U.S. Review
The Economy is Poised to Snap Back in the Second Half
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Recent economic indicators point to a relatively robust bounce back in industrial activity during the second half of this year.
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Stimulus programs are exaggerating the improvement in motor vehicle and home sales but recent gains will translate into stronger near-term GDP growth.
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Bernanke’s reappointment removes some of the uncertainty about the future monetary policy, while large budget deficits will constrain fiscal policy options.
Stronger Economic Gains Boost Recovery Hopes
This past week’s reports on consumer confidence, durable goods orders and new home sales all came in well above expectations and point to a stronger snap back in economic activity during the third quarter. Revisions to second quarter GDP and the early read on consumer spending during the third quarter are also consistent with a strong bounce back in economic activity. Even the home price data look a little better. That said, we have repeatedly noted that stimulus programs such as the cash-for-clunkers, $8,000 tax-credit for first-time home buyers, and the Federal Reserve’s purchase of mortgages, asset-backed debt, and Treasuries is lending a great deal of support to the financial markets and broader recovery. Regardless of how it got started, the recovery looks like it is here to stay, although the initial burst of activity we expect in the current quarter should gradually give way as stimulus programs end or simply lose their effectiveness.
Consumers clearly sense the economy is on the mend. The Consumer Confidence Index rose 6.7 points in August to 54.1. While most of the improvement continues to be in the expectations component, consumers are slightly less pessimistic about near-term employment and income prospects. The improvement likely reflects the winding down of large layoff announcements. Expectations are likely getting a lift from the recent strength in the stock market and better news on housing.
Do not read too much into the recent improvement in consumer confidence. The overall index remains exceptionally low and the current conditions component has barely risen off its lows. The consumer confidence index tends to track employment trends. Weekly first-time unemployment claims have clearly peaked, but the absolute level of claims remains relatively high, and there has also been a large increase in the number of people exhausting their unemployment insurance and filing for extended benefits. We expect consumer confidence to gradually grind higher, just like the rest of the economy.
The industrial side of the economy appears to be poised for a much stronger rebound. Production was slashed earlier this year and inventories were drawn down by $159.2 billion in the second quarter. That figure comes from the revised GDP figures and is $18 billion larger than first reported. A good portion of that inventory drop was likely in motor vehicles, where production was slashed during the period. Sales have rebounded more recently, with the cash-for-clunkers program helping fund the purchase of nearly 700,000 vehicles in July and August. The rise in sales will further reduce inventories in the current quarter but, with production rising, inventories should fall less, adding around 2 percentage points to third quarter real GDP.
Orders for durable goods jumped 4.9 percent in July, with orders for commercial aircraft soaring 107 percent. Orders also picked up for electrical equipment and steel. Part of that may still be tied to the ramp up of vehicle production but part also simply reflects a bounce back following and extended draw down in inventories. Either way production looks set to rebound.
Global Review
More Signs of Stabilization in Foreign Economies
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The Ifo index of German business sentiment rose in August to its highest level since last September, suggesting that industrial production in Germany continues to recover from the low that was hit this spring.
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Most Asian economies grew on a sequential basis in the second quarter, and recent data suggest that the upturn has continued into the current quarter. Latin America appears to be lagging Asia, but there have been indications recently that the region is starting to turn around.
Incoming economic data continue to portray a global economy that is stabilizing and, probably, starting to grow again in the current quarter. For example, the Ifo index of German business sentiment rose for the fifth consecutive month in August (see chart on front page). Because the index is highly correlated with growth in industrial production (IP), the recent increase in the Ifo index suggests that IP is starting to recover.
The breakdown of German real GDP into its underlying demand components shows that macroeconomic stimulus was partially responsible for the 1.3 percent annualized growth rate that Germany was able to achieve in the second quarter (top chart). Real consumer spending rose nearly three percent, due in part to the country’s “cash-for-clunkers” program, and government spending also provided a lift to GDP. Business spending on equipment continued to decline as did exports, although the rate of contraction in both components slowed significantly. That said, the significant liquidation of inventories that occurred in the second quarter lays the groundwork for further gains in GDP in the quarters ahead as the inventory cycle starts to swing the other way.
In Asia, news continues to pour in that shows bona fide recovery is underway in the region. For example, data released this week showed that real GDP growth in Malaysia, the Philippines and Thailand turned positive on a sequential basis in the second quarter. It appears that global trade, which was negatively impacted last year and earlier this year by the global credit crunch, is helping to lift real GDP in most Asian economies. Economic data thus far in the third quarter have generally been positive as well. Industrial production in Singapore jumped up 23 percent on a seasonally adjusted basis in July relative to the previous month. Although Singaporean IP tends to be very volatile on a monthly basis, even when the series is seasonally adjusted, the recent trend suggests that the economy continues to gather steam (middle chart). Moreover, the rise in IP is consistent with the increase in the purchasing managers’ index since spring.
Recent data show that most Latin American countries are lagging behind Asia. For example, rates of economic contraction in Chile, Colombia and Peru all deepened in the second quarter, at least on a year-over-year basis. As we reported last week, Mexican real GDP tanked in the second quarter, plunging more than 10 percent in the second quarter on a year over year basis.
However, there are indications that the current quarter will be stronger than the second quarter for many Latin countries. The value of Chilean exports, which were up 14 percent in July relative to the previous month, rose to the highest level since last October. Brazil’s exports have also trended higher recently, helping to lead to an increase in the country’s trade surplus (bottom chart). In addition, Brazilian auto sales have recovered in recent months. Although most Latin economies are smaller today than they were last year at this time, growth in Latin America appears to be turning positive on a sequential basis.
