A Lot Less Spooked About the Economy

By Michael Englund
MSNBC
July 19, 2004

At last, some clarity on the economic outlook. A string of data reports for June released in the past week -- covering inflation, the factory and retail sectors, and foreign trade -- has significantly reduced uncertainty about the outlook for U.S. growth and price stability for the year. These reports, in total, have eased some concerns about the pace of economic expansion that followed the weaker-than-expected June employment statistics released on July 2.

Of course, uncertainty remains, but we at Action Economics are now more confident that quarterly growth rates for U.S. gross domestic product will remain near a 4% to 5% pace through the four quarters of 2004. We see little risk to our relatively aggressive third-quarter forecast of 5%, despite fears stirred in the markets by the June data.

Our confidence is bolstered by four key points gleaned from the past week's reports:

1] U.S. inflation will indeed moderate through June and July.

The pace should ease after an alarming surge through the first five months of the year, leaving all the price data by later this year right in line with levels expected before the year began. June reports on producer prices, consumer prices, and import and export prices all revealed the moderation under way in energy and food prices included in the overall figures. They also show less oomph in other components [the so-called core data, which exclude food and energy).

The uptick of 0.2% in both the overall and core year-over-year figures for the consumer price index [CPI] for June, to 3.3% and 1.9%, respectively, will keep the inflation story alive for some observers. But we believe the figures mark a near-term peak. We expect a likely drop-off in the overall year-over-year measure to 3% by August and 2.8% by September, if our estimates are correct that CPI will reveal a small 0.1% gain in July, followed by 0.2% gains thereafter.

For the core CPI, the numbers should trend slowly but surely higher to the 2.2% area by yearend, as the cyclical moderation in 2003 is put behind us. But this uptrend would be more modest than what was seen through the first half of the year and should be viewed as encouraging.

We expect the hefty 5% year-over-year gain in the producer price index [PPI] in May to be the peak for 2004, as the drop to a 4% yearly gain in June should be followed by a repeat of this 4% rate in July. We then expect a downtrend to around 3% by yearend, as the index experiences notably easier year-ago comparisons as we move into August.

We also expect the trade-price data to continue to moderate through the summer months even as the dollar resumes its downtrend. This is because the lagged relationship between the dollar and trade prices, and the drops now under way in food and energy prices, tend to have a disproportionate impact on the trade data.

2] U.S. trade data is shifting favorably.

This encouraging trend, which emerged during 2003, appears to have remained in place in 2004, despite the troublesome trade swings in March and April. The goods and services trade data for May released in mid-July reveal that export growth will remain a powerful stimulative force for the U.S. economy through 2004, even if above-trend growth in U.S. aggregate demand boosts imports and restrains improvement in the trade deficit.

The data show notable restraint in U.S. import growth and imply a likely improvement in the current-account deficit once the U.S. passes the likely trade-deficit peak during the second and third quarters.

3] Restrained inventory growth in the first two quarters is setting the stage for an upturn in the second half.

Inventory growth through the second quarter stayed modest even though we at Action Economics had anticipated a more immediate upturn. This depressed production data for the quarter, but it leaves growth in the pipeline for the second half of the year. Inventory figures, like the proverbial supertanker, are proving slower to turn than we expected, but they're poised for even greater momentum once stockpiles begin to accumulate.

Inventory restraint, as directly evident in the business-inventories data released July 15, also underlies the downward revisions and weak June levels for industrial production reported recently, as well as the modest weakening in the various factory-sentiment surveys and employment reported for the month of June.

4] U.S. data downticks in June are likely to be followed by July rebounds.

This is evident from the surge reported for the Empire State manufacturing index in July vs. the restrained levels in June -- and a similar jump in the Philadelphia Fed survey. These gains imply likely rebounds in the other factory-sentiment surveys as well.

We now expect solid readings for both the purchasing managers' and Chicago PMI reports for July, and significant bounces in the factory-sector components of the July employment report to be released in early August. Economists noted the funeral of former President Ronald Reagan as a factor affecting the employment survey week in July. It appears that this had a significant but temporary impact on the U.S. data for the month.

It's not clear that the Reagan funeral distortion explains the downtick in retail sales in June, but we do think the negative shock to the seasonally adjusted production and income data on the month may have been a catalyst for the pause in consumer spending. And a small breather might be seen as long overdue given the trajectory of strength in this category through the first five months of the year. We remain confident that consumers will be as aggressive through the three months of the third quarter as they were over the last four quarters.

If these four factors help solidify the economic outlook, what do they say about Federal Reserve policy in the coming months? With growth at a solid but not too rapid pace, and the modest -- but not problematic -- cyclical uptrend in inflation year-to-date, Alan Greenspan & Co. should be able to maintain their "measured" pace of policy tightening. The markets will be searching for further clues from the Fed Chairman at his testimony before Congress on July 20-21.

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