The U.S. economy grew at an annual rate of 2.2% in the first quarter, marking the eleventh consecutive quarterly increase from the trough in June 2009. Although this consistent growth trend is impressive, the magnitude of improvement of real gross domestic product (GDP) in the current economic recovery has been sub-par. Incoming economic data appear to cast a shadow on the ability of the U.S. economy to post strong self-sustained economic growth in the near term. However, a detailed investigation of economic reports suggests that, for the most part, the U.S. economy has been resilient and resistant to international economic woes, for now.
Starting with the strong positives, the ISM manufacturing survey for April paints a factory sector humming along with activity outpacing the March performance. The Purchasing Managers Index increased to 54.8 in April, the highest since June 2011, while the index tracking new orders increased to 58.2, the best reading in the past year (see Chart 1).
The survey of the National Federation of Independent Business shows an improvement in the outlook of small businesses, with the Small Business Optimism Index advancing to 94.5 in April, the highest mark since December 2007 (see Chart 2).
From the details of the survey, 19% of respondents indicated that poor sales were the single biggest problem in April. This assessment of small business respondents is an improvement, because 22% held this opinion in March. More importantly, in April, the smallest number of businesses since August 2008 reported that demand for their products is problematic (see Chart 3).
In addition to encouraging survey results about the economy in recent weeks, actual economic data also point to forward momentum in the U.S. economy. Consumer spending grew at an impressive clip of 2.9% in the first quarter, the largest quarterly gain since the fourth quarter of 2010. Growth in consumer spending advanced, despite atypical warm weather which resulted in a $14.5 billion and $9.1 billion reduction is consumer outlays on electricity and gas in 2011:Q4 and 2012:Q1, respectively (see Chart 4).
The strong first quarter headline number for consumer spending hides three details that that should be watched. First, consumer spending in the first two months of the year was stronger than in March. Second, autos sales nearly stalled in April at an annual rate of 14.42 million units versus 14.37 million units during March. But, it should be noted that auto sales have held above 14 million units in the first four months of the year versus a 13.5 million pace in the fourth quarter of 2011. The year-to-date auto sales tally is the strongest performance since the crisis unfolded in 2008 (see Chart 5). So, the nearly flat reading in April is not a significant setback but suggests close monitoring in the months ahead.
Third, the recent decelerating trend of real disposable income averaging only 0.6% year-to-year gain in the three months ended March remains a worry as it questions the durability of strength in consumer spending seen in the first quarter (see Chart 4).
At the same time, consumer borrowing for cars, college tuition and much more advanced at a noticeable pace during February and March (see Chart 6). Consumer credit has posted gains in the last six months after declining consistently since the last quarter of 2008. These consumer credit numbers suggest that the consumer deleveraging process is slowing and supports expectations of future growth in consumer spending.
In addition to consumer spending, recent industrial production data are also encouraging. Overall industrial production rose at an annual rate of 5.6% in the first quarter after a 4.9% increase in the final months of 2011. Factory output, which excludes mining and utilities, posted an 11.6% annualized increase in the first quarter (see Chart 7).
Lets move on to labor and housing market data that point to strength but some elements of these reports have planted seeds of doubt about continued self-sustained economic expansion.
The slightly lower unemployment rate in April (8.1% versus 8.2% in March) was largely based on arithmetic; it does not reflect an increase in employment as the reduction in the jobless rate would imply. This aspect, combined with a gain of only 115,000 in payroll employment, has raised the level of concern about the labor market. But looking at the big picture, one months reading of payrolls (which will be revised in the next two employment reports and followed by further annual revisions) is insufficient information for a firm conclusion about the demand for labor. Moreover, revisions of payroll numbers for February and March show an increase of 53,000 jobs from the earlier estimate. Pessimists cite that unemployment claims rose in April by roughly 20,000 from the March tally. But, initial jobless claims have dropped in the last two weekly reports. A more balanced view is that the labor market performance in April was disappointing and it is important to bear in mind that firms are still hiring. The three-month moving average of payroll employment through March stands at 229,000, noticeably larger than the 115,000 increase in payrolls during April. It is entirely conceivable that hiring in the months ahead could exceed the count reported in the first estimate of April payroll employment.
The housing sectors downward trend commenced several quarters before the overall economy started to swoon in the closing months of 2007. Latest data indicate that the housing market has turned the corner in terms of sales and starts of homes. The six-month moving averages of sales of existing and new homes and housing starts have bottomed out (see Charts 8). Home price indexes (see Chart 9) are pointing to stability of home prices. But challenges of foreclosures, short sales and negative equity continue to call for policy action and have overshadowed the improvement in actual sales and starts of homes in recent months.
Pulling together these recent economic developments, the overriding theme that emerges is the noticeable resilience of the U.S. economy. The key question is if the economy will continue to advance in the rest of 2012. The best economic indicator to assess this possibility has been bank credit. The importance of bank credit in assessing the growth path of the economy has been the corner stone of Paul Kasriels (just retired Chief Economist and my boss/mentor of several years) analysis. So, how has bank credit fared in recent months? Bank credit grew at a sturdy pace of 5.9% (annualized) in April, a striking pickup after a 1.6% gain in March (see Chart 10). The consistent year-to-year increase of bank credit for 10 straight months is also worth noting, with the 4.1% increase in April representing the largest increase since October 2008. The forecast presented in Table 1 (see end of document) rests on expectations of continued and accelerated growth of bank credit. There is little reason to doubt that this trend will be reversed in the near term.
A comparison of the performance of the United States and eurozone in recent quarters is additional evidence about the resilience of U.S. economy. As noted earlier, the U.S. economy has posted consistent growth for eleven quarters but real GDP of the eurozone fell 0.3% in the fourth quarter of 2011, and it is nearly certain the region will record another quarterly decline of real GDP and officially enter a second recession in quick succession. Chart 11 illustrates that the euro area and U.S. economy are currently tracking divergent economic paths. (Chart 11 is an index chart with real GDP set equal to 100 in 2008:Q1 to enable an easy comparison of real GDP growth). Real GDP of the U.S. economy has surpassed the low seen in the first quarter of 2008 by almost 2.0%, but the euro areas real GDP continues to hold considerably below the level posted in 2008:Q1.
Real GDP 2008:Q1=100
The update is incomplete without a perusal of economic developments in China. The Purchasing Managers Index of Chinas factory sector shows continued expansion in April (53.3 vs. 53.1 in March, readings above 50.0 denote an expansion in factory activity). But industrial production in China rose only 9.3% from a year ago in April compared with an 11.6% increase in March. The single-digit gain in industrial production during April is the smallest increase in nearly three years (see Chart 12). Inflation in China is no longer a worrisome issue, as inflation numbers show an abating trend from year-to-year gains of 4.5% and above in the fourth quarter of 2011, to a 3.4% year-to-year increase in April (see Chart 13). The favorable trend of inflation allowed the Peoples Bank of China to undertake another round of monetary policy easing last weekend by reducing the required reserve ratio of commercial banks by 50 basis points to 20% for large banks and to 18% for small and medium depository financial institutions. This is the third cut in six months.
Against the backdrop of these economic developments in the United States and major players in the global economy, the primary question at the Feds June 19-20 FOMC meeting will be whether the economic resilience visible, despite a few soft spots, is adequate to maintain self-sustained growth in the quarters ahead. At the present time, the elevated unemployment rate of the U.S. economy, shaky stability of the housing market, and political and economic uncertainties in the eurozone do not allow the Fed to even hint about the possibility of not standing ready to provide financial accommodation, if necessary, just yet. The Fed is nearly certain to stand pat at the close of June FOMC meeting.
THE NORTHERN TRUST COMPANY
ECONOMIC RESEARCH DEPARTMENT
SELECTED BUSINESS INDICATORS