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Pace of U.S. Expansion Downshifting?


Weak economic data for June suggest economic growth is either pausing or shifting down a gear, making the economic omens for July especially important.

The earliest signs suggest factory activity, at least, may be rebounding, but one set of leading indicators designed to signal changes in the future rate of growth are suggesting a slowdown to a more trend-like growth pace from the above-trend pace in place at the end of last year and early this year.

There are two critical tests in the next three weeks that will help determine whether the June slowdown was just a pothole on the road to recovery or a sign of a more meaningful shift in the pace of expansion.

The most serious adverse signal in June was the falloff in the rate of job creation to only 112,000 after average monthly gains of 304,000 in the three prior months. In addition, however, there were declines in retail sales, industrial production, and housing starts which taken together signal a broad-based softening in economic activity last month.

It Could Be Just A Slight Settling Down

The preferred explanation is that the June dip was a one-time event. "I think the June weakness was unique and that there will be a pickup (in economic activity) in the third and fourth quarters," said John Lonski, chief economist at Moody's Investors Service in New York. "Still, 2004 growth will turn out to be lower."

Lonski reckons real gross domestic product growth will be slower on a year-over-year basis in the second half of the year (4.0%) compared to the first six months, but says this is simply a normal transition to a more mature expansion.

However, he does set up two critical tests that the economy must meet in the next three weeks.

"We can't see a third straight monthly decline in durable orders, that would worry me," said Lonski.

Orders for big ticket items fell 1.8% in May after declining 2.7% in April.

Lonski pointed, however, to the regional manufacturing surveys for July by the Federal Reserve Banks of New York and Philadelphia as "telling a quite different tale." Those surveys, reported last week, pointed to strong overall gains and specifically gains in orders.

By the same token, the Institute for Supply Management's manufacturing survey's new orders components increased for a 14th straight month in June, albeit the reading of 60.0 was the lowest reading since July 2003. In that sense, the manufacturing surveys are contradicting other indicators of weakness in the economy.

The need to see a reacceleration in the pace of job growth in July is equally essential. "We need job gains and income growth to sustain the expansion." In fact, Lonski draws a line in the sand dividing what he needs to see to be sure of a return to expansion - a gain of 250,000 or more - from another increase of 150,000 or less "which would be worrisome."

He's been watching the Economic Cycle Research Institute's weekly leading index for guidance, but he noted that the average for that index dipped by 0.1% at an annual rate from the first quarter to the second quarter, "but it was still higher from a year ago by an above-trend 6.0% in June."

Move From Above-trend To Trend Growth

The people who compile the ECRI weekly leading index say it is signaling a move back to just trend growth from the stronger economic activity seen previously.

"We're seeing the change back to a trend rate of around 3% growth from an above-trend 4.5% to 5% rate at the end of last year," said Lakshman Achuthan, managing director at ECRI in New York. "I don't see the June data as a 'pause that refreshes,' but rather as a change in the direction of growth. We still see growth, but at a lower pace."

ECRI stresses the weekly index's percentage change compared to the 52-week moving average as its preferred leading indicator. In January, that measure averaged a 10.6% change and was 11% in February and March, but has slowed sharply since. It slowed to 9.1% in April, 7.2% in May and 3.2% in June. This measure has averaged just below 2% in the first two weeks of July.

Achuthan believes the changes seen in that rate foretold the slump in activity in June, while the more recent leading index readings suggest the trend will continue.

The even more sluggish pace in June and so far in July for the weekly leading index is pointing to the slowdown to the 3% growth that lies ahead. Like Lonski, he says "job growth is really critical and (ECRI's leading indicators) do suggest less strength in employment, which is a concern. The vulnerability of the economy is greater today to a shock with low single-digit growth in the weekly leading index."

Fortunately, the criteria Lonski and Achuthan each point to will be conclusive in the next few weeks. It's not a question of waiting for some indefinite period for judgment.