U.S. Trade Deficit Widened in February: Is Renewed Dollar Strength Stunting Export Volumes?

According to the U.S. Commerce Department, total February exports of $143.2 billion and imports of $182.9 billion resulted in a goods-and-services trade deficit of $39.7 billion, up from $37.0 billion in January (revised). February exports rose by $0.3 billion over January’s $142.9 billion, while imports were $3.0 billion higher than January’s $179.8 billion.

There is a correlation of over 0.60 between the trade deficit and “broad” dollar index (a relative measure of value against a basket of 26 other currencies). I.e., the dollar’s value has some influence on the size of the trade deficit. In general, the deficit widens when the dollar depreciates, and shrinks when the dollar appreciates (lower graph). The trade deficit has been rising since May 2009, partly because the dollar weakened after March 2009, but could begin shrinking again as a result of the dollar’s appreciation since November 2009.

This points to a dilemma for U.S. manufacturers: A weaker dollar makes their products relatively more attractive in both the domestic and export markets, but it also tends to worsen the trade deficit. Conversely, a stronger dollar stunts demand for their products, but improves the overall trade deficit. In a sense, then, what’s good for exporters isn’t necessarily good for the economy as a whole.

Dollar strength appears to be decreasing U.S. forest products export volumes and stimulating a greater volume of imports. That statement may seem to contradict the contention that a stronger dollar narrows the trade deficit, but that apparent disconnect is at least partly resolved by realizing the trade deficit reflects the interaction of volume and per-unit value while the lumber and paper trade data measure just tons or board feet. Exports of pulp, paper and paperboard decreased 6.2 percent in February relative to January (although they were 13.6 percent higher than a year earlier). Imports rose 2.7 percent between January and February, but were 2.2 percent lower than in February 2009. The picture is a bit murkier for lumber: Exports rose 6.9 percent in February at the same time imports also rose 13.0 percent. Lumber exports were up 36.8 percent on a year-over-year basis in February, while imports were 3.6 percent higher.

Manufacturing Mixed in March

The Federal Reserve’s G.17 report showed that industrial production edged up 0.1 percent in March and increased at an annual rate of 7.8 percent in 1Q2010. Manufacturing output rose 0.9 percent in March, led by widespread gains among durable goods industries. Although perhaps held down by February’s winter storms, 1Q2010 factory production as a whole rose at an annual rate of 6.6 percent. At 101.6 percent of its 2002 average, industrial output in March was 4.0 percent above its year-earlier level. Output from individual forest products industries was mixed in March: Wood Products advanced, while Paper retreated.

Capacity utilization for total industry advanced 0.2 percentage point to 73.2 percent, 5.3 percent above the rate from a year earlier. As with industrial production, capacity utilization among forest products manufacturers was mixed – Wood Products ran harder in March, while slack increased among Paper manufacturers. Capacity utilization increased in all-industry and Wood Products because of increased output and the shuttering of additional capacity.

Capacity utilization is a key statistic the Federal Reserve uses to indicate the degree of economic slack and the risk of price instability. The majority of the all-industries capacity utilization improvement since mid-year 2009 has been the result of higher production rather than reduced capacity. Capacity utilization remains well below “normal” levels at present; based on that metric alone, it seems unlikely the Federal Reserve will raise interest rates anytime soon. However, we believe market conditions will force interest rates higher. Should this scenario unfold, capacity utilization may ultimately come back into balance primarily through capacity losses instead of increased production. Aggressively leveraging competitive advantage will be a key to success in such a future.

Retail Sales Increased in March: The Question is “Why?”

Total retail sales increased by 1.6 percent (to $363.2 billion) in March, a sign – according to many economists – that the recovery is broadening. “What we’re seeing now is the consumer take part in the recovery,” said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. “The Fed’s not taking the punch bowl away quite yet,” because inflation is “very tame,” he said.

However, rising unemployment and home foreclosures beg the question: “Where is the money coming from to support higher retail sales?” There are a couple of interesting possibilities beyond the most obvious (i.e., that those still employed are feeling a little freer with their pocketbooks):

* Anecdotal evidence indicates some homeowners are foregoing mortgage payments and purchasing “stuff” with the money they should be paying for housing. We doubt this practice is sufficiently widespread to materially boost consumer spending, but it is useful to be aware of this development.

* The Census Bureau’s method for calculating year-over-year changes uses only same-store sales for comparison; there is no attempt to account for the loss of sales at firms that have gone bankrupt (or underperforming chain stores that have closed) in the intervening time period. Same-store sales rise if, for example, the same total volume of merchandise is being sold through fewer outlets. Since the Census Bureau samples only a portion of existing retail establishments and infers activity of the entire industry from that sample, one can see how the result might look fairly positive.

Alternative views of retail activity, like sales tax revenue and real-time data on internet purchases of major durable goods provide a different – and more pessimistic – picture. Time will tell which view is right.

Rail Traffic Chugs Ahead in March

Data from the Association of American Railroads indicate that the volume of U.S. rail traffic in March 2010 increased by double-digit percentages from February, and – in most cases – was greater than the same month in 2009. Only pulp and paper products traffic was lower than a year earlier.

These data provide another confirmation that the economy grew during 1Q2010.

Manufacturing and Service Sectors Gain in March

The survey of U.S. manufacturing firms by the Institute for Supply Management (ISM) showed the pace of expansion quickened in March (to 59.6 percent, from 56.5 percent in February). Readings over 50 percent indicate more firms said business was improving than said it was worsening.

"The manufacturing sector grew for the eighth consecutive month during March,” reported Norbert Ore, chair of ISM’s Manufacturing Business Survey Committee. “The rate of growth as indicated by the Purchasing Managers’ Index is the fastest since July 2004. Both new orders and production rose above 60 percent this month, closing the first quarter with significant momentum going forward... [S]igns for employment in the sector continue to improve...indicating that manufacturers are continuing to fill vacancies. The Inventories Index provided a surprise as it indicated growth for the first time following 46 months of liquidation – perhaps signaling manufacturers' willingness to increase inventories based on expected levels of activity." One item that Ore failed to highlight was that manufacturing input prices rose 8 percent in March.

Wood Products managed to eek out a gain in March, thanks mainly to a bump up in production. New orders (including export orders) and a backlog of orders put Paper Products in the "plus" column.

Service sector activity added to February's gains; the non-manufacturing index registered 55.4 (up 2.4 percentage points), reflecting growth for a fourth consecutive month. Two of the three service industries we track shared in that gain: Construction and Agriculture, Forestry, Fishing & Hunting. Real Estate lost ground in all categories except order backlogs.

Corrugated containers, packaging and paper were among the commodities up in price; construction labor was one commodity down in price.

Construction “Snowed In” in February

The U.S. Census Bureau reports the value of construction put in place fell “across the board” in February, relative to January. The closest thing to a bright spot was the private non-residential category, which declined by a comparatively modest 0.4 percent. Inclement weather and poor economic conditions have been widely cited as culprits behind the drop.

February’s activity reversed the trend that had been in place during the previous four months; i.e., the decline in overall construction spending picked up speed, after having slowed between October 2009 and January 2010.

March 2010 Employment Report: Turn-up or Turnip?

According to the Bureau of Labor Statistics, the U.S. economy added 162,000 jobs in March. While some described the payroll jump as the "best gain in three years," a bit of digging reveals little to get excited about. For example, of those 162,000 jobs:

• 81,000 were generated from the BLS's birth/death model;
• 40,000 were hired by "temp" agencies; and
• 48,000 were temporary Census Bureau hires.

In other words, 169,000 of the 162,000 new jobs (yes, you read that correctly) were either potentially fictitious or temporary positions -- hardly the stuff of which sustainable recoveries are made.

Elsewhere in the report, the BLS revealed that the number of part-time workers increased, as did those who gave up looking for work. Also, the average workweek increased by only six minutes (to 34.0 hours, still near record lows) while average hourly earnings fell by two cents. These metrics demonstrate only tepid labor demand.

Finally, although 27 months have passed since the recession began, employment is still essentially six percent lower than the number of jobs that existed in December 2007 (click on graph above for a larger image).

In conclusion, taking the BLS employment report at face value could leave a bad taste in one's mouth -- much like eating turnips (apologies to those who actually like turnips).

We will have more to say about future prospects for employment in the upcoming April issue of Economic Outlook, available from Forest2Market.