Hoisington/Hunt commentary page 1THE COMING SLOWDOWNBack to...

Hoisington/Hunt commentary


page 1
THE COMING SLOWDOWN
Back to back, strong employment numbers
have increased the odds of an upward move in the
Federal funds rate in June or August. The markets
have priced this anticipated move into all Treasury
maturities.
Despite their strength, we view the nearterm
numbers as transitory. Powerful restraining
forces are impacting the consumer, and this will
result in slower growth in the latter part of this
year and into 2005. As a consequence, we fully
expect interest rates to be lower by year end, and
noticeably lower a year from now.
Regarding the recent employment reports,
these items are of note:
• Payroll jobs rose 288,000 after upward
revised increases of 337,000 in March and 83,000
in February. Incidentally, 270,000 of the April job
gains came from the birth/death model, a statistical
extrapolation rather than a direct increase in the
job head count. Previously this model was called
the plug factor.
• The normal sequence whereby firms
increase the workweek while they are hiring was
not in place for the second consecutive month. The
average private workweek failed to recover after
falling 0.1 hour in March.
• The economy added 21,000 manufacturing
jobs in April and 9,000 in March. The increases
do not appear sustainable since the manufacturing
workweek fell a very sharp 0.3 hours in April,
Interim Update and Comment
May 2004
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after dropping 0.1 hours in March. Since February
the manufacturing workweek has fallen 1%, with
the drop in the workweek widespread throughout
the manufacturing sector in both key durable and
non durable goods categories. The manufacturing
workweek was the lowest since December when
it was 40.6 hours, the same as in April.
• The construction workweek fell 0.4
hours, reversing the March 0.2 hour gain, dropping
the workweek in this sector to the lowest level
since December 2003.
• Average hourly earnings rose 0.3%,
boosting the year/year rise to 2.2%. Average
weekly earnings fell to $520.71 in April, down
22 cents from March with the softness in the
workweek and job gains centered in low paying
sectors. Moreover, the March decline was revised
to a drop of $6.35, compared with a preliminary
decline of 88 cents. Weekly paychecks rose just
$10.69 versus April 2003, or a mere 2.1%. This
is less than the inflation rate. Thus, job gains
notwithstanding, the real standard of living would
have declined in the past year if not for the cut in
household income taxes.
• The economy is exhausting last year’s
stimulants. For the first time in four years
consumers will not get an income tax cut this July,
and they have already spent the 2001 to 2003 tax
cuts. When Presidents Nixon, Ford and Reagan
cut taxes, the personal saving rate jumped sharply.
Thus, consumers were able to draw saving down
and propel the economy for several years. But
today we see a saving rate mired below 2%, which
is equivalent to the pre-2001 tax cut rate. Since
page 2
Interim Update and Comment May 2004
the beginning of 2001, after-tax household income
rose 10%, but pre tax wage and salary income
gained a paltry 1%. Not only were the tax cuts
key to a 4% growth in real consumer spending,
but a record mortgage refinancing boom occurred
in 2003 while interest rates were low. The rise in
market interest rates has resulted in a collapse in
mortgage refinancing, with the last 4 weeks 50%
lower than a year earlier. The evidence is mounting
that the former stimuli are waning.
• The consumer sector would be vulnerable
to a downturn in normal circumstances, but
conditions are far from normal since we are
experiencing the fifth oil shock since 1970. Total
consumer fuel expenditures have advanced from
a 2001 low of 6.3% to 7.7% of wage and salary
income in the quarter just ended, and energy prices
are even higher now. This is a dead weight loss
to the domestic economy. All of the four prior
oil shocks led the economy into recessions, and
this risk is present again because of the persistent
weakness in average weekly earnings. Thus,
with fuel rising sharply, especially in the heavy
population centers on the coasts, consumers
are being forced to shift spending from the
discretionary to the necessary. The energy spike
is showing its effects.
• Federal Reserve accommodation does
not depend on whether the Federal funds rate (the
overnight lending rate between banks) is rising or
falling. Rather, it reflects the status of mortgage
and long-term rates, as well as the rate of growth
in money and credit. The news on this front is not
good (see our quarterly letter.) Key interest rates
have already risen, and contrary to what some
believe, money and credit growth is poor. In the
last 12 months, both M2 and M3 are ahead by
about 4%. Such rates of growth are the slowest in
the past seven years. Over a longer time frame, the
growth in M2 equals the growth in nominal GDP
(inflation plus real growth). Thus, if inflation is 2%
late in the year, this would mean that real growth
will drop to 2% also, down from better than 4% in
the first quarter. Business loans and non financial
commercial paper are continuing to decline for the
fourth consecutive year. Moreover, the monetary
base (reserves injected into the banking system
by the Fed) is up just 4.7% in the past year. This
represents a sharp slowing, and replays the pattern
prior to the recession of 2000-2001.
• With all the focus on the Fed and the
perceived strength in back end sectors of the
economy, the front end, or consumer, is already
slowing. The personal spending trend ended the
first quarter on a very weak note, rising at just
a 1.2% annual rate in March, after annual rate
increases of 2.4% in both January and February.
The reason the first quarter growth in spending
was at a 3.8% annual rate was the high entry point
from the fourth quarter. The April evidence on the
consumer is weaker. Vehicle sales were at a 16.4
million annual rate, the lowest since last October.
This happened in spite of increased incentives at
GM. Also, weekly surveys of consumer spending
moved lower in April on a seasonally adjusted
basis. Admittedly, the ISM manufacturing and non
manufacturing indexes were strong in April, but
they will not remain so if the consumer does not
pick up the pace. In our opinion, there is nothing
to provide the consumer a lift.
Van R. Hoisington
Lacy H. Hunt, Ph.D.