July 2010 Macro Pulse -- More Economic “Stall” Warnings

Executive Summary

The second downward revision of 1Q2010’s change in gross domestic product (GDP) to 2.7 percent is one warning indicator that the U.S. economy may be in the process of stalling. Moreover, it is becoming increasingly evident that a significant share of consumer spending since late 2008 resulted from government transfer payments and tax breaks. But even that government-induced growth was not sufficient to materially lower the jobless rate. Manufacturing appears to be providing some lift for now, as industrial production and capacity utilization both rose in May. However, two other indicators are possibly sending warning signals: New factory orders declined in May and growth in the Institute for Supply Management’s purchasing managers’ index slowed during June

More time will be required to determine whether the downturn in world trade during April was just a false alarm or something about which to be genuinely concerned. Exchange rates could frustrate U.S. exporters’ attempts to expand market share, as the dollar strengthened against the euro in June. The monthly average price of West Texas Intermediate crude oil ticked higher in June despite a stronger dollar, the lagged impacts of a slight setback in consumption in April, and crude stocks that are well above the average five-year range.

Construction in the United States, including the housing market, is sounding the loudest warning. The value of construction put in place declined across nearly all categories during May – public works projects excepted. Hence, the contribution to GDP of private residential fixed investment is at its lowest level since the 1940s.

Click here to read the entire July 2010 Macro Pulse.


Macro Pulse is a compilation of economic developments over the past month that provide context for our complete, 24-month forecast, which is contained in the Economic Outlook newsletter available through Forest2Market. While we note developments on the Macro Pulse blog as they occur, the monthly Macro Pulse newsletter provides a summary and point-of-access to economic conditions over the past 30 days affecting the forest products industry.

June 2010 ISM Reports: Manufacturing and Service Sector Growth Slows

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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 Board’s report on industrial production and capacity utilization or the U.S. Census Bureau’s report on manufacturers’ shipments, inventories and orders.

Although economic activity in the manufacturing sector expanded in June for an eleventh consecutive month, ISM’s report on manufacturing hints at an impending slowdown. "The manufacturing sector continued to grow during June,” said Norbert Ore, chair of the ISM Manufacturing Business Survey Committee. “However, the rate of growth as indicated by the Purchasing Managers Index (PMI) slowed when compared to May. The lower reading for the PMI came from a slowing in the New Orders and Production Indexes. We are now 11 months into the manufacturing recovery, and given the robust nature of recent growth, it is not surprising that we would see a slower rate of growth at this time. The sector appears to be solidly entrenched in the recovery. Comments from the respondents remain generally positive, but expectations have been that the second half of the year will not be as strong in terms of the rate of growth, and June appears to validate that forecast."

Forest products manufacturers put in a mixed performance in June. Changes in Wood Products were almost universally negative, a situation confirmed by one respondent who observed that the "market had begun to change [for the better], but it is now declining again." Metrics for Paper Products, on the other hand, were largely positive.

Behavior of the service sector paralleled that of manufacturing; i.e., it grew at a slower pace in June than May. However, overall service employment shrank in June. Real Estate, Rental & Leasing; Agriculture, Forestry, Fishing & Hunting; and Construction were all among the industries reporting growth.

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One of the most remarkable aspects of the manufacturing report was that the input price index fell to 57 percent, 20.5 percentage points (or 26.5 percent) lower than the 77.5 percent reported in May. I.e., prices rose overall in June, but the rate of change slowed dramatically when compared to the prior month (50 percent is the breakpoint between rising and falling prices). Copier paper, corrugated containers and products, and paper products were among the wood-derived products up in price. Diesel and gasoline were down in price.

June 2010 Monthly Average Crude Oil Price: Higher Despite Current Fundamentals

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The monthly average price of West Texas Intermediate crude oil ticked higher in June, to $75.35 per barrel – an increase of $1.51 (2.0 percent). That price increase occurred despite a stronger dollar, the lagged impacts of a slight setback in consumption of roughly 0.2 million barrels per day (BPD) in April, and crude stocks that are well above the average five-year range.

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The Deepwater Horizon oil leak dominated energy-related news during the past month. The extent and impacts of the leak have been difficult to quantify, but reports from the research vessel Thomas Jefferson estimated the amount of oil leaking into the Gulf of Mexico at 120,000 BPD; also, the oil “lake” underneath the surface of the water could be covering up to 40 percent of the entire Gulf. The National Oceanographic and Atmospheric Administration predicts that tar balls will likely reach the Florida Keys and Miami in the months ahead.

A legal tug-of-war erupted after 27 May, when the Obama administration imposed a six-month moratorium on offshore drilling in water deeper than 500 feet. The administration claimed to have based its moratorium on the recommendations of seven experts, but had to backtrack when the panel members wrote a letter criticizing the moratorium and revealing that the version of the Interior Department report they were asked to review had not mentioned a drilling ban. A federal judge in Louisiana issued a preliminary restraining order against the ban, but the White House kept the moratorium in place by immediately appealing the judge’s ruling.

The Interior Department has said shallow-water drilling is unaffected by the ban, but area operators counter that the Department has imposed a “stealth” moratorium on virtually all operations by holding up permits. The Bureau of Ocean Energy Management, Regulation and Enforcement (formerly known as the Minerals Management Service), issued 11 permits for rigs in waters less than 500 feet from June 8 through June 30, when the first of two new safety rules was released. The government normally issues about 10 to 15 permits a week, said Randall Stilley, chief executive officer for Seahawk Drilling Inc. "We've got a long way to go before we get back to that level," said Stilley, whose Houston-based company provides so- called jack-up rigs supported by legs that extend to the seafloor. "It is so slow. We're having to shut down rigs, and that's a bad situation for everybody."

Although the BP oil spill and moratorium may wreak lasting havoc on local communities, the United States’ energy budget and GDP are likely to suffer only a mild impact. Wells Fargo economist Mark Vitner expects up to 250,000 Gulf jobs in fishing, tourism and energy will be lost in 2H2010. However, Vitner estimates those job losses will lower 3Q2010 GDP growth by only 0.2 percentage point; he envisions little or no effect on growth in 4Q2010, assuming the leak is plugged by then.

June 2010 Currency Exchange Rates: Two Steps Back and Two Forward

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The U.S. dollar depreciated in June against two of the three currencies we track: by 0.3 percent against Canada’s “loonie” and 1.3 percent against the yen; but the greenback appreciated by 2.8 percent against the euro. On a trade-weighted index basis, the dollar gained 0.6 percent against a basket of 26 currencies.

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Canada: The loonie’s gain against the U.S. dollar occurred despite a stall in economic growth. Real gross domestic product was unchanged in April after seven consecutive monthly increases. A large decline in retail trade and smaller declines in manufacturing and utilities were offset by increases in mining, wholesale trade and, to a lesser extent, the public sector and construction.

Part of the loonie’s support derived from Russia’s addition of the currency to its foreign reserves. Russia's push to diversify reserves "is more a result of their desire to do something in response to the extreme volatility of the dollar and the euro," said Elena Matrosova, a Moscow-based economist at BDO International.

Europe: The euro’s depreciation against the greenback coincided with more bad news for the region – including a downgrade of Greece’s government bond rating to junk status. Concerns over the economic health of the so-called peripheral European nations caused bond yields – particularly those of Greece and Spain – to continue rising.

Not all of the news coming out of the 16-nation euro area is bad, however; a number of statistics are fairly positive. For example, GDP expanded in 1Q2010, and the external trade surplus jumped six-fold in April. The unemployment rate appears to have stabilized (although at an admittedly high 10 percent). Industrial new orders rose for a third consecutive month in April and represented the steepest annual percentage increase since May 2000.

Japan: The yen appears to have benefited from investors running from the euro. Whether that move will ultimately prove to be a wise one remains to be seen. Although the Bank of Japan stated the economy in that country "shows further signs of a moderate recovery, induced by improvement in overseas economic conditions," that recovery apparently still needs another $32.8 billion in new lending. Falling consumer prices, slower-than-expected increases in exports, and a surprising spike in the unemployment rate seem to have spooked the Bank.

China: Because China’s currency does not trade freely against the U.S. dollar, our interest in that country primarily centers around whether it will continue buying U.S. debt. A year after criticizing U.S. fiscal policy as "irresponsible," the answer to that question appears to be “yes” – at least for the time being. China boosted holdings of Treasury notes and bonds by 2.6 percent to $900.2 billion in March and April, after reducing its stake by 6.5 percent from November through February, the longest consecutive monthly declines in a decade.

May 2010 Manufacturers’ Shipments, Inventories and New Orders: Broad-based Decline

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Shipments, inventories and new orders all experienced setbacks at the total manufacturing level in May, but most performance metrics of the solid wood and paper manufacturers improved.

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The value of shipments, down following two consecutive monthly increases, decreased $5.3 billion (1.3 percent) to $416.8 billion. The decline in shipments of durable goods was led by the ever-volatile transportation equipment, which retreated by 2.8 percent. Shipments of nondurable goods also declined, led by petroleum and coal products. Petroleum and coal products were down 8.0 percent, the largest decrease since December 2008.

Forest products manufacturers put in a mixed performance in May. Solid wood shipments declined 0.9 percent (to $7.2 billion) while paper shipments rose 0.7 percent (to $14.2 billion).

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Although the value of paper shipments may have increased, data from the Association of American Railroads show that the volume of material shipped by rail declined in May. Nonetheless, rail traffic remained well ahead of year-earlier volumes.

The Ceridian-UCLA Pulse of Commerce Index (PCI), which is based on real-time diesel fuel consumption data from over-the-road trucking, provides a “contrary” piece of evidence. The PCI climbed 3.1 percent in May, the first increase this year. “Absent good news from the usual recovery indicators – i.e., consumer optimism expressed by buying homes and cars, and business optimism expressed by hiring – the spike in the PCI is indeed very welcome news for the economy,” said Ed Leamer, the PCI’s chief economist. “One month does not make a trend, but at least we are back in a recovery groove.” According Ceridian, the May results “suggest the recovery is on pace for GDP growth in the healthy range of 3 to 5 percent for the second quarter of 2010, moving closer to the 5 to 6 percent increase necessary to drive down the unemployment rate.”

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Inventories, down following four consecutive monthly increases, decreased $2.0 billion (0.4 percent) to $520.4 billion in May. Inventories of durable goods increased 0.9 percent (to $304.7 billion), led by primary metals. Inventories of manufactured nondurable goods decreased 2.1 percent (to $215.7 billion), driven lower by petroleum and coal products.

Solid wood and paper inventories “bucked” the wider trend in May: Wood inventories rose by a substantial 9 percent (likely in response to a concurrent jump in lumber futures prices); the rise in paper inventories was a more modest 0.5 percent.

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New factory orders may be providing a sign that manufacturing (and perhaps the broader economy) could be starting to cool. New orders for manufactured goods in May, down following eight consecutive monthly increases, decreased $5.8 billion (1.4 percent) to $413.2 billion. Excluding transportation, new orders decreased 0.6 percent.

New orders for durable goods decreased 0.6 percent (to $192.9 billion), led by transportation equipment. Orders for nondurable goods fell 2.1 percent, to $220.4 billion.

"Manufacturing has been the star of the economy this year so any signs that conditions are turning would cause some concern," said Joel Naroff, president of Naroff Economic Advisors. "The demand for products is slowing."

June 2010 Employment Report: Rising and/or Falling?

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U.S. employment fell for the first this year in June as thousands of temporary census jobs ended and private hiring grew less than expected. Total nonfarm payroll declined by 125,000, reflecting a decrease (-225,000) in the number of temporary employees working on Census 2010. Private-sector payroll employment edged up by 83,000.

One might be tempted to take encouragement from the news that the number of unemployed persons, at 14.6 million, and the unemployment rate, at 9.5 percent, edged down in June; unfortunately, the underlying cause for those declines is that more people stopped looking for work, and thus were not counted as unemployed – not because of a sudden burst in hiring.

Also, average hourly earnings declined by $0.02 (to $22.53), and the average workweek for all private nonfarm payrolls decreased by 0.1 hour (to 34.1 hours).

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"Overall, [the employment report is] weak with very little breadth in new hiring," said John Herrmann, a senior fixed-income strategist at State Street Global Markets. "This will lead to second-half consumption growth well below the first half."

With unemployment stubbornly high, recent sluggish household spending is threatening to tip the economy back into recession. Moreover, federal decision makers are about out of ammunition in terms of what else they might try. "We are in a difficult situation. I don't think there is political will to have another stimulus program and even if we did I am not sure people feel it would be that effective," said Stephen Bronars, a senior economist at Welch Consulting.

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It is noteworthy that 147,000 of the 863,000 (nearly one in five) not-seasonally adjusted private sector jobs came from the Current Employment Statistics (CES) models. The Bureau of Labor Statistics uses the CES models to account for business closings and openings that occurred recently enough that they were not captured in the employment survey. Because these numbers are statistically derived, many 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.

Also noteworthy is the observation that, although 225,000 Census 2010 workers were “sent packing,” federal government employment fell by only 173,000. That means 52,000 other – most of them presumably full-time – employees were added to the federal payroll. Hiring among state and local governments appears to be in full-scale retreat, however.

May 2010 U.S. Construction: Serious Setbacks in Residential Starts and New-home Sales

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Following two months of gains, construction spending dipped in May as residential building slowed -- concurrent with the demise of the federal homebuyers' tax credit. The 0.4 percent rise in public construction spending (mainly highways and other infrastructure projects) was insufficient to offset the 0.5 percent drop in private spending, resulting in a 0.2 percent overall decline.

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The drop in private residential construction was concentrated in the single-family section (-17.2 percent, the largest monthly retreat since January 1991). Total starts are up 24.3 percent from their trough in April 2009, but still off by 73.9 percent relative to the peak of January 2006.

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The impact of the tax credit’s expiration was most evident in new home sales, which “cratered” by nearly one-third in May – falling to a new record-low level of only 300,000 units (seasonally adjusted and annualized rate, or SAAR).

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Despite a modest decrease in the absolute number of unsold homes, the fall-off in sales caused the months of inventory to bolt upward from 5.8 months in April to 8.5 months in May. Resales of homes, townhouses, condominiums and co-ops also retreated in May, but nowhere near as dramatically (-2.2 percent) as new homes.

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New home prices “fell off a cliff” after March (the median price dropped by $22,500 between March and April), and now stand 9.6 percent below year-earlier levels. The median price of existing homes, by contrast, has been rising since February. Much of that rise is attributable to seasonality – prices typically rise during the middle of the year, but even the S&P/Case-Shiller home price index showed a modest increase.

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Miami and New York were the only markets in which home prices fell between March and April (the latest data available). Prices in more than half the markets were higher than during April 2009; also, year-over-year increases were typically larger on a percentage basis than the decreases in declining markets.

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The slight uptick in composite prices may be only temporary. “Home price levels remain close to the April 2009 lows set by the S&P/Case Shiller 10- and 20-City Composite series,” said David Blitzer, chair of the Index Committee at Standard & Poor’s. “The April 2010 data for all 20 metropolitan statistical areas (MSA) and the two Composites do show some improvement with higher annual increases than in March’s report. However, many of the gains are modest and somewhat concentrated in California. Moreover, nine of the 20 cities reached new lows at some time since the beginning of this year. The month-over-month figures were driven by the end of the Federal first-time home buyer tax credit program on April 30th. Eighteen cities saw month-to-month gains in April compared to six in the previous month. Miami and New York were the two that fared the worst in April compared to March. New York is the only MSA to have posted a new relative index low with April’s report.”

“Other housing data confirm the large impact, and likely near-future pullback, of the federal program,” Blitzer continued. “Recently released data for May 2010 show sharp declines in existing and new home sales and housing starts. Inventory data and foreclosure activity have not shown any signs of improvement. Consistent and sustained boosts to economic growth from housing may have to wait to next year.”

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If recent history is any indication, private residential fixed investment is unlikely to contribute significantly to GDP in the near futures. Part of the reason for this turn of events, according to Moneynews.com, is that developers are trying to sell a glut of homes built during the boom years. And they must compete against foreclosed homes selling at deep discounts. As a result, new home sales made up about 7 percent of the housing market last year (5 percent in May), down from about 15 percent before the bust.

Each new home built creates the equivalent of three jobs for a year and generates about $90,000 in taxes paid to local and federal authorities, according to the National Association of Home Builders. The impact is felt across multiple industries, from makers of faucets and dishwashers to lumber yards, but it has weakened in recent years. Spending on residential construction and remodeling made up only about 2.4 percent of GDP in 1Q2010, down from a peak of more than 6 percent during the housing market's boom years.

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