April 2, 2008

Weakening Real Economy, Moderating Inflation

Data released over the past few weeks are mixed. The national economy has weakened further, but inflationary pressures appear to be moderating.

Economy Grew 0.6 Percent in Fourth Quarter 2007
Economic performance in fourth quarter 2007 was poorer than market expectations, with real GDP growing only 0.6 percent. A sharp fall in inventory investment and further declines in residential investment and consumer spending were behind the slowdown (Chart 1). Net exports also slowed somewhat as the global economy decelerated. Data releases on the current quarter continue to be weak.

Payroll Employment Fell Sharply in February
Nonfarm payroll employment declined by 63,000 jobs in February, and the loss in January was revised downward by 5,000 to 22,000. In the first two months of this year, payroll employment fell by 85,000. The last time we saw a payroll employment decline was during the “jobless recovery” of 2003 (Chart 2).

The February payroll decline occurred despite a large 38,000 rise in government payrolls, which partially offset a large 110,000 drop in private payrolls during the month. Weakness was broad-based: manufacturing employment fell 52,000, construction declined by 39,000, and job gains in service sector were only a very modest 26,000. The housing market downturn and the credit crunch have apparently spilled over into other sectors of the economy.

Housing Market Is Sending Mixed Signs
Housing starts fell 0.6 percent to 1.065 million annualized units in February, led by a 6.7 percent decline in single-family starts. Housing permits fell 7.8 percent and have dropped 37 percent in the past 12 months. Both housing permits and starts were significantly lower than their levels a decade ago (Chart 3).

New home sales continued to slide in February, down by 1.8 percent from January to 0.59 million annualized units. Inventories of unsold homes was unchanged at 9.8 times the current monthly sales pace. The median existing-home price fell 1.9 percent in February, but sales of these houses rose 2.9 percent to 5.03 million annualized units, suggesting that the continuing fall in house prices might have started affecting home sales. Inventories of unsold existing homes edged down to 9.6 months (Chart 4).

Credit Conditions Remain Strained
Conditions in short-term funding markets have weakened since the last FOMC meeting, unwinding much of the earlier improvement following the establishment of the Term Auction Facility. Short-term borrowing costs edged down somewhat in response to the massive cuts in the federal funds rate, but the spreads over Treasury bill rates have widened.

Long-term corporate bond yields and mortgage rates kept rising despite the precipitous federal funds rate cuts. Spreads between corporate and Treasury bond yields continued to increase, reflecting greater concern among investors about the outlook for corporate credit quality over the next few years.

Consumer Inflation Was Zero in February
Overall and core CPI inflation were zero in February, resulting from both a deceleration in oil price increases in late January and February and weak aggregate demand growth. Compared with 12 months ago, the overall CPI has risen 4.1 percent, and the core CPI has risen 2.3 percent (Chart 5).

—Tao Wu

About the Author Wu is a senior research economist in the Research Department at the Federal Reserve Bank of Dallas.