May 22, 2009

Slowing Rate of U.S. Economic Contraction

As the U.S. economy enters the 17th month of recession—now the longest recession in the post-WWII period—the overall pace of economic contraction appears to be slowing. Credit markets are slowly thawing, employment declines have lessened somewhat and glimmers of stabilization may be appearing in the housing market. Despite these tentative signs of improvement, the U.S. economy remains in a solid state of contraction.

GDP Falls Again, First Quarter 2009
According to the advance report, real gross domestic product (GDP) fell 6.1 percent in the first quarter—over a percentage point more than market expectations. Compared with fourth quarter, when almost all major components of GDP were negative, there were some positives first quarter. Most notably, personal consumption expenditures (PCE), which had been the cause of almost half the contraction in the fourth quarter, made a surprisingly positive contribution in the first quarter. Net exports were also positive. However, this was due to a large decrease in imports rather than an increase in exports. Real exports declined 8.5 percent over the first quarter. Real residential and nonresidential fixed investment each decreased more than 11 percent, causing almost twice the contraction in the first quarter as in the fourth quarter. Of note was the dip in government spending in the first quarter, showing that fiscal stimulus has yet to reach the economy (Chart 1).

In April, total and core retail sales (excluding motor vehicles and parts) fell by 0.4 percent and 0.5 percent, respectively. Real core retail sales are now down 7.1 percent year-over-year, the steepest recorded annual decline since the index began in 1967. Real total retail sales are also near their steepest year-over-year decline at –9.5 percent, second only to the –10.6 percent registered in December 2008 (Chart 2). New orders for durable goods also trended down again in March, after only one month of positive growth, falling 0.8 percent. Finally, industrial production fell an additional 0.5 percent in April—the sixth straight month of decline—and capacity utilization deteriorated further to yet another historic low.

On a positive note, the Institute for Supply Management’s indices of manufacturing and service-sector growth continued their upward trends in April, reaching their highest levels in at least six months, showing less widespread contraction in activity. Additionally, the Conference Board’s Index of Leading Economic Indicators rose 1 percent in April, ending a 10-month streak of either a declining or unchanged index. Fairly broad-based, the increase in the index was primarily due to April’s stock market rebound. The market was buoyed by improved consumer expectations—which have continued to improve in May—and a positive-sloping yield curve. While the upturn in the index is encouraging, the leading index is still more than 3 percent below its year-ago level.

Labor Market Still Suffering
The labor market continued to suffer in April, with a loss of 539,000 jobs. In addition, the number of lost jobs in March and February rose after revisions (from 663,000 to 699,000 in March and from 651,000 to 681,000 in February). Although the rate of decline in nonfarm payroll employment slowed in April to its slowest pace since October and losses were considerably less than the market expected, April’s decline was still the largest one-month drop since July 1956, excluding the current recession. As a result, the unemployment rate climbed an additional 0.4 percentage points and now sits at 8.9 percent, only 0.1 percentage point away from peak unemployment in the 1973–75 recession. To date, the economy has lost 5.7 million jobs since the beginning of the recession (Chart 3). Despite the battered state of the labor market, the slower rate of decline in nonfarm payrolls and possible early signs of peaking initial jobless claims provide some encouragement that the steep pace of overall contraction may be letting up.

Steady, Slow Improvement in Financial Markets
Financial markets have steadily improved through April and into May. In short-term credit markets, interest rate spreads in the interbank and commercial paper markets edged down further. Whereas longer-term bond markets were showing increasing signs of stress near the end of March, interest rate spreads in those markets have come down—albeit to elevated levels—over the past two months to levels near those of early October. The benchmark spread between Baa- and Aaa-rated corporate bonds has narrowed by 60 basis points since the end of March, reflecting an improvement in firms’ ability to obtain financing. Junk bond rates have fallen about 410 basis points since the end of March (Chart 4), and mortgage rates have again retreated to new lows. Additionally, issuance of both corporate and junk bonds has continued to increase, indicating these markets are finally thawing.

Some improvement in loan availability was also evident in April as fewer senior loan officers at banks reported tightening of credit standards, with the exception of mortgage loans. The index that measures banks’ willingness to make consumer loans also improved in April but was still negative, meaning fewer senior loan officers were less willing to lend than they were three months earlier.

Possible Signs of Stabilization in Single-Family Housing
The housing market is beginning to show possible signs of stabilization in single-family homes, albeit at very low levels (Chart 5). After many months of declines, the number of single-family building permits and starts has increased in two of the past three months. In April, single-family permits rose 3.6 percent and starts rose 2.8 percent. However, dragged down by multifamily declines, overall building permits fell 3.3 percent and starts fell 12.8 percent. Single-family existing and new home sales turned down again in March, falling 2.8 percent and 0.6 percent, respectively, after having increased in February. For the second month in a row, the median existing home sales price increased, rising 4.1 percent in March. However, the S&P/Case-Shiller home price index, a broader measure of home prices, continued to fall, indicating that further home price declines may be necessary before high housing inventories can retreat.

Deflationary Pressures Present
After inflation rates appeared to stabilize somewhat in February, deflationary pressures emerged in March and April, pushing year-over-year headline Consumer Price Index (CPI) inflation down to –0.5 percent and –0.6 percent, respectively (Chart 6). The headline personal consumption expenditures (PCE) deflator, while registering positive numbers, declined 0.3 percentage points in March to a low 0.6 percent year-over-year—the lowest since December 1961—while core PCE inflation was unchanged. In its fifth month in negative territory, the producer price index (PPI) registered at 3.5 percent below its year-ago level. The rate of deflation since July 2008 has been 3.6 percent at an annual rate. However, the April Blue Chip survey expects these pressures to ebb and is forecasting a 0.4 percent rise in headline CPI inflation in 2009.

—Jessica J. Renier

About the Author Renier is a research analyst in the Research Department at the Federal Reserve Bank of Dallas.