PRINTMarket Update -- Economic Comment
May 7, 2007
The Fed's Beige Book prepared for the 9 May FOMC meeting characterized economic growth as modest to moderate across the nation. This is in keeping with the subdued 2.1% year-ago GDP growth rate posted in the first quarter, a downshift from the 3% trend rate enjoyed since mid-2003. Slower growth is largely a result of the substantial correction underway in the housing market and the need to clear out bloated inventories in some manufacturing sectors, autos in particular. In addition, business investment spending has been quite subdued for reasons that are not entirely clear. Economic strength, on the other hand, has come from the unfaltering consumer.
A rotation in growth drivers is currently taking place. Real consumption growth in the second quarter is expected to slow as consumers bend under the pressure of high gasoline and food prices coupled with a modest slowdown in nominal income growth. Manufacturing activity, on the other hand, is expected to improve now that inventories are back to acceptable levels and orders are picking up again. The housing sector, where inventories remain high and demand tepid, is likely to remain weak, but the drag emanating from this sector should taper. Business investment spending should improve but remain at levels lower than typically seen when profits margins are as wide as they currently are. Finally, exports are benefiting from dollar weakness vis-á-vis some key trading partners' currencies.
April economic data released so far have been mixed. The ISM reports were very strong and pointed to a notable improvement in economic activity in April, but the employment report portended subdued industrial activity and slower income growth. The manufacturing ISM diffusion report jumped nearly four percentage points to 54.7, while the ISM non-manufacturing "business activity" index rebounded to 56.0. Both of these reports showed strength in their employment subcategories, but this strength was not seen in the April employment report. Private payrolls increased only 63,000 for the month. The April result pulled the three-month average gain down to just 92,000 compared to 195,000 in the three months prior. Weather and calendar-related paybacks explain some of the weakness but not all of it; a deceleration in hiring appears to be taking place. With economic growth trending around 2%, it is not unexpected that payroll growth will also slow. Indeed, we expect nonfarm payroll growth to be near 1.2% this year following 1.7% growth last year. Low jobless claims, high withheld tax receipts and firm sentiment readings in surveys suggest nothing is seriously wrong in the labor market, which keeps our moderate growth forecast on track. It also should keep the Fed on hold for now.
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