Tuesday, May 29, 2007

Is This Really A Goldilocks Economy?

From IBD:

"This points to improving prospects for the economy in the second half," said Lakshman Achuthan, ECRI's managing director. He called the possibility of a recession this year "minuscule."

The index's rise stems from some healing in sickly manufacturing.

"Services were always holding up. But the industrial side is (improving) where it used to be a drag on the economy," he said.

Durable goods orders rose 0.6% in April, the third straight monthly gain. Core capital goods orders, a proxy for business investment, are turning higher again as well.

The ISM manufacturing index and industrial production also signal a factory rebound.

Achuthan characterized the current economy as "Goldilocks with blemishes," or one marked by moderate growth and expectations for moderate inflation.

Business investment has been slow for the last two quarters, coming in at a seasonally adjusted annual rate of -3.1% and 2%. While durable goods orders have increased, they are still at low levels. Here is a durable goods chart from Martin Capital. Notice where orders are in the cycle. It is just as possible for orders to drop from here as go up.

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Later in the article, the author makes the following observations:

Gasoline prices are already at record highs as the summer driving season kicks off.

But wages, a bigger factor for inflation, have risen less than expected for much of the year. Sustained productivity growth has kept anticipated inflationary increases mostly at bay, though efficiency gains are slowing

So far, consumer spending has been very strong. However, decreasing wages and increasing gas prices are a recipe for a slowdown in consumer spending. While we haven't seen a slowdown in consumer spending establish a trend, we saw a really bad April. And there is also the housing slump to contend with.

I am not a fan of the "Goldilocks" description. I think a better description is the "hanging on" economy. There are just enough positive developments to keep us out of recession. The key right now is consumer spending, which represents 70% of GDP growth. As previously mentioned, consumer spending has been solid so far. But with gas prices spiking before summer it's possible the consumer will come under increasing pressure for the next three months. This may be just long enough for the consumer to reign in spending enough to really impact GDP.