December 21, 2009

Optimistic but Still Cautious

As 2009 closes, we find the economy continuing to steadily recover from recession. However, the slow and sometimes uncertain pace at which the recovery is taking place inspires only cautious optimism.

GDP: Less Rosy
GDP growth estimates for the third quarter were less rosy than initially reported; the advance estimate of 3.5 percent growth was revised downward to 2.8 percent. This principally came from a sharp, upward revision to imports and downward revisions to personal consumption expenditures (PCE) and nonresidential fixed investment (Chart 1).

Employment: No Celebrating Yet
The labor market brought the biggest surprise of the month as nonfarm payrolls fell by a small 11,000 jobs in November and revisions to September and October figures cut average payroll losses over that two-month period from 204,500 to 125,000 (Chart 2). The unemployment rate fell by 0.2 percentage points to 10 percent in November. Beyond the top-line numbers, other good news in the report included an uptick in average weekly hours worked (from a record-low 33 to 33.2) and a hefty 52,000-job increase in temporary employment.

This sudden and dramatic improvement in nonfarm payroll losses in November is welcome but should be taken with a grain of salt and recognized as out of line with other data which point to slower improvement in the labor market. The other data include the ADP employment report, that estimated a decline of 169,000 private-sector jobs in November—less than October’s 195,000 and the eighth consecutive month of declining losses, but still a sizeable loss.

More substantively, weekly initial jobless claims have fallen sharply over the past several weeks. At 480,000, they remain well above the threshold—around 400,000—that usually signals nonfarm payroll growth (Chart 3). The threshold, like any statistical estimate, comes with some uncertainty. Still, our experience after the 2001 recession points to its usefulness: From late 2001 to late 2003, claims hovered around 400,000, and nonfarm payrolls moved little.

A Step Forward for Production
After losing some of its momentum in October, industrial production rebounded in November, up 0.8 percent, the largest increase in four months and a vast improvement from its flat level between September and October. Even excluding autos, a principal source of strength in past months, November’s 0.8 percent is well in line with the third-quarter monthly average growth rate of 0.7 percent (Chart 4).

This industrial production bounce is slightly inconsistent with the November Institute for Supply Management manufacturing survey. The survey showed some loss of momentum, with the composite index slipping from 55.7 percent to 53.6 percent—a rather large 2.1 percentage-point drop (identical to the decline in November 2008, for example). Despite this decline, the figure still reflects expansion in the manufacturing sector, in contrast to the nonmanufacturing sector, which slipped back into contraction territory.

Housing Market Moving Sideways
Recent data from the housing market—at least the data most directly impacting output growth—have moved mostly sideways the past few months, raising the possibility that the housing sector recovery has stalled. In October, single-family housing starts fell by 21,000 and permits by 3,000 before ticking back up in November (by 9,000 and 24,000). This trend has been more or less ongoing since July (Chart 5).

These data could be described as most relevant to the economy’s growth—more so than sales of existing homes or prices—because construction of new homes contributes directly to GDP, while reallocation of households among a fixed stock of housing units does not. October's dip may be due to the now-invalid expectation that the first-time homebuyer tax credit would expire in December. The credit (now with a potential $6,500 benefit for repeat buyers) has since been extended to cover purchases signed by April 30 and closed by June 30, 2010, which may account for the slight increase in November.

Prices Tick Up, but Inflation Worries Remain Low
Headline consumer price inflation rates have increased steadily over the past several months, with the 12-month headline PCE inflation rate finally moving back into positive territory in October and the Consumer Price Index (CPI) rate following suit in November.

Of potentially greater interest is the recent uptick in ex food and energy measures of inflation: 12-month rates for both core measures increased slightly in October—core PCE from 1.3 percent to 1.4 percent, core CPI from 1.5 percent to 1.7 percent. While core CPI has since held steady at 1.7 percent, one might prematurely find the direction of change worrisome, particularly because core inflation rates have been expected to decelerate rather than accelerate. However, more robust core measures like the Trimmed Mean PCE or median CPI have shown continued deceleration, and 12-month rates for both are at or near all-time lows. This suggests fears of accelerated inflation should still be tempered (Chart 6).

Financial Markets Take Further Steps
On the financial side, indicators used to examine the stability of credit markets continue to approach or reach levels seen before the onset of the financial crisis. Key credit spreads, though above their precrisis averages, have shown great improvement: the Baa-Aaa corporate bond spread, with a precrisis average of 90 basis points, stood at 108 basis points as of Dec. 16, while the junk bond spread stood above its precrisis average of 540 basis points at 623 basis points.[1]

Financial intermediaries are also slowly becoming more comfortable with providing credit. According to a quarterly survey of senior loan officers conducted by the Federal Reserve, when compared with third quarter, about 16 percent fewer banks reported tightening consumer loan standards in the fourth quarter. Unfortunately, the survey also showed weaker consumer demand for these loans.

To the End of 2009
In sum, both bright spots and uncertainties remain on the economic landscape as we approach the end of the year. One of the former has been consumer spending, whose annualized rate has solidly improved over the past three months to levels not seen since mid-2007 (the most recent release of real personal consumption expenditures showed an increase of 2.6 percent in October). It will be important to see how this and other indicators behave during the holiday season, and what this portends for the economy as a whole going into the new year.

—Max Lichtenstein and Jessica Renier

Note Calculated from the Merrill Lynch High Yield Index, less seven-year Treasury rates. About the Authors Lichtenstein is a research assistant and Renier is a senior economic analyst and coordinator of economic and financial analysis in the Research Department at the Federal Reserve Bank of Dallas.