a weak labor market are usually the recipe for declining inflation, and Japan is flirting with deflation with the overall CPI down more than one percent in May (bottom chart). Some of the decline in the overall rate of inflation is due to the collapse in energy prices. However, the core rate of inflation, which excludes food and energy prices, is also in negative territory. Although a global recovery should help Japan to avoid an outright deflationary spiral, Japanese CPI inflation should remain slightly negative for the foreseeable future.
