What is Macro Pulse?

Macro Pulse highlights recent activity and events expected to affect the U.S. economy over the next 24 months. While the review is of the entire U.S. economy its particular focus is on developments affecting the Forest Products industry. Everyone with a stake in any level of the sector can benefit from
Macro Pulse's timely yet in-depth coverage.

Monday, May 31, 2010

March 2010 International Trade: Higher Volumes but Flat Prices

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World trade volume went up by 3.5 percent in March, following an increase of 1.7 percent in February, according to the Netherlands Bureau for Economic Policy Analysis (known by its Dutch acronym CPB). Trade volumes increased worldwide, with the notable exception of Japanese imports. Both exports and imports of the euro area grew “remarkably fast.” In March, world trade was 4 percent below the peak level reached in April 2008 and 21 percent above the trough reached in May 2009. Imports into emerging Asia were already 13 percent higher than their April 2008 peak.

CPB also estimates that average world prices rose slightly (0.4 percent) between February and March, breaking a two-month string of declines. Prices remain 15.2 percent below the July 2008 peak and 4.8 percent above the January 2009 trough.

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Narrowing the focus to the United States, total March exports of $147.9 billion and imports of $188.3 billion resulted in a goods and services deficit of $40.4 billion, the largest deficit since December 2008. March exports were $4.6 billion more than February exports of $143.3 billion, while imports were $5.6 billion more than February imports of $182.7 billion.

The February-to-March rise in goods exports reflected increases in industrial supplies and materials ($2.1 billion); other goods ($0.9 billion); consumer goods ($0.7 billion); capital goods ($0.5 billion); and foods, feeds, and beverages ($0.1 billion). Automotive vehicles, parts, and engines were virtually unchanged.

Imports of goods increased in industrial supplies and materials ($3.6 billion); automotive vehicles, parts, and engines ($1.2 billion); consumer goods ($0.5 billion); foods, feeds, and beverages ($0.4 billion); and capital goods ($0.3 billion). A decrease occurred in other goods ($0.1 billion).

The U.S. trade report was characterized as "very strong" by David Greenlaw and Ted Wieseman, economists for Morgan Stanley; they noted that the upside came mostly from higher volumes of trade, rather than from higher prices. John Ryding and Conrad DeQuadros, economists at RDQ Economics, agreed with that assessment: "This report speaks to the recovery in the both the United States and overseas as both exports and imports continue to advance at a fairly robust pace.”

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U.S. pulp, paper and paperboard trade followed the larger trade trend, in that both imports and exports rose; in this case, however, the change in exports outstripped that of imports by a wide margin. Interestingly, exports are well ahead of year-earlier levels but imports are barely even.

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Lumber imports and exports both expanded in March, but the change in imports was more than six times larger than that of exports. The lumber trade has picked up modestly relative to the same period in 2009.

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Because the greenback weakened in April against a broad range of currencies, we expect the next report to show the U.S. trade deficit widened once again in April. Concerns over Europe’s sovereign debt problems strengthened the dollar in May, however, and so we anticipate the May deficit will shrink somewhat.

Thursday, May 27, 2010

1Q2010 GDP: Revisions Going the Wrong Way

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The U.S. economy grew at a 3.0 percent pace in 1Q2010 - slower than the 3.2 percent previously reported – primarily because of increases in consumer spending and investment in business software that were smaller than originally estimated.

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Growth in real 1Q2010 GDP reflected positive contributions from personal consumption expenditures (PCE), private inventory investment (a component of private domestic investment, or “PDI”), exports, and nonresidential fixed investment (another PDI component) that were partly offset by negative contributions from state and local government spending (government consumption expenditures, or "GCE") and residential fixed investment (another PDI component). Imports, which are a subtraction in the calculation of GDP, increased.

The downward revisions in real GDP reflected decelerations in private inventory investment and in exports, a downturn in residential fixed investment, a larger decrease in state and local government spending, and a deceleration in nonresidential fixed investment that were partly offset by an acceleration in PCE and a deceleration in imports.

Thursday, May 20, 2010

April 2010 Consumer and Producer Price Indices: At a Tipping Point?

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U.S. consumer prices fell 0.1 percent on a seasonally adjusted (SA) basis in April as energy, housing, auto and apparel prices declined. It was the first drop in the consumer price index (CPI) since March 2009. The CPI is up 2.2 percent on a year-over-year basis, however. Because the “core” CPI (excluding food and energy prices) was unchanged in April, the annual increase in core inflation shrank to 0.9 percent, the lowest rate increase since January 1966.

Meanwhile, the main producer price index (PPI) fell 0.1 percent (SA). The more closely followed core rate – which, like the CPI, excludes volatile energy and food prices – rose 0.2 percent. Over the past 12 months, wholesale prices have risen 5.5 percent. But the core rate has risen only 1.0 percent in the past year.

The gap between the PPI and CPI lines indicates that companies’ ability to pass higher costs on to consumers is limited. We expect this situation to continue while capactity utilization rates remain low. Although capacity utilization improved again in April, it stands roughly midway between the previous peak and trough.

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The recent run-up in the finished-goods PPI has been driven mainly by rapid increases in the cost of commodities (“crude materials” in the graph above) such as oil and copper. Many of those same commodity prices have fallen sharply over the past month, however, in the wake of the Greece debt crisis. April’s year-over-year rise in crude materials prices was 28.8 percent, down from the recent peak of 33.4 percent in March. By contrast, the intermediate goods PPI continued higher (to 8.8 percent); one analyst opined that “while this isn’t an immediate recipe for higher consumer prices, it is definitely indicative that pressure is building in the pipeline.”

It is true pressure is building; producers face higher costs, but are unable to recover them in higher prices. Profits are being squeezed (or negative) and thus more capacity will be shut down. Reduced capacity will tighten capacity utilization, laying the groundwork for the potential of costs being passed through to the consumer as higher prices down the road.

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Although the headline PPI has "tipped over," forest products-related PPIs (except pulpwood) have not yet followed suit. Granted, many of them rose at slower rates in April when compared to March, but their trajectories were still on the incline.

The scaling in the six-chart figure above gives the impression that year-over-year percentage changes in the PPIs of virtually all processing stages or commodity groups are “rocketing to the moon.” That is actually the exception rather than the rule, as shown by the figure at left (click on graph for larger image) and table below. While prices of softwood logs, bolts and timber are presently on a year-over-year “tear” at 35.9 percent (although we expect softwood logs to follow pulpwood’s lead and lose momentum as expectations of a robust rebound in construction demand continue to fade), prices faced by the pulp, paper and allied products sector are a comparatively tame 3.5 percent. Lumber futures have plummeted in recent weeks; as of today's (5/19/2010) close the July contract has lost over $100/mbf since mid-April (a 30 percent drop) and we anticipate that loss of optimism will be reflected in the softwood log PPI measure during coming months.

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Wednesday, May 19, 2010

April 2010 U.S. Treasury Statement: More Red Ink

The U.S. Treasury released its latest Monthly Treasury Statement on May 12 and revealed that for the second year in a row – and for only the third time since 1983 – outlays from the Treasury exceeded revenues during the month of April (click on graph for larger image).

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Surprisingly, the cumulative budget deficit is $2 billion smaller – so far in fiscal year 2010 – than it was last year. We expect the shortfall to widen and overtake 2009’s levels as the year progresses, however.

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The long-term picture is equally gloomy. The International Monetary Fund expects U.S. debt levels to exceed 100 percent of GDP by 2015. Moreover, Moody’s Investor Services forecasts that a debt crisis will hit the United States sometime between 2013 and 2018 – whenever 18 to 20 percent of federal revenue is consumed by debt service (i.e., interest) payments. Given the global fallout that has transpired in the wake of Greece's sovereign debt crisis (with $357 billion 2Q2010 GDP, or only 0.58 percent of the world's economy), the potential consequences of a similar turn of events in the United States is nearly incomprehensible.

Tuesday, May 18, 2010

April 2010 Industrial Production Climbs More Than Forecast

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According to the Federal Reserve’s G.17 report, “Industrial production increased 0.8 percent in April after having risen 0.2 percent in March… Manufacturing output climbed 1.0 percent in April for a second consecutive month and was 6.0 percent above its year-earlier level. The increases in manufacturing continued to be broadly based across industries…At 102.3 percent of its 2002 average, total industrial output in April was 5.2 percent above its year-earlier level.” The April gain was the biggest since a 1.2 percent jump in January.

Economists forecast industrial production would increase 0.7 percent in April, according to the median of 81 projections in a Bloomberg survey. "The manufacturing sector continues to sort of lead the way in the recovery," said Julia Coronado, a senior economist at BNP Paribas in New York. Factories are "benefiting from the upswing in the inventory cycle, recovering global trade and the upswing in consumer spending," she said.

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The all-industries capacity utilization rate advanced 0.9 percent (to 73.7 percent), the highest since November 2008, and 6.5 percent above the rate from a year earlier. Wood Products and Paper both posted solid gains.

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Capacity shrank in April, not only at the all-industries level, but also in Wood and Paper.

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Because the industrial production recovery has been engineered to some extent by fiscal and monetary stimulus over the past year, there is still debate about its sustainability. In particular, some analysts wonder if current growth is merely borrowing expansion from the future. If so, 2H2010 or 1H2011 may suffer as payback kicks in. As one pundit put it, "The next several months may prove to be a crucial period for deciding what lies ahead. In essence, the snapback period of growth after the recession will be stress tested for durability through the coming weeks and months. One burden that awaits is the Herculean task of digesting the piles of debt mounting in the United States and around the world while containing inflation."

Monday, May 17, 2010

Macro Pulse May 2010 -- Extending the Trend

Executive Summary

Our call last month for a 3.1 percent rise in 1Q2010 real gross domestic product (GDP) hit close to the Bureau of Economic Analysis’ peg of 3.2 percent. Although considerably lower than 4Q2009’s 5.6 percent, the 1Q2010 growth would have been slower yet had consumer spending not jumped at the fastest rate in three years.

On its surface, the April employment report looked quite encouraging. Non-farm payroll employment rose by an estimated 290,000 jobs, although the unemployment rate edged up to 9.9 percent because of the number of people returning to the labor force. Because of slow hiring, the rise in consumer spending outstripped the increase in incomes again in March. Although incomes still exceed outlays, the two metrics are converging.

The manufacturing sector expanded in April for the ninth consecutive month. The performance of individual industries at least somewhat related to the forest products sector improved “across the board.” Most housing metrics showed gains in March; in the activity category, only single-family starts and total completions declined.

The Netherlands Bureau for Economic Policy Analysis estimates the volume of world trade expanded at least through February. Closer to home, U.S. exports and imports both rose in February; the trade deficit widened, though, because imports rose more quickly than exports. The monthly average price of West Texas Intermediate crude oil rose for a second consecutive month in April, to $84.48 per barrel – a gain of $3.24 (4.0 percent). The wider trade deficit and more expensive oil stemmed from the U.S. dollar’s depreciation against a basket of 26 currencies.

Click here to read the entire May 2010 Macro Pulse.

Friday, May 7, 2010

April 2010 Employment Report: Ghosts, Temps and Census Workers – Oh My!

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Although the Bureau of Labor Statistics (BLS) estimates non-farm payroll employment rose by 290,000 in April, the unemployment rate edged up to 9.9 percent because of the number of people returning to the labor force. Job gains occurred in manufacturing, professional and business services, health care, and leisure and hospitality. Federal government employment also rose, reflecting continued hiring of temporary workers for Census 2010.

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Total non-farm employment stood at 130.2 million in April, down 7.8 million (5.6 percent) from the December peak of 138.0 million.

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The estimate of 290,000 added jobs is just that – an estimate. It is important to note that 188,000 (65 percent) of those 290,000 jobs were the result of Current Employment Statistics (CES) models the BLS uses to account for business closings and openings that occurred recently enough that they were not captured in the employment survey. Because these jobs are derived from statistical models, some analysts refer to them as “ghost” jobs. Those models do no always perform well, so their results should be taken with a grain of salt.

Another aspect of the report that many in the mainstream media often overlook is the number of temporary jobs. As mentioned above, the Census Bureau hired 66,000 temporary workers to help with the 2010 census. What is less widely reported, however, is that another 26,000 workers were hired by temporary help services. I.e., 92,000 (almost a third) of the 290,000 jobs were temporary in nature.

Subtracting the 188,000 “ghost” jobs, the 66,000 Census workers, and the 26,000 temporary private-sector hires from the 290,000 leaves us able to assert with some confidence that at least 10,000 permanent, full time positions were created in April.

Some other findings from the employment report include:
  • 15.3 million remained unemployed in April; also the unemployment rate edged up to 9.9 percent after remaining stable at 9.7 percent during the previous three months. The unemployment rate edged up because more people returned to the workforce.
  • The number of long-term unemployed (those jobless for 27 weeks and over) continued to trend up over the month, reaching 6.7 million. In April, 45.9 percent of unemployed persons had been jobless for 27 weeks or more.
  • The number of persons employed part time for economic reasons (either because their hours had been cut back or because they were unable to find a full-time job) was about unchanged at 9.2 million.
  • About 2.4 million persons were marginally attached to the labor force in April (compared with 2.1 million a year earlier). These individuals were not in the labor force, wanted and were available for work, and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the four weeks preceding the survey. Among the marginally attached, there were 1.2 million discouraged workers (up by 457,000 from a year earlier). Discouraged workers are persons not currently looking for work because they believe no jobs are available for them. The remaining 1.2 million persons marginally attached to the labor force had not searched for work in the four weeks preceding the survey for reasons such as school attendance or family responsibilities.
  • An alternative measure of labor underutilization (called the “U-6”) – which tallies the “officially” unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all persons marginally attached to the labor force – rose to 17.1 percent in April (from 16.9 percent in March). The U-6 measure used to be the official unemployment rate until during the Clinton administration.
  • The average workweek for all employees on private non-farm payrolls increased by 0.1 hour to 34.1 hours. Also, average hourly earnings of those employees increased by one cent to $22.47 in April.

In summary, although it is impossible to know how many people actually succeeded in finding permanent employment in April, we can be at least reasonably confident that the employment situation has not worsened materially since January. Nonetheless, there remains considerable slack in labor demand.

Thursday, May 6, 2010

February 2010 World Trade: Volumes Mostly Up but Prices Down

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Based on preliminary data from the Netherlands Bureau for Economic Policy Analysis (known by its Dutch acronym “CPB”), world trade volume rose by 1.8 percent in February from the previous month, following a revised decrease of 0.5 percent in January. Trade volumes increased worldwide, with the exception of imports of emerging economies in Asia. Export growth was highest in emerging economies, most notably in Asia and Latin America. In February, trade was 7.1 percent below the peak level reached in April 2008, but 16.0 percent above the trough reached in May 2009.

U.S. dollar prices of goods involved in world trade dropped 1.8 percent between January and February, but were 9.5 percent higher than a year earlier. Prices were 15.2 percent below the peak reached in July 2008, but 6.0 percent higher than the January 2009 trough.

Looking ahead, we believe the uncertainty associated with sovereign debt problems around the world is likely to slow the global recovery.

Wednesday, May 5, 2010

March 2010 Housing Affordability Index and February 2010 Case-Shiller Home Price Index

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The National Association of Realtors’ (NAR) Housing Affordability Index remained near record highs in March. However, at 170.6, the index was down 3.3 percent from February’s value of 176.5 due to higher home prices. Despite the drop, the index remains 7.7 percent above July 2009’s low point.

Meanwhile, data released by Standard & Poor’s for its Case-Shiller Home Price Indices showed that year-over-year rates of change in the 10- and 20-city composites were positive in February (the latest data available) for the first time since December 2006.

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Although home prices in nine of the 20 metro areas improved on a year-over-year basis, San Diego was the only market that showed improvement between January and February.

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"Beginning last November, each [Case-Shiller] report showed gains as fewer cities reported year-over-year declines than in the previous month; those gains ended with this report," said David Blitzer, chair of the Index Committee at Standard & Poor's. “Further, in six cities prices were at their lowest levels [in February] since the prices peaked three-to-four years ago. These data point to a risk that home prices could decline further before experiencing any sustained gains…It is too early to say that the housing market is recovering. Nineteen of the 20 metropolitan statistical areas [MSAs] and both Composites declined in February over January. Fourteen of the MSAs and both Composites have now fallen for at least four consecutive months. In addition, prices reached recent new lows for six cities in February (Charlotte, Las Vegas, New York, Portland, Seattle and Tampa) sending a more cautionary message compared to the annual figures. While 14 MSAs and the two composites show improvement over their trough values reached in the spring 2009, we are not completely out of the woods.

"Existing and new home sales, inventories and housing starts all show tremendous improvement in their March statistics,” Blitzer continued. “The homebuyer tax credit, available until the end of April, is the likely cause for these encouraging numbers and this may also flow through to some of our home price data in the next few months. Amidst all the news, however, we should also pay heed to foreclosure activity, which have reached their highest level in at least the last five years. As these homes are put up for sales, we may see some further dampening in home prices."

April 2010 Monthly Average Crude Oil Price: Extending the Trend

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The monthly average price of West Texas Intermediate crude oil rose for a second consecutive month in April, to $84.48 per barrel – a gain of $3.24 (4.0 percent). That price increase coincided with a weaker dollar, and occurred because of the lagged impacts of an uptick in consumption of roughly 0.3 million barrels per day (BPD) in February – the latest data available – and despite rising crude stocks.

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News of “national significance” on the domestic energy front involved the explosion aboard and subsequent sinking of Transocean’s deepwater Horizon rig (leased by BP) in the Gulf of Mexico on April 25, in which 11 crew members were killed. Although the explosion’s cause has yet to be determined, the likeliest explanation now seems to be pressure surges, which can become more dangerous as drilling goes deeper. Exxon abandoned its Blackbeard well in 2006 because of excessive pressures and temperatures. The Obama administration caused a brief swirl of speculation that sabotage might have been the cause when it sent SWAT teams to inspect other area rigs.

Failure to cap the well (now estimated to be leaking about 5,000 barrels per day), and a lack of “fire booms” that could have been used to burn off the oil – despite a 1994 federal plan calling for such equipment to be available in the Gulf, means a considerable amount of oil is going to wash up on area shores.

Although the spill’s short-term impacts on crude prices will likely be minimal, the longer-term implications – i.e., stricter regulation and less offshore drilling activity – will almost inevitably contribute to higher energy prices.

April 2010 ISM Reports: Manufacturing Sector Gaining, and Service Sector Holding, Head of Steam

The Institute for Supply Management’s (ISM) reports on the manufacturing and service sectors provide a more up-to-date view of conditions than either the Federal Reserve’s report on industrial production and capacity utilization or the U.S. Census Bureau’s report on manufacturers’ shipments, inventories and orders.

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Economic activity in the manufacturing sector expanded in April for the ninth consecutive month according to Norbert Ore, chair of ISM’s Manufacturing Business Survey Committee. "The rate of growth as indicated by the Purchasing Managers’ Index [60.4 percent] is the fastest since June 2004…Manufacturers continue to see extraordinary strength in new orders, as the New Orders Index has averaged 61.6 percent for the past 10 months. The signs for employment in the sector continue to improve as the Employment Index registered its fifth consecutive month of growth. Overall, the recovery in manufacturing continues quite strong, and the signs are positive for continued growth."

Anthony Nieves, chair of ISM’s Non-Manufacturing Business Survey Committee, indicated that – with the Non-Manufacturing Index registering 55.4 percent – the service sector expanded at the same pace in April as in March.

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The performance of individual industries that are at least somewhat related to the forest products sector improved “across the board” during April. All industries reported growth in new orders, except for Agriculture, Forestry, Fishing & Hunting; also, all but Real Estate, Rental & Leasing reported stable or growing employment. Only Paper Products reported growth in new export orders.

Inputs cost more in April, although the price increases were smaller than in March. Commodities whose prices rose in April included fuel, corrugated containers, pulp, envelopes, lumber and wood products, OSB, paper, and paper products.

Although present activity appears quite robust, its continued strength will depend heavily upon the dollar’s performance against other currencies, and the rate at which the overhang of housing inventory can be cleared away.

Tuesday, May 4, 2010

April 2010 Currency Exchange Rates: Greenback Pecked by Loonie

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The U.S. dollar appreciated in April against two of the three currencies we track: by 1.1 percent against the euro and 3.0 percent against the yen. But the greenback slipped by 1.7 percent against Canada’s “loonie.” On a trade-weighted index basis, the dollar depreciated 0.5 percent against a basket of 26 currencies and is 20.9 percent below its February 2002 peak. The paragraphs below explain some of the currencies' behavior against the greenback.

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Canada: Much of the loonie’s strength derived from the fact that Canadian GDP expanded by 0.3 percent in February (3.6 percent annualized), mainly on the strength of manufacturing (+1.2 percent). The mining sector, with the exception of oil and gas extraction, also contributed (+0.4 percent) to growth in February. In addition, some industries benefited from the Olympic Winter Games held in Vancouver, such as performing arts and spectator sports, accommodation services, as well as radio and television broadcasting. Retail trade also advanced (+0.6 percent), while wholesale trade (-1.4 percent) and oil and gas extraction (-1.8 percent) declined.

Incidentally, lumber production by Canadian sawmills fell 1.8 percent from January to 4.0 million cubic meters in February. Compared with the same month in 2009, however, lumber production was 14.7 percent higher. Sawmills shipped 3.9 million cubic meters of lumber in February, down 4.7 percent from January.

Europe: The euro exhibited remakable resilience during April, particularly given the many travails facing the single unit. For example, Standard&Poors downgraded the credit ratings of Portugal, Greece and Spain in rapid succession. All three countries were also assigned negative outlooks.

Part of the euro’s resilience was due to market expectation the European Central Bank (ECB) and International Monetary Fund would finally cobble together a rescue plan for Greece. That expectation has been realized in the creation of a €110 billion package. Interestingly, the ECB borrowed a page from the Federal Reserve’s playbook and suspended the requirement of a minimum credit-rating theshold for debt instruments issued or guaranteed by the Greek government. I.e., the ECB is willing to take “junk” in exchange for its cash.

Other than the unfolding “Greek tragedy,” the situation in Europe does not appear too dire. A review of selected principal European economic indicators indicates that the 16-nation euro area maintained a February trade surplus of €3.3 billion with the rest of the world; the March unemployment rate was comparable (10 percent) to that in the United States; industrial production was up in February relative to both the previous month and year; and the economic sentiment indicator extended its year-long improvement in April.

Japan: Japan reported a March trade surplus of ¥949 billion (exports rose 43.5 percent in March from the same month a year earlier, while imports rose 20.7 percent). At the same time, the economy has improved to the point the Bank of Japan (BOJ) felt able to terminate its commercial bank stock purchases (an element of its quantitative easing program) – although the BOJ’s interest rate and other special monetary stimulus programs remained unchanged. Nonetheless, the yen depreciated against the dollar in light of a rather pessimistic outlook by the BOJ and realization that falling consumer prices mean more headwinds to come for that economy.

If the U.S. dollar continues its mixed performance, forest products manufacturers can expect to make greater inroads against their Canadian counterparts, but face greater competition in European and Japanese markets.

March 2010 Manufacturers’ Shipments, Inventories and New Orders

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Census Bureau data showed the U.S. manufacturing sector posted reasonably solid gains in March.

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Shipments, up seven consecutive months, increased $8.6 billion or 2.2 percent to $395.6 billion; this followed a 0.4 percent February increase. Shipments have returned almost to the midpoint between the peak of July 2008 and the trough of May 2009.

Shipments of manufactured forest products rose as well: Solid wood increased 2.1 percent between February and March, while paper products increased 2.6 percent.

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Inventories, up five of the last six months, increased $1.5 billion or 0.3 percent to $500.7 billion; this followed a 0.7 percent February increase. The inventories-to-shipments ratio was 1.27, down from 1.29 in February.

Wood and paper manufacturers bucked the prevailing trend and reduced their inventories by, respectively, 0.5 and 0.3 percent. Despite the uptick among solid wood manufacturers earlier in the year, the forest products sector appears to be in the midst of a secular trend of declining inventories.

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New orders for manufactured goods in March – up during 11 of the last 12 months – increased $5.0 billion (1.3 percent) to $391.5 billion. This followed a 1.3 percent February increase. Excluding transportation, new orders increased 3.1 percent.

New orders for manufactured durable goods in March, down following three consecutive monthly increases, decreased $1.0 billion or 0.6 percent to $178.7 billion, revised from the previously published 1.3 percent decrease. New orders for manufactured nondurable goods increased $6.0 billion or 2.9 percent to $212.8 billion.

Monday, May 3, 2010

March 2010 Value of Construction Put in Place: More Down than Up

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The value of construction put in place advanced slightly (0.2 percent) in March, primarily because of a 2.3 percent jump in the value of public construction. Both categories of private construction declined in March.

The year-over-year decline in total construction is gradually slowing, but remained around 12 percent in March. The overall rate of retreat would have been even greater were it not for private residential construction having stabilized during the past year. In fact, residential construction is the only category “in the black” on an annual change basis.

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As we indicated in our May 3 blog entry Consumers Lead the Way on 1Q2010 GDP Growth, the lack of a strong bounce in residential construction calls into question the robustness of the recovery – and its sustainability.

Consumption Outstrips Incomes in March

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According to a report by the Bureau of Economic Analysis,both personal incomes and outlays rose in March. However, the increase in spending outstripped the increase in disposable incomes by over 81 percent:

"Personal income increased $36.0 billion, or 0.3 percent, and disposable personal income (DPI) increased $32.3 billion, or 0.3 percent, in March, according to the Bureau of Economic Analysis. Personal consumption expenditures (PCE) increased $58.6 billion, or 0.6 percent. In February, personal income increased $7.1 billion, or 0.1 percent, DPI increased $4.3 billion, or less than 0.1 percent, and PCE increased $56.4 billion, or 0.5 percent, based on revised estimates.

"Real disposable income increased 0.2 percent in March, compared with an increase of less than 0.1 percent in February. Real PCE increased 0.5 percent, the same increase as in February."

Although PCE and DPI are increasing on a year-over-year basis, both of those increases are well below their historical averages of, respectively, 7.2 and 7.1 percent.

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Spending rose, at least in part, because of the unprecedented amount of federal transfer payments received by households. Since the recession began in December 2007, federal transfer payments (defined in this case as only federal unemployment insurance benefits and “other” government social benefits to persons) have jumped from 5.3 percent of total personal income to 7.5 percent – the highest percentage since 1947.

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Given the rise in PCE, it follows that retail sales also jumped higher. The graph above and table below contain the Census Bureau’s revised figures for March – which differ only slightly from the “advance” versions posted in April 19’s blog entry Retail Sales Increased in March: The Question is “Why?” The comments made in the posting still apply.

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As we have frequently stressed, the current gradual convergence between incomes and spending is unsustainable. Either incomes need to rise or spending will need to be cut for the U.S. economy to revert back to a more healthy state. In light of the myriad other hurdles facing the U.S. consumer – particularly our expectations of waning federal stimulus after 3Q2010 and rising interest rates – we think the most likely outcome is for spending to eventually retrench, along with the overall economy.

Consumers Lead the Way on 1Q2010 GDP Growth

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Real gross domestic product (GDP) increased at a seasonally adjusted and annualized rate of 3.2 percent 1Q2010 (relative to 4Q2009), according to the "advance" estimate released by the Bureau of Economic Analysis. While still well in positive territory, growth during 1Q2010 was considerably slower than 4Q2009’s 5.6 percent.

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The 1Q2010 increase reflected positive contributions from personal consumption expenditures (PCE) – which increased at the fastest pace in three years – and private domestic investment (PDI). But the rate of was slower than in 4Q2009 primarily because of decelerations in private inventory investment (part of PDI) and in exports (part of NetX); a downturn in residential fixed investment (part of PDI), and a larger decrease in state and local government spending (GCE) also slowed growth.

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Interestingly, consumer spending continues to drive the U.S. economy despite supposed deleveraging by consumers. In fact, the proportion of total GDP represented by PCE is homing in on the record of 71.3 percent set in 3Q2009. How can consumers be carrying such a large proportion of economic activity in the face of high unemployment and other difficulties? As we hypothesized in our April 19 blog entry Retail Sales Increased in March: The Question is “Why?” one possibility is that some homeowners are engaging in “strategic” defaults whereby they forego mortgage payments and purchase “stuff” with the money they should be paying for housing. A more likely possibility is that government transfer payments are the enabling mechanism. Stay tuned for future posts that will discuss personal income and outlays.

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The behavior of residential fixed investment (RFI) as a percentage of GDP is of great concern to us. RFI typically hit bottom and then bounced back rather quickly during past recessions. Not this time, however. Not only is RFI’s contribution to GDP at a record low, it also shows no sign of turning upward; its sideways move suggests that a robust recovery is not in the cards for 2010.