U.S. Review
Expectations of Recovery Continue to be Scaled Back
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A slight rise in the ISM non-manufacturing survey and another weak ICSC Chain Store sales report highlighted this week’s economic calendar.
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Unemployment claims fell sharply in early July but the drop was distorted by unusually large swings in motor vehicle production schedules and the Fourth of July holiday.
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Some members of the Obama Administration have expressed surprise about how high the unemployment has risen, hinting at the possibility of a second stimulus package.
Reality Sets in for the Summer
The economic data continue to show an economy gradually moving toward recovery. The ISM non-manufacturing survey increased slightly more than expected in June and has now risen convincingly above its 12-month moving average. Such moves have tended to coincide with turning points in the business cycle. The business activity series rose 7.4 points during the month. New orders also improved and export orders jumped 7.5 points to 54.5. The overall index remains slightly below the level it rose to when the economy emerged from the 2001 recession. Inventory liquidations remain a drag on the economy. The inventory sentiment index remains unusually high at 67.0, suggesting many firms still believe their inventories are too high.
While the ISM non-manufacturing survey reported a much less contraction in business activity during June, one notable exception was retail trade, which continued to report declining activity during the month. The ICSC chain store sales report for the month of June appears to confirm this notion. Chain store sales fell 5.1 percent over the past year, with sales at apparel shops and department stores tumbling 9.3 percent and 9.1 percent, respectively. Consumers continue to shy away from making major purchases but are showing an increased tendency to purchase discounted and lower cost products. An increase in food stamp allocations also appears to be bolstering spending at grocery stores and discount stores that sell groceries.
June’s chain store sales were widely viewed as disappointing but there were a few extenuating circumstances. Chain store sales are reported on a year-to-year basis and sales last June were bolstered by the rebate checks sent out under President Bush. Last June saw the strongest year-to-year gain in chain store sales for all of 2008, meaning that this past month’s sales faced its most difficult comparison of the year. The chain store sales figures also exclude Wal-Mart, which continues to gain market share and is the nation’s largest retailer. Finally, June was unusually cool, which likely dampened demand for summer merchandise. The tough year-to-year comparisons and absence of Wal-Mart’s sales mean next week’s retail sales report will likely be stronger than this past week’s chain store sales figures.
Consumers’ reluctance to make big ticket purchases was also apparent in May’s consumer credit numbers. Overall consumer credit fell 1.5 percent in May, with practically all the drop occurring in revolving credit. Spending for big ticket items was notably weak in both May and June. The best performing sectors tended to be stores where a larger proportion of sales tend to be paid with cash. Nonrevolving credit was little changed during the month, reflecting the recent leveling off in motor vehicle sales.
Unemployment claims fell 52,000 to 565,000 in early July. The decline was readily dismissed, however, since it has more to do with the timing of motor vehicle assembly plant shutdowns than any fundamental improvement in the labor market. Continuing unemployment claims increased by 159,000 in the latest week and the insured unemployment rate rose 0.1 percentage point to 5.1 percent. The increase suggests the unemployment rate will rise further in July. Some members of the Administration have expressed dismay at how much the unemployment rate has increased, even though many forecasts made earlier in the year, including our own, had the jobless rate rising to around nine percent this summer.
Global Review
Signs of a Bounce in the Euro-zone?
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Industrial production in France, Germany and Italy was stronger than expected in May. In Germany, it appears that the “cash for clunkers” program is helping to lift IP.
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Don’t pop the champagne corks just yet. May’s stronger-than-expected rise in production notwithstanding, IP in most European economies probably contracted in the second quarter relative to the previous quarter. Moreover, the level of production currently stands at levels that were achieved more than a decade ago. Although the worst may be over, the Euro-zone economy faces a long, slow climb out of its current hole.
Signs of a Bounce in the Euro-zone?
After months of disappointing economic news, there were some positive developments in the Euro-zone this week. First, factory orders in Germany shot up 4.4 percent in May relative to the previous month, which was much stronger than most investors had expected. The upturn in orders over the past few months translated into a 3.7 percent rise in industrial production (IP) in May, the largest monthly increase since Germany climbed out of the 1992-93 recession.
What’s behind the rise in German IP? The country’s “cash for clunkers” legislation that went into effect earlier this year undoubtedly is helping. Indeed, new car registrations in June were up 40 percent on a year-over-year basis. In that regard, production of consumer durable goods, which includes autos, shot up 6.4 percent in May relative to the previous month.
The better-than-expected news in Western Europe was not confined to just Germany. French IP climbed 2.6 percent in May, and a measure of business sentiment in France rose in June to its highest level since last September. Italian IP bested expectations of a sizeable decline in May by remaining unchanged during the month. Moreover, the 1.1 percent increase in Italian IP that was registered in April was revised up a bit.
Is it time to pop the champagne corks and toast the strong economic recovery that is taking hold in the Euro-zone? In our view, that celebration would be very premature. Although industrial production in the three largest Euro-zone economies has bounced recently, IP in those countries is down sharply on a year-over-year basis (see charts). If German IP holds steady in June, the second quarter average will still be down almost five percent (annualized rate) relative to the first quarter. France is looking at a similar rate of decline in the second quarter. Major European economies continue to contract, albeit less rapidly than in the first quarter.
In short, the Euro-zone fell into a deep hole late last year and early this year, and it is just now starting to claw its way back. May’s strong rise notwithstanding, IP in both France and Germany currently stand at their levels in the mid to late 1990s. In other words, the rise in production that took a decade to achieve was wiped out in a few months.
Moreover, the Euro-zone faces a number of strong headwinds. Both Ireland and Spain experienced sharp increases in house prices over the past decade or so, and the bursting of the respective housing bubbles has imparted significant shocks to those economies. Unemployment rates in both Ireland and Spain have more than doubled over the past year, and both economies probably face years of sluggish growth.
Speaking of burst bubbles, many economies in Eastern Europe became over-leveraged earlier this decade, and most countries in the region are experiencing their own deep recessions. The shockwaves from Eastern Europe have affected Germany via capital goods exports. Indeed, the value of German exports is down more than 20 percent at present (bottom chart). Therefore, sluggish growth in German exports, especially to Eastern Europe, will likely constrain growth in IP in Germany, and in the broader Euro-zone, for some time. Although we expect Western Europe to emerge from recession later this year, the pace of the upturn should be very slow, at least initially.
