Thursday, July 9, 2009
Changing Firms as a Hybrid Rep
The July issue of Transitions Magazine includes the article Changing Firms as a “Hybrid” Rep written by Heidi Wheatley, director of marketing for J.P. Turner. In the article Al Pierantozzi, national sales manager, and Rod Kresge, chief compliance officer for J.P. Turner & Company Capital Management, LLC provide helpful information for reps who are advisors and brokers – “hybrids” -- considering a move to a new firm.
Tuesday, July 7, 2009
JP Turner Weekly Economic Commentary
WEEKLY ECONOMIC COMMENTARY -- WEEK OF JULY 2, 2009
Wall Street took it on the chin on Friday, as the Labor Department released a gloomier jobs report than had been expected. The 467 thousand decline in nonfarm payrolls reported for June was about 100 thousand more than the consensus had been looking for and considerably larger than the revised 322 thousand decline that occurred in May. The May decline, which was much smaller than those posted over the previous six months, had fueled hopes that the harsh recession was ebbing and growth would resume sometime over the second half of the year. As much as anything, those heightened expectations provided fuel to the powerful 35 percent stock market rally that began in early March.
So does the disappointing June employment report invalidate those expectations and derail the recovery timetable? Clearly, it would be foolhardy to attribute the disappointing June reading entirely to "noise", i.e., monthly gyrations that tend to even out over time. Not only was the headline number bad, the underlying details portrayed a dismal employment landscape. Virtually all major industry groups reduced payrolls except for the health and education sector, which is the only secular growth story in the economy. The cyclically-sensitive construction, manufacturing and business services industries registered big cuts in payrolls, the unemployment rate edged up another 0.1 percentage point to 9.5 percent, hourly earnings were flat and the work week was trimmed to 33 hours, the lowest on record.
Simply put, there was hardly anything upbeat in the June report, certainly nothing that would suggest the economy moved closer to a turning point as the mid-year approached. Indeed, some of the internal details were downright ugly. For example, of the 14.7 million people classified as unemployed in June, fully 4.4 million or 30 percent had been looking for a job for at least 27 weeks. And if the so-called marginally attached workers are included in the unemployment tally - i.e. those who are working part time because full-time positions were not available or those who are too discouraged to look for a job but would like one - the jobless rate would be 16.5 percent, far above the 9.5 percent official rate.
The picture turns even darker when the spotlight focuses on what's pushing the unemployment rate up. Essentially, the rate can rise for a number of reasons - new people entering the labor force hoping to find work, such as graduating students, reentrants to the labor force, such as housewives looking to supplement the family paycheck, or job losers, the unfortunate workers who get sacked from a position. While the participants in all three groups experience pain when they go on the unemployment lines, the worst of the lot are the job losers who are usually the primary wage earners responsible for meeting mortgage and other household expenses. Needless to say, the economy takes a bigger hit when the unemployment rate is driven up by job losers, rather than by unsuccessful job seekers who had not been drawing a paycheck.
In June, fully 65.5 percent of the 14.7 million unemployed workers were job losers, about the same as the previous month and up from 52 percent at the start of the recession. More significantly, that share exceeds the previous postwar high of 63 percent set during the 1981-82 recession. Hence, while the official unemployment rate, at 9.5 percent, is still well below the 10.8 percent postwar peak reached in 1982, the higher proportion of job losers suggest that conditions today may be more severe than was the case during that downturn. Keep in mind that during the 1970s and 1980s the labor force was growing more rapidly than job openings, thanks to the growing participation of women and the explosion of the baby boom population reaching prime working age.
That said, the June jobs report, as disappointing as it is, should not be viewed as a major setback for the economy. By and large, it does little to invalidate the notion that the severity of the recession is ebbing or that the road to recovery is still in sight. Yes, the payroll decline was worse than in May, to the chagrin of those who would like to see a smooth progression of ever-smaller job cuts from month to month. But the economy rarely conforms to that ideal scenario, and the June reversal was not alarming enough to cause a major rethinking of where we are heading. If anything, the deterioration of the major employment indicators was incremental and consistent with the notion that conditions are getting "less bad". For example, the unemployment rate edged up 0.1 percent from May's 9.4 percent level, which was much smaller than the 0.4 percent increases that occurred in five of the previous six months. Similarly, the 0.1 percent increase in the broader unemployment rate noted earlier was the smallest monthly increase in more than a year. Over the previous 12 months, this yardstick, known as the U-6, registered average increases of 0.6.
As is the case with most measures of activity, it is better to take a longer perspective by averaging out the latest month with the one before. When applying this approach to the employment figures, the trend showing a slower pace of deterioration remains firmly in place. The May/June average decline in nonfarm payrolls comes to 395 thousand, which is a far better reading than the 645 thousand average decline over the previous six months. What's more, the pace of job losses in most major industry groupings is also slowing. Indeed, that's even the case for manufacturing companies where the beleaguered auto companies are shutting down plants, either temporarily to reduce inventories or permanently as part of bankruptcy proceedings. Ditto for the much-maligned construction industry, where an average of 65 thousand workers lost jobs in May and June, about half the pace over the previous six months.
It's important to recognize that the job market follows a time-honored cyclical dynamic that keeps alive the notion that the recession is entering its late, if not final, stage. The most important feature of that dynamic is that job cuts continue, albeit at a slower pace, even after the recession ends and a recovery gets underway. By extension, the unemployment rate also continues to rise, sometimes as much as a year and a half into the next recovery as was the case following the 2001 recession. Such "job-loss" recoveries usually don't last that long, and are more common when the economic engine revs up slowly coming out of recessions, as was the case during the last two cycles. Will the same path be taken this time?
For the most part, the general perception is that the job market will be weak for some time, with the unemployment rate climbing throughout the balance of the year and into 2010, peaking out at close to the 10.8 percent high reached following the 1982 recession. Interestingly, back then the rate began to recede within two months of the start of the ensuing recovery, which was marked by exceptionally vigorous growth almost from the start. No such vigor is expected this time, given the powerful headwinds that will retard growth for some time to come, including an impaired financial system and the ongoing unwinding of the speculative housing and credit-market bubbles of recent years. Indeed, studies of global economies over the past sixty years show that recoveries tend to be much weaker following a financial crisis and housing bust than following recessions caused by garden-variety forces, such as inventory corrections and policy mistakes.
With virtually unanimous agreement that the pending recovery will be weak, the logical conclusion is that so will the recovery in the job market. But there are some dissenters who believe job cuts have been so severe during the current recession - 6.5 million and counting - that companies are already operating with a bare-bones staff ill equipped to handle a sudden pickup in demand. Hence, at the first sign that the recovery is solidly underway, even if it is not up to past growth standards, human resource managers will be ordered to step up hiring, filling positions vitally necessary to accommodate a sales revival. This would be particularly the case in labor-intensive sectors, such as those providing services, which account for an ever-growing proportion of jobs.
While that line of reasoning may have some merit, it is not compelling enough to justify expectations of a quick recovery in job creation. For one, the current recession has swollen the ranks of part time workers who were either downsized or failed to land desired full-time positions. For another, as already noted, the work week has been shortened to record lows, as companies have furloughed workers and eliminated overtime. When demand recovers, the first move will be to expand the hours of these underutilized workers and then give part time workers permanent positions. Only then will companies start to expand payrolls. Given the extent by which the labor force is being underutilized, it will be a long while before the hiring process gets underway.
Again, the slow recovery in the job market does not preclude a broad based recovery in economic activity, which we expect will commence sometime during the second half of the year. This lagged response is a normal cyclical pattern that should be accentuated by a sluggish recovery and the deep pool of underutilized labor that companies can tap into. But the key takeaway from this week's reports is that the job market, like the overall economy, is getting "less bad". Indeed, one encouraging note is that the number of Americans filing for unemployment benefits is continuing to shrink, falling by 16000 in the latest week. This trend has been underway for several months, but still has a ways to go before the number of filings drops to a level that is consistent with job growth. Simply put, the employment glass may be half empty, but it is draining at a slower pace and the time for a refill may not be too far ahead.
JPT070209-501
Wall Street took it on the chin on Friday, as the Labor Department released a gloomier jobs report than had been expected. The 467 thousand decline in nonfarm payrolls reported for June was about 100 thousand more than the consensus had been looking for and considerably larger than the revised 322 thousand decline that occurred in May. The May decline, which was much smaller than those posted over the previous six months, had fueled hopes that the harsh recession was ebbing and growth would resume sometime over the second half of the year. As much as anything, those heightened expectations provided fuel to the powerful 35 percent stock market rally that began in early March.
So does the disappointing June employment report invalidate those expectations and derail the recovery timetable? Clearly, it would be foolhardy to attribute the disappointing June reading entirely to "noise", i.e., monthly gyrations that tend to even out over time. Not only was the headline number bad, the underlying details portrayed a dismal employment landscape. Virtually all major industry groups reduced payrolls except for the health and education sector, which is the only secular growth story in the economy. The cyclically-sensitive construction, manufacturing and business services industries registered big cuts in payrolls, the unemployment rate edged up another 0.1 percentage point to 9.5 percent, hourly earnings were flat and the work week was trimmed to 33 hours, the lowest on record.
Simply put, there was hardly anything upbeat in the June report, certainly nothing that would suggest the economy moved closer to a turning point as the mid-year approached. Indeed, some of the internal details were downright ugly. For example, of the 14.7 million people classified as unemployed in June, fully 4.4 million or 30 percent had been looking for a job for at least 27 weeks. And if the so-called marginally attached workers are included in the unemployment tally - i.e. those who are working part time because full-time positions were not available or those who are too discouraged to look for a job but would like one - the jobless rate would be 16.5 percent, far above the 9.5 percent official rate.
The picture turns even darker when the spotlight focuses on what's pushing the unemployment rate up. Essentially, the rate can rise for a number of reasons - new people entering the labor force hoping to find work, such as graduating students, reentrants to the labor force, such as housewives looking to supplement the family paycheck, or job losers, the unfortunate workers who get sacked from a position. While the participants in all three groups experience pain when they go on the unemployment lines, the worst of the lot are the job losers who are usually the primary wage earners responsible for meeting mortgage and other household expenses. Needless to say, the economy takes a bigger hit when the unemployment rate is driven up by job losers, rather than by unsuccessful job seekers who had not been drawing a paycheck.
In June, fully 65.5 percent of the 14.7 million unemployed workers were job losers, about the same as the previous month and up from 52 percent at the start of the recession. More significantly, that share exceeds the previous postwar high of 63 percent set during the 1981-82 recession. Hence, while the official unemployment rate, at 9.5 percent, is still well below the 10.8 percent postwar peak reached in 1982, the higher proportion of job losers suggest that conditions today may be more severe than was the case during that downturn. Keep in mind that during the 1970s and 1980s the labor force was growing more rapidly than job openings, thanks to the growing participation of women and the explosion of the baby boom population reaching prime working age.
That said, the June jobs report, as disappointing as it is, should not be viewed as a major setback for the economy. By and large, it does little to invalidate the notion that the severity of the recession is ebbing or that the road to recovery is still in sight. Yes, the payroll decline was worse than in May, to the chagrin of those who would like to see a smooth progression of ever-smaller job cuts from month to month. But the economy rarely conforms to that ideal scenario, and the June reversal was not alarming enough to cause a major rethinking of where we are heading. If anything, the deterioration of the major employment indicators was incremental and consistent with the notion that conditions are getting "less bad". For example, the unemployment rate edged up 0.1 percent from May's 9.4 percent level, which was much smaller than the 0.4 percent increases that occurred in five of the previous six months. Similarly, the 0.1 percent increase in the broader unemployment rate noted earlier was the smallest monthly increase in more than a year. Over the previous 12 months, this yardstick, known as the U-6, registered average increases of 0.6.
As is the case with most measures of activity, it is better to take a longer perspective by averaging out the latest month with the one before. When applying this approach to the employment figures, the trend showing a slower pace of deterioration remains firmly in place. The May/June average decline in nonfarm payrolls comes to 395 thousand, which is a far better reading than the 645 thousand average decline over the previous six months. What's more, the pace of job losses in most major industry groupings is also slowing. Indeed, that's even the case for manufacturing companies where the beleaguered auto companies are shutting down plants, either temporarily to reduce inventories or permanently as part of bankruptcy proceedings. Ditto for the much-maligned construction industry, where an average of 65 thousand workers lost jobs in May and June, about half the pace over the previous six months.
It's important to recognize that the job market follows a time-honored cyclical dynamic that keeps alive the notion that the recession is entering its late, if not final, stage. The most important feature of that dynamic is that job cuts continue, albeit at a slower pace, even after the recession ends and a recovery gets underway. By extension, the unemployment rate also continues to rise, sometimes as much as a year and a half into the next recovery as was the case following the 2001 recession. Such "job-loss" recoveries usually don't last that long, and are more common when the economic engine revs up slowly coming out of recessions, as was the case during the last two cycles. Will the same path be taken this time?
For the most part, the general perception is that the job market will be weak for some time, with the unemployment rate climbing throughout the balance of the year and into 2010, peaking out at close to the 10.8 percent high reached following the 1982 recession. Interestingly, back then the rate began to recede within two months of the start of the ensuing recovery, which was marked by exceptionally vigorous growth almost from the start. No such vigor is expected this time, given the powerful headwinds that will retard growth for some time to come, including an impaired financial system and the ongoing unwinding of the speculative housing and credit-market bubbles of recent years. Indeed, studies of global economies over the past sixty years show that recoveries tend to be much weaker following a financial crisis and housing bust than following recessions caused by garden-variety forces, such as inventory corrections and policy mistakes.
With virtually unanimous agreement that the pending recovery will be weak, the logical conclusion is that so will the recovery in the job market. But there are some dissenters who believe job cuts have been so severe during the current recession - 6.5 million and counting - that companies are already operating with a bare-bones staff ill equipped to handle a sudden pickup in demand. Hence, at the first sign that the recovery is solidly underway, even if it is not up to past growth standards, human resource managers will be ordered to step up hiring, filling positions vitally necessary to accommodate a sales revival. This would be particularly the case in labor-intensive sectors, such as those providing services, which account for an ever-growing proportion of jobs.
While that line of reasoning may have some merit, it is not compelling enough to justify expectations of a quick recovery in job creation. For one, the current recession has swollen the ranks of part time workers who were either downsized or failed to land desired full-time positions. For another, as already noted, the work week has been shortened to record lows, as companies have furloughed workers and eliminated overtime. When demand recovers, the first move will be to expand the hours of these underutilized workers and then give part time workers permanent positions. Only then will companies start to expand payrolls. Given the extent by which the labor force is being underutilized, it will be a long while before the hiring process gets underway.
Again, the slow recovery in the job market does not preclude a broad based recovery in economic activity, which we expect will commence sometime during the second half of the year. This lagged response is a normal cyclical pattern that should be accentuated by a sluggish recovery and the deep pool of underutilized labor that companies can tap into. But the key takeaway from this week's reports is that the job market, like the overall economy, is getting "less bad". Indeed, one encouraging note is that the number of Americans filing for unemployment benefits is continuing to shrink, falling by 16000 in the latest week. This trend has been underway for several months, but still has a ways to go before the number of filings drops to a level that is consistent with job growth. Simply put, the employment glass may be half empty, but it is draining at a slower pace and the time for a refill may not be too far ahead.
JPT070209-501
Wednesday, July 1, 2009
JP Turner -- Top 10 Atlanta Brokerage Firm
The Atlanta Business Chronicle has named J.P. Turner & Company, LLC one of Atlanta’s Top 10 Brokerage Firms. The survey, which ranked firms by the number of brokers in Atlanta, was released on June 26 and positions J.P. Turner alongside industry leaders like Morgan Stanley Smith Barney, UBS Financial Services, Edward Jones and Raymond James Financial.
Tuesday, June 30, 2009
JP Turner Weekly Economic Commentary
WEEKLY ECONOMIC COMMENTARY – WEEK OF JUNE 26, 2009
The Federal Reserve did a masterful job of placating both the economic doves and the inflation hawks this week. Its mastery over the grumbling adversaries had nothing to do with what was actually done during the two-day policy-setting meeting held on Tuesday and Wednesday. As expected, the central bank kept the federal funds rate, the short-term rate over which it has direct control, at the near zero level set back in December. To do otherwise would have been folly, given that an increase could not be supported by the weak economy and a decrease below zero is physically impossible.
Instead, all eyes and ears focused on how the Fed would finesse the competing views overhanging the market. On the one side is the perception that the economy remains exceptionally weak and in need of more stimulus. On the other is the notion that the seeds of higher inflation down the road are being sown by the unprecedented monetary ease now in place. Simply put, the doves and the hawks were competing for the Fed's attention, and both received a measure of satisfaction. For the doves, the Fed stated that it definitely intends to stay the course, keeping interest rates at near zero for "an extended period of time" and continuing its program of purchasing almost $2 trillion of Treasury bonds, mortgage-backed securities and agency issues designed to keep long-term interest rates low and credit flowing to the critical housing and other sectors of the economy. No mention was made of an "exit strategy", which has agitated many doves that feared the Fed would prematurely tighten policy before the economic recovery had a chance to gain traction.
But the Fed's statement also threw a bone to the hawks. For one, it downplayed the threat of deflation, which had clearly been present in previous statements. Case in point: following the April policy meeting, the statement said "… the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term." (i.e., deflation is more of a risk than inflation). This time, the statement said "The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time." That's still a relatively dovish position, but far less forceful than the one in April, particularly since the Fed also stated that the .." pace of (economic) contraction appears to be somewhat slower. "
We will add our kudos to the Fed's performance, which likely contributed to the positive response in the financial markets on Thursday, the day following the conclusion of the meeting. Both stock and bond prices surged during the day, although the bond market's strength probably reflected a better-than-expected reception of the Treasury's 7 - year note offering as much as the Fed's statement. Keep in mind that Treasury bond yields had been climbing sharply, with the 10-year issue spiking from a nearby low of 2.5 percent in early March to almost 4 percent on June 10. To be sure, a number of factors spurred the rise, including rising inflation concerns, improving economic signals and a shift away from the extreme risk aversion so prevalent earlier in the year that drove up the demand for ultra safe Treasury securities.
But there was also some concern that investors were now shunning Treasury securities in the face of a huge looming supply that the nearly $2 trillion budget deficit was about to unleash on the market. That concern was allayed somewhat on Wednesday by the strong investor response to the aforementioned 7-year auction. Hence, after some volatile trading sessions, Treasury bond yields have receded noticeably from the highs reached in early June, with the 10-year issue moving back towards 3.5 percent on Friday. The downward move could not come at a better time for the beleaguered housing industry, as the climb - which drove up mortgage rates - threatened to abort a potential housing recovery.
Not that housing is on the cusp of the recovery road. Indeed, new home sales continue to struggle mightily, slipping 6 percent in May to an annual rate of 342 thousand units from 344 thousand in April. The May level is s mere 4 percent above the all time low set in January. But at least the sales data this year have stabilized, which should be viewed as a sign of progress following the dispiriting plunge last year that not only saw sales tumble by almost 50 percent but prices decline by 26 percent from their 2006 peak. What's more, the new home market is feeling pressure from both a lousy economy as well as heavy competition from the existing housing market. As the chart shows, sales of previously owned homes have held up relatively better this year, largely because foreclosures and short sales are accounting for between one-third and one-half of all transactions. Needless to say, these sales are giving buyers a much better deal than home builders can.
But there are a number of reasons for home builders to be encouraged going forward. For starters, sales should receive a boost from the expanded $8000 tax credit granted to first time home buyers this year. For another, the earlier fall in mortgage rates plus the sharp reduction in home prices has greatly increased housing affordability, thus expanding the pool of potential buyers. While mortgage rates have increased by more than half a percentage point since early May, they are still more than a percentage point below the average level of last summer. Finally, competition from the existing home market may be easing. In May, "only" about a third of previously-owned home sales consisted of foreclosures or short sales. That's still unacceptably high, but it is less than the 45 percent share reached in previous months. Home builders are already seeing signs of green shoots; this week, one of the nation's largest builders (Lennar) reported a 63 percent rise in new home orders between the first and second quarters.
Historically, the housing market led the economy out of recessions, as the combination of lower interest rates, easier credit terms and reduced home prices imparted a big boost to home sales, jump-starting consumer purchases on an array of housing-related products. Hence, the revival in housing coincided with rebounding consumer purchases, setting in motion a cycle of virtuous forces that would amp up the early stages of a recovery. Obviously, the housing market will not be a catalyst this time. While it may not be sinking as rapidly as last year, it is at best moving sideways with little prospect of a powerful rebound anytime in the foreseeable future. Property values are still eroding, albeit at a slower pace, keeping prospective buyers on the sidelines. Meanwhile, financial conditions, while greatly improved compared to last year, remain relatively tight, as lenders have become much tougher in screening applicants for loans even as they face a stricter regulatory climate.
Without the impetus from rebounding home sales, the demand for housing-related durable goods will fail to provide the typical economic boost that has characterized the early stages of past cyclical recoveries. The absence of these two catalysts alone reinforces the widespread view that the pending recovery will be more tepid than robust. But the all-important consumer sector is at least regaining its footing, raising the odds that a recovery - tepid or not - will soon get underway. Make no mistake, households are hardly in a position to vigorously ramp up expenditures. Debt burdens remain extraordinarily high and the plunge in property values has left a big hole in retirement nest eggs that will take years to replenish. Still, the healing process has begun. Indeed, the huge rally in stock prices since early March alone has lifted the value of household equity portfolios by about $2.5 trillion. That, together with the unprecedented paydown of consumer debt over the past six months has restored a semblance of health to consumer balance sheets.
But a big assist is now coming from Washington. As we have been pointing out for the past several months, the government's stimulus package - known officially as the American Recovery and Reinvestment Act - is supplementing the normal expansion in transfer payments that typically occurs during recessions. Thanks to the one-time $250 payment made to older Americans eligible for social security, veterans and railroad retirement benefits, transfer payments to individuals surged by an annual rate of $162.6 billion in May, nearly triple the benefits paid out in April. As a result, personal incomes grew by an outsize 1.4 percent, the largest monthly increase in over a year, giving households the wherewithal to step up consumption, which rose in both real and nominal terms during the month.
What's more, households funneled most of the increased government aid into savings accounts, as personal savings surged to an annual rate of $769 million in May from an elevated $609 million in April. That's by far the largest two-month reservoir of savings ever created and dwarfs the $192 million monthly average put aside in 2008. From 2005 through 2007, households spent almost every penny of their paychecks, putting aside a miserly $54 million a month. Of course, that was the period when housing and stock values were surging, inflating nest eggs so rapidly that Americans felt little need to save out of current incomes. The collapse of those asset bubbles together with the destruction of 6 million jobs during the recession dramatically altered that mindset, and households are now beefing up their contingency funds as never before. In May, the savings rate surged to 6.9 percent, the highest it has been since 1993.
Unquestionably, the buildup in savings is a necessary corrective response to the overspending and overborrowing that allowed households to live beyond their means for several years. But the correction has been far more dramatic than what usually takes place during recessions, leading us to believe that the savings rate will not increase much further in coming months. If that's the case, the long slump in consumer spending may also be coming to an end. Our sense is that the balance sheet repair will continue throughout the second half of the year, but to a lesser extent than over the first half, allowing for a modest pickup in consumption. The process would be expedited if labor compensation, which continues to sag under the weight of a weak job market, also recovers. It's too soon for that to happen, as companies are still shedding payrolls. However, we will find out next Thursday whether the smaller cutbacks observed in May has continued into June. If the upcoming employment report is encouraging, it will corroborate the recent increase in household confidence, setting the stage for a pickup in consumer spending and fueling the start of a broad based recovery in the second half of the year. Stay tuned.
JPT062609-482
Monday, June 29, 2009
Michael Isaac, chief compliance officer for JP Turner, Quoted in Investment News
Michael Isaac, chief compliance officer, was interviewed by Investment News for their article “Lax compliance can be costly, warn experts” which appears in today’s online edition. Read article >>
Monday, June 22, 2009
JP Turner / Weekly Economic Commentary
WEEKLY ECONOMIC COMMENTARY -- WEEK OF JUNE 19, 2009
Since this week's headlines were dominated by Washington's plans to reform the financial system, fix health care and deal with the election debacle in Iran, an array of important economic statistics hardly dented the radar screen. Yet they provided vital information that will ultimately have at least as much significance for policy makers than the headline-grabbing news that held sway during the week. For example, a major debate that is gaining traction is whether the massive government stimulus needed to end the credit crisis and lift the economy out of the "Great Recession" is in danger of overstaying its welcome. At this point, neither the administration nor the Federal Reserve has shown any inclination to withdraw its aggressive initiatives, fearing that the economy is still in a very fragile state and vulnerable to another setback from any sudden shock. However, they are facing a growing chorus of critics who assert that the current mix of policies is setting the stage for higher inflation and out-of-control budget deficits, which will clobber the dollar and send interest rates sharply upwards. These critics received some support this week by a high-profile poll that reflected rising public disenchantment with the administration's economic policies.
Only time will tell which side of the debate has more compelling arguments. Clearly, policy makers are not turning a deaf ear to their critics, as both Treasury Secretary Geithner and Fed Chairman Bernanke acknowledge the need for a viable "exit strategy" once the economy regains its footing. Both assert, however, that it is still far too premature to consider such a strategy - and their view would seem to be supported by the latest batch of data. First off, the inflation threat has yet to receive any substance from the figures. If anything, the consumer price index for May, released this week, suggests that the economy is still threatened more by deflationary than inflationary tendencies. That's clearly reflected in the headline number, which stands a whopping 1.3 percent below the level of a year ago. That's the steepest annual fall in the overall CPI in more than 50 years.
True, the CPI's descent was heavily influenced by the plunge in energy prices from last May's nose-bleed levels, when crude oil was hovering around $125 a barrel on the way to its ultimate high of $145 by the summer. With the collapse in global demand for oil last fall and winter, crude quotes have tumbled as well, plunging to a low of $30 at the start of the year before climbing back to a current level of about $70. But abstracting from the gyrations in oil, as well as volatile food prices, the so-called core CPI hardly bespeaks of rising inflationary pressures. This inflation measure rose by a miserly 0.1 percent in May, the smallest increase since last December - when deflation fears were high - and less than half the monthly average increase registered since then. Relative to a year ago, the core CPI is up 1.8 percent, virtually unchanged in each of the past five months and well within the Fed's comfort zone.
The tame reading in the CPI mirrors the trend in most other broad inflation gauges and further dilutes the argument that the recent spike in some commodity prices, including oil, is an early sign that inflation pressures will gain traction under current policies. If indeed the commodity price run-up were a reflection of stronger global demands for natural resources, such as copper, aluminum, zinc, etc., that argument might have some validity. However, there is little indication that - aside from rumored stockpiling in China for hedging purposes - that the price increases are in any way associated with improving global conditions. The IMF and other international organizations are still forecasting a contracting world economy in 2009, although one that is not free falling as rapidly as thought a few months ago. While prospects in the U.S. - and to a lesser extent in the U. K. - have improved recently, most European nations continue to be buffeted by weak domestic demands and exports and are experiencing ever-rising unemployment rates.
Additionally, commodity prices play a much smaller role in the U.S. inflation picture than the headlines surrounding their gyrations would suggest. Indeed, the recent climb in oil and gasoline prices since the beginning of the year should probably be viewed more of a deflationary force than an inflation threat, as it siphons off consumer discretionary dollars that could be spent on other goods and services. Indeed, the higher cost of gasoline and heating oil is already taking a big bite out of household budgets, diverting about $50 billion ( at an annual rate) that could be spent elsewhere. That's not small change when considering that consumer spending is already stalling out after posting a modest gain in the first quarter.
Simply put, the sluggish U.S. and world economy means that companies have little or no pricing power. If the higher cost of raw materials persists, something that is dubious given still-weak global demand, companies will not be able to pass them on to consumers without losing sales. Hence, either profit margins will come under additional pressure, or businesses will have to make offsetting cost cuts elsewhere. The biggest target, of course, would be labor, which is already bearing the brunt of cutbacks in the form of shrinking wages, hours worked and outright declines in payrolls. This reinforces a negative feedback loop, which starts with downward pressure on labor income and ends up hurting the demand for goods and services.
Clearly this feedback loop has not been broken, as evidenced by the dramatic production cutbacks taking place across most major sectors. In May, industrial production sagged by another 1.1 percent following a downwardly revised 0.7 fall in April. The latest drop was the eighth in a row and 17th out of the last 18 months, leaving the May level a full 13.4 percent below the corresponding month a year earlier. How bad is that? Consider that the year-over-year plunge in May was the steepest in over 60 years. True, like the CPI, the overall production numbers are being skewed by an outlier, in this case the shutdowns of auto assembly plants among the beleaguered car and light truck manufacturers. But the production cutbacks are widespread, as would be expected in an environment where big-ticket sales are suffering, construction is in the doldrums and business investment is falling like a stone.
Accordingly, the industrial production index in May featured sharp declines in output of consumer goods, business equipment and construction supplies. Not surprisingly, with the sizeable production cutback companies are being left with ever-more spare capacity, and May was no exception. During the month, capacity utilization for all industries sank to 68.3 percent, which is not only considerably below the 80.9 percent average for the 1972-2008 period, but below the low point set in any previous recession going back to the late 1960s. For the shriveling manufacturing sector, the picture is even darker. Here, capacity utilization slid to an all-time low of 65 percent. Prior to this recession, according to the Fed, the low for this series, which goes back to 1948, was the 68.6 percent reached in December 1982. That's another metric consistent with the notion that the current recession is the harshest of the post-war era.
In short, the huge amount of spare capacity in both the product and labor markets combined with sluggish global demands is a recipe for tame inflation over the foreseeable future. Yet many feel that the reflation trade in the financial markets is alive and well. The 10-year Treasury bond yield has receded from the near 4 percent level reached a few weeks ago, but at the current 3.80 percent, it is substantially higher than the near 2 percent historic low reached at the end of last year. Have the bond vigilantes come out of the woodworks, ready to join forces with the inflation hawks to strike fear into policymakers?
No doubt, there is an inflation component behind the increase in Treasury yields. However, we would not attach too much significance to that influence just yet. From our lens, most of the increase reflects the unwinding of the crisis-induced deflation trade that drove the Treasury yield down to its historic low last December. At the time, risk aversion among investors was rampant, as they shunned just about every other asset class in favor of the safety of government securities. Since then, however, the credit crisis has ebbed significantly, thanks to the muscular efforts of the Fed and Treasury, which are well documented by now. As a result, investors have shown more of a willingness to take on risk, shifting funds out of Treasuries into higher-yielding corporate issues. This unwinding of the deflation trade has probably accounted for a big chunk of the increase in Treasury yields.
From our lens, the bigger issue is not whether the backup in rates reflects increased inflation expectations, but whether it has the potential to derail a nascent recovery. Keep in mind that mortgage rates are closely tied to Treasury yields, and the moribund housing industry is hardly in a position to withstand more restrictive financing conditions. However, we don't view the rate backup to be overly worrisome at this point. Even at just under 4 percent, the 10-year Treasury yield is still considerably below its 5.62 percent average of the past twenty years. Mortgage rates are also low by historical standards. It is not the cost of financing that will hamper a recovery in borrowing in general or in housing activity in particular. A bigger impediment is the supply of credit, which, while looser than at the height of the credit crisis, is still a restraining factor.
Auto finance companies, for example, have stiffened lending standards, doubling down payments required for car and light truck purchases, and most no longer offer leasing. While the Federal Reserve is flooding the system with liquidity, lenders have imposed tighter risk controls that, together with tougher regulatory oversight, still make for relatively tight credit conditions. Small businesses, in particular, are still finding it extremely difficult to obtain funds from lenders. Simply put, while financial conditions are not nearly as oppressive as they were late last year, which put a stranglehold on the economy, they are still not favorable enough to grease the gears of a normally functioning economic engine. This is just another headwind, along with a still-deteriorating job market and budget-strained households that threaten to prevent the "green shoots" from sprouting into a full-fledged recovery. Until that threat is removed, inflation concerns and fears that policy makers will overstay their welcome are not yet justified.
Since this week's headlines were dominated by Washington's plans to reform the financial system, fix health care and deal with the election debacle in Iran, an array of important economic statistics hardly dented the radar screen. Yet they provided vital information that will ultimately have at least as much significance for policy makers than the headline-grabbing news that held sway during the week. For example, a major debate that is gaining traction is whether the massive government stimulus needed to end the credit crisis and lift the economy out of the "Great Recession" is in danger of overstaying its welcome. At this point, neither the administration nor the Federal Reserve has shown any inclination to withdraw its aggressive initiatives, fearing that the economy is still in a very fragile state and vulnerable to another setback from any sudden shock. However, they are facing a growing chorus of critics who assert that the current mix of policies is setting the stage for higher inflation and out-of-control budget deficits, which will clobber the dollar and send interest rates sharply upwards. These critics received some support this week by a high-profile poll that reflected rising public disenchantment with the administration's economic policies.
Only time will tell which side of the debate has more compelling arguments. Clearly, policy makers are not turning a deaf ear to their critics, as both Treasury Secretary Geithner and Fed Chairman Bernanke acknowledge the need for a viable "exit strategy" once the economy regains its footing. Both assert, however, that it is still far too premature to consider such a strategy - and their view would seem to be supported by the latest batch of data. First off, the inflation threat has yet to receive any substance from the figures. If anything, the consumer price index for May, released this week, suggests that the economy is still threatened more by deflationary than inflationary tendencies. That's clearly reflected in the headline number, which stands a whopping 1.3 percent below the level of a year ago. That's the steepest annual fall in the overall CPI in more than 50 years.
True, the CPI's descent was heavily influenced by the plunge in energy prices from last May's nose-bleed levels, when crude oil was hovering around $125 a barrel on the way to its ultimate high of $145 by the summer. With the collapse in global demand for oil last fall and winter, crude quotes have tumbled as well, plunging to a low of $30 at the start of the year before climbing back to a current level of about $70. But abstracting from the gyrations in oil, as well as volatile food prices, the so-called core CPI hardly bespeaks of rising inflationary pressures. This inflation measure rose by a miserly 0.1 percent in May, the smallest increase since last December - when deflation fears were high - and less than half the monthly average increase registered since then. Relative to a year ago, the core CPI is up 1.8 percent, virtually unchanged in each of the past five months and well within the Fed's comfort zone.
The tame reading in the CPI mirrors the trend in most other broad inflation gauges and further dilutes the argument that the recent spike in some commodity prices, including oil, is an early sign that inflation pressures will gain traction under current policies. If indeed the commodity price run-up were a reflection of stronger global demands for natural resources, such as copper, aluminum, zinc, etc., that argument might have some validity. However, there is little indication that - aside from rumored stockpiling in China for hedging purposes - that the price increases are in any way associated with improving global conditions. The IMF and other international organizations are still forecasting a contracting world economy in 2009, although one that is not free falling as rapidly as thought a few months ago. While prospects in the U.S. - and to a lesser extent in the U. K. - have improved recently, most European nations continue to be buffeted by weak domestic demands and exports and are experiencing ever-rising unemployment rates.
Additionally, commodity prices play a much smaller role in the U.S. inflation picture than the headlines surrounding their gyrations would suggest. Indeed, the recent climb in oil and gasoline prices since the beginning of the year should probably be viewed more of a deflationary force than an inflation threat, as it siphons off consumer discretionary dollars that could be spent on other goods and services. Indeed, the higher cost of gasoline and heating oil is already taking a big bite out of household budgets, diverting about $50 billion ( at an annual rate) that could be spent elsewhere. That's not small change when considering that consumer spending is already stalling out after posting a modest gain in the first quarter.
Simply put, the sluggish U.S. and world economy means that companies have little or no pricing power. If the higher cost of raw materials persists, something that is dubious given still-weak global demand, companies will not be able to pass them on to consumers without losing sales. Hence, either profit margins will come under additional pressure, or businesses will have to make offsetting cost cuts elsewhere. The biggest target, of course, would be labor, which is already bearing the brunt of cutbacks in the form of shrinking wages, hours worked and outright declines in payrolls. This reinforces a negative feedback loop, which starts with downward pressure on labor income and ends up hurting the demand for goods and services.
Clearly this feedback loop has not been broken, as evidenced by the dramatic production cutbacks taking place across most major sectors. In May, industrial production sagged by another 1.1 percent following a downwardly revised 0.7 fall in April. The latest drop was the eighth in a row and 17th out of the last 18 months, leaving the May level a full 13.4 percent below the corresponding month a year earlier. How bad is that? Consider that the year-over-year plunge in May was the steepest in over 60 years. True, like the CPI, the overall production numbers are being skewed by an outlier, in this case the shutdowns of auto assembly plants among the beleaguered car and light truck manufacturers. But the production cutbacks are widespread, as would be expected in an environment where big-ticket sales are suffering, construction is in the doldrums and business investment is falling like a stone.
Accordingly, the industrial production index in May featured sharp declines in output of consumer goods, business equipment and construction supplies. Not surprisingly, with the sizeable production cutback companies are being left with ever-more spare capacity, and May was no exception. During the month, capacity utilization for all industries sank to 68.3 percent, which is not only considerably below the 80.9 percent average for the 1972-2008 period, but below the low point set in any previous recession going back to the late 1960s. For the shriveling manufacturing sector, the picture is even darker. Here, capacity utilization slid to an all-time low of 65 percent. Prior to this recession, according to the Fed, the low for this series, which goes back to 1948, was the 68.6 percent reached in December 1982. That's another metric consistent with the notion that the current recession is the harshest of the post-war era.
In short, the huge amount of spare capacity in both the product and labor markets combined with sluggish global demands is a recipe for tame inflation over the foreseeable future. Yet many feel that the reflation trade in the financial markets is alive and well. The 10-year Treasury bond yield has receded from the near 4 percent level reached a few weeks ago, but at the current 3.80 percent, it is substantially higher than the near 2 percent historic low reached at the end of last year. Have the bond vigilantes come out of the woodworks, ready to join forces with the inflation hawks to strike fear into policymakers?
No doubt, there is an inflation component behind the increase in Treasury yields. However, we would not attach too much significance to that influence just yet. From our lens, most of the increase reflects the unwinding of the crisis-induced deflation trade that drove the Treasury yield down to its historic low last December. At the time, risk aversion among investors was rampant, as they shunned just about every other asset class in favor of the safety of government securities. Since then, however, the credit crisis has ebbed significantly, thanks to the muscular efforts of the Fed and Treasury, which are well documented by now. As a result, investors have shown more of a willingness to take on risk, shifting funds out of Treasuries into higher-yielding corporate issues. This unwinding of the deflation trade has probably accounted for a big chunk of the increase in Treasury yields.
From our lens, the bigger issue is not whether the backup in rates reflects increased inflation expectations, but whether it has the potential to derail a nascent recovery. Keep in mind that mortgage rates are closely tied to Treasury yields, and the moribund housing industry is hardly in a position to withstand more restrictive financing conditions. However, we don't view the rate backup to be overly worrisome at this point. Even at just under 4 percent, the 10-year Treasury yield is still considerably below its 5.62 percent average of the past twenty years. Mortgage rates are also low by historical standards. It is not the cost of financing that will hamper a recovery in borrowing in general or in housing activity in particular. A bigger impediment is the supply of credit, which, while looser than at the height of the credit crisis, is still a restraining factor.
Auto finance companies, for example, have stiffened lending standards, doubling down payments required for car and light truck purchases, and most no longer offer leasing. While the Federal Reserve is flooding the system with liquidity, lenders have imposed tighter risk controls that, together with tougher regulatory oversight, still make for relatively tight credit conditions. Small businesses, in particular, are still finding it extremely difficult to obtain funds from lenders. Simply put, while financial conditions are not nearly as oppressive as they were late last year, which put a stranglehold on the economy, they are still not favorable enough to grease the gears of a normally functioning economic engine. This is just another headwind, along with a still-deteriorating job market and budget-strained households that threaten to prevent the "green shoots" from sprouting into a full-fledged recovery. Until that threat is removed, inflation concerns and fears that policy makers will overstay their welcome are not yet justified.
Monday, June 15, 2009
JP Turner Weekly Economic Commentary
WEEKLY ECONOMIC COMMENTARY -- WEEK OF JUNE 12, 2009
It should be fairly self evident that the $14 trillion behemoth known as the U.S. economy moves at a glacial speed. Like a giant cruiser ship, it takes time and massive effort to navigate a sea change in direction for a vessel of such gargantuan proportions. Clearly, policymakers have been applying as much effort as needed to turn the economy around, unleashing an unprecedented amount of fiscal and monetary stimulus to counter the powerful headwinds that have steered the nation onto its recession course for the past eighteen months.
The jury is still out as to what extent these massive efforts are bearing fruit. Surely, the free-fall in activity induced by last fall's financial panic has been arrested. The economy may not yet have hit bottom, but the rate of descent is clearly subsiding. By all accounts, the worst of the decline is behind us and a recovery is poised to begin, if not this year then early in 2010. To be sure, there is still the unresolved issue of how strong the pending recovery will turn out to be. Most economists expect a very tepid one, but the historical pattern is that the economy rebounds sharply after harsh recessions, which this one certainly qualifies as. Only time will tell if history repeats itself, or if the crystal ball of economists is correct.
Although squarely in the slow-recovery camp, we recognize that the crystal ball of the forecasting community has a murky record. It may well be that the economy responds much better than expected to the policy initiatives, and the recovery could live up to historical patterns. But for that to happen, a major catalyst that typically propelled the economy out of the starting gate would have to kick in, namely a strong rebound in consumer spending. Keep in mind that the nation's economic engine is fueled primarily by consumers; should this key cylinder sputter, all other components will fail to kick in. Business investment will remain sluggish, job growth will stall and the recovery in paychecks needed to sustain consumer demand would be short-circuited.
It comes as no surprise, therefore, that an inordinate amount of attention is being focused on household behavior. At this point, the signs are mixed. Yes, the free fall in consumption over the second half of last year has been halted. After falling by an annual rate of more than 4 percent - the steepest two-quarter drop in the post-war period - real outlays on goods and services have stabilized so far this year, increasing by a 1.5 percent annual rate in the first quarter. However, all of that recovery took place in January, as consumer demand has basically flat-lined since then. Simply put, the cliff-diving in spending may have stopped, but no sustainable rebound is yet underway.
That pattern shows up in the latest retail sales numbers released this week. In May, retail sales increased by 0.5 percent, about as expected. But as the chart shows, there has been no discernable trend this year. After January's bounce, sales declined for two months and increased in two others. Nor can any great insights be gleaned from the May increase. More than half of the gain reflected increased sales at gasoline stations, where prices at the pump increased by 10.6 percent. Auto dealer sales also increased by 0.5 percent during the month, which was actually less pronounced than the jump in light vehicle sales, which posted the largest monthly selling rate since last December. That difference between the dollar value of sales and unit sales reflects the steep discounts dealers were offering customers to clear out inventories. Excluding autos and gasoline stations, retail sales were up 0.1 percent in May following a 0.1 percent drop in April - again no discernable upside trend.
From a quarterly perspective, the April/May average stands 2.7 percent below the first-quarter average for retail sales. This has to be disappointing to the recovery optimists, if only because the lackluster response of consumers is coming at a time of growing policy stimulus. Not only were Federal withholding rates reduced in April as part of the stimulus package, but more than 50 million social security recipients received a one-time $250 check in May, which collectively sums up to $13 billion in additional purchasing power. It may be that those recipients will spend the funds in June, imparting a nice lift to sales during the month. At first blush, however, it appears that households are more inclined to beef up savings and/or repay debt as part of a massive effort to repair battered finances.
Assuming that June sales do not reach blockbuster proportions, the second quarter is likely to see a modest relapse in consumer spending, perhaps entirely reversing the first-quarter's 1.5 percent gain. Since consumer spending accounts for about 70 percent of total activity, that augurs for another negative quarter of GDP growth, keeping the economy mired in recession territory. But the theme of reaching a bottom remains firmly intact. Unlike the previous two quarters, the growth-retarding drags from inventory liquidations and plunging capital spending should constitute less of a weight this quarter. Also, the mysterious drop in Federal outlays in the first quarter should be reversed, reflecting the phasing in of the $787 billion Economic Recovery and Reinvestment Act enacted in February.
Another positive contribution to growth should also be coming on the trade front. The trade deficit did widen a bit in March and April, thanks mainly to rising oil prices, but the April level still stands well below the first quarter average. And that's in current dollars. If the inflation in oil and other commodities is factored out, the real trade balance is improving markedly, giving the economy a solid lift. The second quarter will no doubt register another fall in GDP, but it should be less that half the 6 percent average drop that occurred over the previous two quarters. In other words, the indicators are supporting the emerging consensus that the recession is on its final legs.
That said, there is nothing of substance to alter the notion that the shape of the pending recovery will resemble a U more than a V. As noted earlier, without the spark from a consumer-spending rebound, the fuel to power a V-shaped recovery will be absent. And there is no indication that consumers are about to go on a spending spree. Households have boosted their personal savings rate to a fourteen-year high of 5.7 percent in May, and further increases are likely until job and income prospects improve. What's more, a long deleveraging process lies ahead. Despite debt paydowns over the past six months, there is still a ways to go before debt burdens are brought down to manageable levels. At the end of the first quarter, the ratio of debt to disposable incomes stood at 127 percent, more than 30 percent higher than at the start of the decade
To be sure, there is nothing new about the need to reduce debt and shore up savings in the forecast equation. Ever since the bursting of the housing and stock market bubbles that vaporized $14 trillion of household net worth since 2007, economists have factored into their forecast a long period of reduced spending as part of the balance-sheet rebuilding process, something that will likely take years to accomplish. What is more worrisome lately, especially for the near-term recovery prospects, has been the sudden spike in energy prices again, as well as the recent upsurge in long-term interest rates. No one expects oil prices to return to $140 a barrel, but the climb from $33 to the recent quote of $70 has the potential to do significant damage to growth prospects. At current levels, the runup in gasoline prices that has already occurred stands to siphon about $50 billion from household purchasing power, enough to offset a significant portion of the tax cuts.
Just as disconcerting has been the climb in long-term interest rates, as showcased by the 10-year Treasury yield. This bellwether rate, which serves as a benchmark for rates set on mortgages and some other consumer loans, has jumped from last year's low of just over 2 percent to a recent high of 3.98 percent. The optimistic interpretation of this move is that it reflects improving economic fundamentals and, hence, is a good thing, something that the economy can readily withstand. That may turn out to be the case, but it would be foolhardy to discount the negative impact that the rate increase can have in short-circuiting a housing recovery. Fixed long-term mortgage rates have already risen by more than a full percentage point from their low and refinancing activity has ebbed as a consequence. We suspect that the increase in financing costs will have an impact on home sales, at least at the margin, given that affordability is still a key factor for first-time home buyers, particularly since lenders are demanding more up-front equity than was the case in the easy credit days prior to the real estate collapse.
Still, even with the latest run-up, long-term Treasury yields remain low by historical standards, well below the 4.62 percent average of the past 10 years. Likewise, mortgage rates are still relatively low, and should not be a housing killer at current levels. More important is the ability of households to service their mortgage payments out of incomes, which will be a key driving force of home sales in coming years. That, in turn, hinges ever so importantly on the job market, which is still contracting and squeezing paychecks. But the pace of job losses is slowing, as noted in last month's employment report, and there's a good chance that companies will start to expand payrolls some time over the second half of the year, consistent with the expected start of a broad-based recovery. If so, the recent climb in energy costs and interest rates will become less worrisome, and may even continue. Indeed, the climb may well ignite a new source of concern that is already starting to seep into investor psychology, namely the prospect of higher inflation. From our lens, that's a worry for another day.
It should be fairly self evident that the $14 trillion behemoth known as the U.S. economy moves at a glacial speed. Like a giant cruiser ship, it takes time and massive effort to navigate a sea change in direction for a vessel of such gargantuan proportions. Clearly, policymakers have been applying as much effort as needed to turn the economy around, unleashing an unprecedented amount of fiscal and monetary stimulus to counter the powerful headwinds that have steered the nation onto its recession course for the past eighteen months.
The jury is still out as to what extent these massive efforts are bearing fruit. Surely, the free-fall in activity induced by last fall's financial panic has been arrested. The economy may not yet have hit bottom, but the rate of descent is clearly subsiding. By all accounts, the worst of the decline is behind us and a recovery is poised to begin, if not this year then early in 2010. To be sure, there is still the unresolved issue of how strong the pending recovery will turn out to be. Most economists expect a very tepid one, but the historical pattern is that the economy rebounds sharply after harsh recessions, which this one certainly qualifies as. Only time will tell if history repeats itself, or if the crystal ball of economists is correct.
Although squarely in the slow-recovery camp, we recognize that the crystal ball of the forecasting community has a murky record. It may well be that the economy responds much better than expected to the policy initiatives, and the recovery could live up to historical patterns. But for that to happen, a major catalyst that typically propelled the economy out of the starting gate would have to kick in, namely a strong rebound in consumer spending. Keep in mind that the nation's economic engine is fueled primarily by consumers; should this key cylinder sputter, all other components will fail to kick in. Business investment will remain sluggish, job growth will stall and the recovery in paychecks needed to sustain consumer demand would be short-circuited.
It comes as no surprise, therefore, that an inordinate amount of attention is being focused on household behavior. At this point, the signs are mixed. Yes, the free fall in consumption over the second half of last year has been halted. After falling by an annual rate of more than 4 percent - the steepest two-quarter drop in the post-war period - real outlays on goods and services have stabilized so far this year, increasing by a 1.5 percent annual rate in the first quarter. However, all of that recovery took place in January, as consumer demand has basically flat-lined since then. Simply put, the cliff-diving in spending may have stopped, but no sustainable rebound is yet underway.
That pattern shows up in the latest retail sales numbers released this week. In May, retail sales increased by 0.5 percent, about as expected. But as the chart shows, there has been no discernable trend this year. After January's bounce, sales declined for two months and increased in two others. Nor can any great insights be gleaned from the May increase. More than half of the gain reflected increased sales at gasoline stations, where prices at the pump increased by 10.6 percent. Auto dealer sales also increased by 0.5 percent during the month, which was actually less pronounced than the jump in light vehicle sales, which posted the largest monthly selling rate since last December. That difference between the dollar value of sales and unit sales reflects the steep discounts dealers were offering customers to clear out inventories. Excluding autos and gasoline stations, retail sales were up 0.1 percent in May following a 0.1 percent drop in April - again no discernable upside trend.
From a quarterly perspective, the April/May average stands 2.7 percent below the first-quarter average for retail sales. This has to be disappointing to the recovery optimists, if only because the lackluster response of consumers is coming at a time of growing policy stimulus. Not only were Federal withholding rates reduced in April as part of the stimulus package, but more than 50 million social security recipients received a one-time $250 check in May, which collectively sums up to $13 billion in additional purchasing power. It may be that those recipients will spend the funds in June, imparting a nice lift to sales during the month. At first blush, however, it appears that households are more inclined to beef up savings and/or repay debt as part of a massive effort to repair battered finances.
Assuming that June sales do not reach blockbuster proportions, the second quarter is likely to see a modest relapse in consumer spending, perhaps entirely reversing the first-quarter's 1.5 percent gain. Since consumer spending accounts for about 70 percent of total activity, that augurs for another negative quarter of GDP growth, keeping the economy mired in recession territory. But the theme of reaching a bottom remains firmly intact. Unlike the previous two quarters, the growth-retarding drags from inventory liquidations and plunging capital spending should constitute less of a weight this quarter. Also, the mysterious drop in Federal outlays in the first quarter should be reversed, reflecting the phasing in of the $787 billion Economic Recovery and Reinvestment Act enacted in February.
Another positive contribution to growth should also be coming on the trade front. The trade deficit did widen a bit in March and April, thanks mainly to rising oil prices, but the April level still stands well below the first quarter average. And that's in current dollars. If the inflation in oil and other commodities is factored out, the real trade balance is improving markedly, giving the economy a solid lift. The second quarter will no doubt register another fall in GDP, but it should be less that half the 6 percent average drop that occurred over the previous two quarters. In other words, the indicators are supporting the emerging consensus that the recession is on its final legs.
That said, there is nothing of substance to alter the notion that the shape of the pending recovery will resemble a U more than a V. As noted earlier, without the spark from a consumer-spending rebound, the fuel to power a V-shaped recovery will be absent. And there is no indication that consumers are about to go on a spending spree. Households have boosted their personal savings rate to a fourteen-year high of 5.7 percent in May, and further increases are likely until job and income prospects improve. What's more, a long deleveraging process lies ahead. Despite debt paydowns over the past six months, there is still a ways to go before debt burdens are brought down to manageable levels. At the end of the first quarter, the ratio of debt to disposable incomes stood at 127 percent, more than 30 percent higher than at the start of the decade
To be sure, there is nothing new about the need to reduce debt and shore up savings in the forecast equation. Ever since the bursting of the housing and stock market bubbles that vaporized $14 trillion of household net worth since 2007, economists have factored into their forecast a long period of reduced spending as part of the balance-sheet rebuilding process, something that will likely take years to accomplish. What is more worrisome lately, especially for the near-term recovery prospects, has been the sudden spike in energy prices again, as well as the recent upsurge in long-term interest rates. No one expects oil prices to return to $140 a barrel, but the climb from $33 to the recent quote of $70 has the potential to do significant damage to growth prospects. At current levels, the runup in gasoline prices that has already occurred stands to siphon about $50 billion from household purchasing power, enough to offset a significant portion of the tax cuts.
Just as disconcerting has been the climb in long-term interest rates, as showcased by the 10-year Treasury yield. This bellwether rate, which serves as a benchmark for rates set on mortgages and some other consumer loans, has jumped from last year's low of just over 2 percent to a recent high of 3.98 percent. The optimistic interpretation of this move is that it reflects improving economic fundamentals and, hence, is a good thing, something that the economy can readily withstand. That may turn out to be the case, but it would be foolhardy to discount the negative impact that the rate increase can have in short-circuiting a housing recovery. Fixed long-term mortgage rates have already risen by more than a full percentage point from their low and refinancing activity has ebbed as a consequence. We suspect that the increase in financing costs will have an impact on home sales, at least at the margin, given that affordability is still a key factor for first-time home buyers, particularly since lenders are demanding more up-front equity than was the case in the easy credit days prior to the real estate collapse.
Still, even with the latest run-up, long-term Treasury yields remain low by historical standards, well below the 4.62 percent average of the past 10 years. Likewise, mortgage rates are still relatively low, and should not be a housing killer at current levels. More important is the ability of households to service their mortgage payments out of incomes, which will be a key driving force of home sales in coming years. That, in turn, hinges ever so importantly on the job market, which is still contracting and squeezing paychecks. But the pace of job losses is slowing, as noted in last month's employment report, and there's a good chance that companies will start to expand payrolls some time over the second half of the year, consistent with the expected start of a broad-based recovery. If so, the recent climb in energy costs and interest rates will become less worrisome, and may even continue. Indeed, the climb may well ignite a new source of concern that is already starting to seep into investor psychology, namely the prospect of higher inflation. From our lens, that's a worry for another day.
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