It’S a Summer Pause . . .
. . . not a slowdown.


David Malpass

Some U.S. economic data weakened in June, but this doesn’t indicate an inflection point or a change. Rather, GDP growth and job creation in the second half of 2004 will be even stronger than in the first half.

Much of the current economic “pause” is a slowdown in the month-over-month data from very strong levels earlier in the year. Recent data included record levels for GDP, employment in the Labor Department’s household survey (which has been notably more accurate at economic turning points than the payroll survey), corporate profits, wages for manufacturing and non-manufacturing jobs, and household savings.

Higher interest rates shouldn’t slow the expansion. Positive factors — such as low U.S. and foreign inventory levels, lengthening lead times for deliveries, still very low interest rates in nominal and real terms, and signs of continued very fast growth in China and most of Asia — will more than offset the prospect of higher interest rates from the Federal Reserve.

Countering the slowdown theory, most indicators continue to show strength in both past and expected economic activity. Despite the downward revision in first-quarter GDP growth (to 3.9 percent from the earlier-reported 4.4 percent), economic growth is still very fast. The four quarters through March showed faster growth (4.82 percent) than any four quarters in the 1990s (the ’90s peak was 4.79 percent in the third quarter of 1997). Assuming 4 percent growth in the second quarter, growth over the four quarters through June will be even faster at 5.05 percent.

The July 2 employment report for June showed weaker-than-expected growth in jobs in the payroll (or establishment) survey. But again, the payroll survey is not a good indicator of the economic expansion. Jobs in established firms are a deeply lagging indicator of the economy; establishment jobs were pushed to an exaggerated peak in the late 1990s and are now reverting to more normal levels. Remember, too, the jobs report is a statistical sampling aimed at determining small changes (say 100,000 jobs) in a huge base (131 million establishment jobs).

Contradicting the July 2 employment report, many other employment indicators are showing strength. The household survey showed 259,000 new jobs in June, bringing U.S. non-farm employment to an all-time record 139 million. Indicators for hiring intentions by the Institute of Supply Management (ISM) showed very strong levels in June. The four-week moving average of initial employment claims stands at 0.26 percent of employment, the lowest level since January 2001 and consistent with the very strong growth environment of the late 1990s.

Forward-looking indicators from the ISM also showed strong growth in June — 61.1 for the manufacturing index and 59.9 for the non-manufacturing index. Readings above 50 indicate month-over-month increases in activity. The 60 level indicates that June was better than May (which, in turn, was better than April).

More, the ISM’s important manufacturing vendor-performance sub-index is at levels seen in the late 1970s, pointing to a durable expansion and the likelihood of inventory building in the coming quarters as companies seek to catch up with sales and avoid delivery delays.

Going forward, corporate spending, not the consumer, will lead the U.S. expansion. Unlike previous recessions, the 2001 recession was deflationary in nature and was characterized by severe weakness in investment — not consumption. While the U.S. consumer should remain resilient (meaning moderate consumption growth and not a slowdown), the focus of consumption growth will shift abroad in late 2004 and 2005.

Yes, some parts of the economy paused in June. But this does not imply a trend. (In particular, auto sales weakened when auto companies reduced their incentives.) Looking through the monthly noise, the underlying trends in many key areas of the economy remain strong.

– David Malpass is the chief global economist for Bear Stearns.


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