Friday, June 17, 2011

Thoughts on the Slowdown

As the posts from the Beige Book this week indicate (see these posts on consumer spending, manufacturing, services and lending to catch-up) the economy is clearly slowing down. The combination of high gas prices, political uncertainty (domestic and international), aftereffects of the Japanese earthquake and the slowdown in emerging economies are all hitting US growth. The question now becomes -- what is the length and total impact? Let me answer that by looking at the various economic sectors specifically outlined in the Beige Book.

Consumer spending is being hit by weak wage growth, (caused by) high unemployment and high commodity prices. To the extent high commodity prices are responsible, we're seeing consumers change their overall spending from discretionary goods to necessities. In addition, to the extent gas prices remain high, we'll continue to see a change in car purchasing behavior from heavier trucks and SUVs to more fuel efficient cars. High unemployment leads to future uncertainty which causes depressed spending and more saving. While the former has an obvious negative impact, the latter does have long-term benefits as it provides a safety cushion for consumers.

Manufacturing is clearly seeing a slowdown caused by two factors: Japan and the slowdown in India and China. Japan is hurting supply chains across the globe. Estimates for when the problem will be cleared up have ranged from the third to end of the fourth quarter. Of importance here are the future indicators in the various Federal Reserve surveys. So far, we've seen these drop sharply over the lat two months, indicating there is a general sense of concern in the manufacturing community about something. As for emerging markets, both China and India are trying to tamp down high inflation, which is still at higher than desired rates in both countries. As such, their respective interest rates will continue to increase, slowing domestic growth. This combined with the aftereffects of the Japanese earthquake will slow US domestic manufacturing.

Services: As an aside, there is actually precious little information on the service economy, save for a few regional surveys and the ISM national data. The latest ISM report is actually positive, with signs the service sector is expanding and expecting more of the same. The federal macro level Beige Book report was solid, and the various districts reported strength as well.

Commodity Prices: The primary driver for the recent spate of high commodity prices has been tight supply and increased demand. On the agricultural side, this mis-match started last summer when Russia was hit by a summer of burning crops, which forced the government to ban exports, leading other countries to hoard grains. Combine that with a year of odd weather across the globe impacting supply, and you wind up with tight agricultural supplies.

On the oil side, we have increased demand from a growing India and China and tight supplies out of OPEC that also has little spare capacity left.

Both of these scenarios indicate that a slowing economic environment will decrease upward price pressures, thereby easing some of the problems caused by high commodity prices.

Real Estate: the economic basket case. The good news here is the pace of sales has stabilized, although at an incredibly low level. In addition, home affordability is at great levels, the rent/buy decision tree indicates that owning is better than renting and interest rates are still at incredibly low levels. In short, real estate is clearly a bargain. On the con side, unemployment is high, credit is still tight and there is a tremendous amount of overall uncertainty in the air. However, the fact that real estate is already at terrible levels means that it is highly unlikely it will move lower. As real estate drops are a big cause of recessions, this fact is actually a good thing, as it indicates one of the primary drivers of recession probably won't cause another.

Employment: Last months reports was one report in an otherwise good string of reports. The obvious question is what is the overall trend? The latest indications from initial unemployment claims are positive, but not overwhelmingly so as the total figure is still above 400,000. In addition, with the economy entering a soft patch it's logical to assume that hiring plans will be at least marginally depressed. In short, there is little reason to see a huge pick-up in this number. However, there is also little reason to see a high drop-off either. Frankly, it seems as though the economy cut-out 10% of the overall workforce about two years ago and has moved one without looking back.

Overall, there is no reason to see a double dip. But neither is there a reason to see a pace of strong overall strong growth. It's quite likely that for the next few quarters the economy will grow just enough to stave off a recession, but not fast enough to create a self-perpetuating, demand driven state of strong growth.