U.S. Economy to Grow Slowly and Not Sink into Recession
Varied economic indicators point to slow growth ahead in the U.S., but not a recession, according to The Conference Board, the global research and business membership organization.
This period of sub-par growth should have little impact on inflation and short-term interest rates are likely to remain high for an extended period of time or even rise. Over the last three months, The Conference Board index of Leading Economic Indicators (LEI) has turned down for the first time in this expansion relative to its level six months ago.
This signal, says The Conference Board, is not alarming since the downturn is modest, but it does suggest that the economic cycle is more mature than previously thought. Such downturns usually happen toward the end of the economic cycle. The current downturn is still in the range of the 1995 slowdown rather than the sharper declines before the 1990 and 2001 recessions.
The rate of change in the LEI index index is as important as its level. The LEI may dip into negative territory, but the decline is likely to be modest or brief. The key element is not only the level of the index, but the magnitude and duration of its decline. According to both these indicators, the LEI is now signaling a downturn–not a recession.
According to The Conference Board, the Federal Reserve Board is operating with little leeway. The current topline Consumer Price Index (CPI) is rising above a 4 percent annual rate, which is the highest inflation rate in 15 years. Core CPI is running at about 2.5 percent, which is on par with the rate that preceded the 2001 recession and appears to be moving up to the 3 percent inflation rates of the mid-1990s.
The Fed might have to continue to raise the funds rate in the face of inflation pressure. Before the Fed can cut rates, The Conference Board suggests that an event or shock of a sufficient magnitude to reverse the entrenched optimism in commodity markets will have to occur.
The next several months bear watching. Earlier, the Fed’s tightening had little or no impact and it appeared that the U.S. economy might be reaccelerating after the shock from Hurricane Katrina in the fourth quarter. The deceleration in the economy is clearer now that consumer and investment spending and the housing and employment sectors are beginning to weaken. Over the last two years, the financial indicators in the LEI have taken the U.S. economy toward lower ground and the nonfinancial indicators are now following suit.
One of the biggest disconnects in the U.S. economy, says The Conference Board, has been between the rapid growth in the capital goods and manufacturing sectors and the systemic weakness of the consumer sector. Propped up by low interest rates during 2000-2002, the consumer goods sector never faced the traditional recession challenge. Outside housing investment, the consumer sector never recovered, either. While consumer spending has remained in the 3-4 percent range, the major benefactor has been consumer-related imports. Domestic consumer goods orders on average have not grown over the last four years.
The capital goods sector has been the other economic driver during this cycle. The current acceleration in nondefense capital goods orders dwarfs past investment booms–even those of the tech “bubble” of the late 1990s. The year-to-year growth in capital goods orders peaked at about 30 percent late last year. This growth is the result of what has been, until recently, rapid growth in domestic infrastructure, housing, technology, and capital goods investment, as well as a boom in investment in other parts of the world–especially emerging markets–that is reflected in the rapid growth in export orders. Exports of capital goods have been rising at a 13 percent annual rate over the last year.
But the capital goods sector appears to be slowing. Besides the slowdown in capital investment in the second quarter Gross Domestic Product, there has been a sharp drop in capital goods orders overall.
Despite a bounce back in August from July’s dip, the slowdown over the last several months in the Institute of Supply Management export orders index, which is generally a leading indicator of export orders, is a matter of concern. The decline in the short-term trend of this index suggests that external global demand for capital goods may be slowing. Vendor performance, as measured by the percentage of companies reporting slower deliveries, is still relatively high (above 50 percent).
Corporate profitability, however, which is an important long-lead indicator of the business cycle, is making stunning gains. When corporate profits are high, investment usually grows rapidly and businesses spend more freely on travel, marketing, and other general administrative expenses. Hiring rises and, equally important, so does liquidity.
Companies that have been spending their cash flow through investments, stock buybacks, and increased dividends still appear relatively liquid, but the financing gap, according to The Conference Board, is now in territory that bears vigilance.
The Conference Board is one of the world’s leading research and business membership organizations. It produces the widely watched Consumer Confidence Index, Help-Wanted Advertising Index, and Leading Economic Indicators for the U.S. and eight other major nations. The Conference Board is also noted for its economic forecasts and CEO surveys, and for its studies on global productivity, corporate governance, business ethics, corporate citizenship, workplace diversity and mature workers. Its conference and council programs attract more than 18,000 senior executives each year.
