Economic Week in Review

ECRI Weekly Leading Index 131.20 -.23%

Housing Starts for June fell to 1802K versus estimates of 1990K and an upwardly revised 1970K in May.  Building Permits for June fell to 1924K versus estimates of 2000K and an upwardly revised 2097K in May.  The drop in permits was the biggest since 1994, when the Fed last started raising its target interest rate following a recession.  Fed Chairman Greenspan told lawmakers that "housing starts, which have come up at an extraordinary pace in recent years, are very likely to shade lower over the next couple of years.  It's hard to maintain the pace that we're maintaining.  But we do not expect that the fall-off will be abrupt."  Construction, which in 2003 was the strongest in 25 years, may also have been hampered by rainy weather last month.  Rainfall averaged 7.46 inches in the South last month, the wettest June since record-keeping began in 1895.  Moreover, 3.5 inches of rain fell on the entire U.S. last month, the seventh-wettest June on record.  The number of homes authorized but not yet started increased 10% in June to 202,100, the most since April 1987, suggesting builders' backlogs still are widening, Bloomberg reported.      

Fed Chairman Greenspan said a recent slowdown in consumer spending "should prove short-lived" and that the central bank can continue to raise interest rates at a "measured" pace.  "Inflation also seems to have been boosted by transitory factors such as the surge in energy prices," Greenspan told the Senate Banking Committee.  The FOMC, in a related report, predicted the economy will grow as much as 4.75% in 2004 from last year's fourth quarter, down from a 5% estimate in February.  This would still be the fastest U.S. economic growth since the height of the internet bubble in 1999, Bloomberg said.  The FOMC predicted its preferred inflation measure, the core personal consumption expenditures price index, will rise to a range of 1.5% to 2% this year, Bloomberg reported.  "A sustained pick-up in the rate of inflation" is not likely as "businesses are limited in the degree to which they can raise prices because of global competition and slack resources in the economy", Greenspan said.  The FOMC also predicted that the unemployment rate would drop in the fourth quarter, averaging 5.25-5.5%.  Businesses have now added an average of 211,000 new jobs per month over the past six months, Bloomberg said.  "Nothing is frightening them that growth will stall out or that inflation is getting out of hand," said James Paulsen, who oversees about $125 billion as chief investment strategist at Wells Capital Management. 

Initial Jobless Claims fell to 339,000 versus estimates of 345,000 and 350,000 the prior week.  Continuing Claims were 2,797,000 versus estimates of 2,930,000 and 2,964,000 prior.  "Job growth went through a soft patch in June and is picking up again in July," said Chris Rupkey, senior financial economist at Bank of Tokyo-Mitsubishi.  The Fed Bank of Philadelphia's measure of factory hiring rose to the highest ever this month and the Fed Bank of New York also reported a rise in the number of factories hiring more workers, Bloomberg reported.  "I know a number of people looked at recent data and took it as some indication that there is some significant weakness developing.  If that were the case, I think we would have seen it in a marked pick-up in initial claims for unemployment insurance which, of course, we did not," Greenspan told the Senate Banking Committee.

Leading Indicators for June fell .2% versus estimates of an unchanged reading and a .4% rise in May.  The index fell for the first time in more than a year in June, as a decrease in building permits and hours worked restrained the measure, Bloomberg reported.  Recent reports of gains in the manufacturing sector show any slowdown may be temporary, economists said.  "These data still suggest that, on balance, the economy has shifted to a moderate self-sustaining expansion from a robust stimulus-led one," said Steven Wood, president of Insight Economics.  "Strong economic performance in May gave way to a weaker June.  The index is still about 3.4% higher in the second quarter than in the first," said Ken Goldstein, an economist at the Conference Board.

Bottom Line:  Housing starts were definitely affected by the weather.  As well, the spike in mortgage rates in March likely scared many potential new home buyers into locking-in rates.  This likely resulted in a depletion of some pent-up demand.  However, with mortgage rates falling 46 basis points from recent highs, building will likely stabilize in the near future.  It is obvious from multiple Fed members' comments that they perceive the recent economic weakness as only temporary and that they will continue to raise rates in 25 basis point increments as inflation is not currently a problem.  However, a rise in the Core PCE Price Index of greater than 2% would likely result in an acceleration of the rate of hikes.  Data also suggest that the recent slowdown in job growth was only temporary, as well.  The change in non-farm payrolls for July should meet or exceed the current estimate of 223,000.  The decline in the Leading Indicators Index, while hurt to an extent by bad weather, likely portends a slowdown in GDP growth for this quarter.  I agree with the Fed that current economic weakness is only temporary and that growth will accelerate in the fourth quarter.
  
Overall, the data were mixed and likely point to continued weakness in the short-run.  It is my belief that three main issues are currently slowing economic growth.  First, recent polls suggest that the largest number of small-business owners and executives in recent memory feel that the Democratic ticket will damage the economy.  This perception, combined with President Bush's slide in some polls, is actually resulting in a decrease in business spending in anticipation of a weaker economy.  The still nagging overcapacity generated by the excesses of the late nineties and increased global competition result in earnings shortfalls in some sectors with any slight downtick in demand.  Second, there is the growing perception that a domestic terror act, to disrupt the U.S. election or political conventions, is inevitable.  This is also likely affecting energy prices, confidence and spending by corporate America.  Finally, the extremely wet conditions in much of the country and the spike in home-buying in the first half of the year have dampened consumer spending recently.  I view this as only temporary as I do not believe rates have risen enough or that inflation is a big enough problem to damage consumer spending longer-term.