Green Shoots Update: Not Good

Well we didn’t have to wait too long before we were doused with some cold water: this morning’s release of April’s retail sales was a distinct downer. No only did sales fall by an unexpectedly large 0.4% in April, but March’s decline was widened to 1.3% form its original 1.2%. That April drop was about four times as large as the ‘street’ was looking for, and is a very sharp reminder to us all that the rays of hope we have been talking about are very very fragile.

The fall was fueled by continued consumer reticence to ante up for anything other than the necessities of life. There had been plenty of anecdotal and industry information recently that consumers were coming back to stores and buying more ‘discretionary’ items. Sales earlier in the year, in January in particular, fed into this stream of thinking and was one of the biggest factors underlying the sighs of relief emanating from the White House and from the Federal Reserve Board.

In this light the March and April fall back is especially disappointing. We should remain very cautious about the year as a whole. If the data in May or June isn’t any better then we will have to think again about our expectations for an end to the recession later this year.

Let me demonstrate this point by reference to the first quarter. From January to March GDP fell 6.1%. But it would have fallen much more had it not been for the rise in consumption of 2.2% over that same time. I realize that retail sales data and GDP level data do not match one for one, but they do track quite well. As we go through this second quarter the recent fall in retail sales suggests that consumption is unlikely to repeat its 2.2% first quarter gain, a number of less than 1.0% seems far more probable. Since consumption is 70% of GDP that small decrease becomes magnified and GDP itself suffers. So the end of the recession is pushed off further into the future.

Unemployment and wages are still the key. As long as jobs are being cut and wages trimmed we cannot reasonably expect a recovery. Just yesterday the government released grim data on what it calls ‘mass layoffs’ – a mass layoff is where a company accounts for 50 or more unemployment claims in a short period of time – and estimates that there were 3,489 such events in the first quarter alone. These large scale events are the ones that catch the headlines are thus play a big role in setting the tone of consumer psychology.

“Unemployment and wages are still the key”

Meanwhile there is rapidly accumulating evidence that wages are under unusually strong downward pressure. That cannot be good news for the economy as a whole. The specter of deflation clearly still lingers, even after all the hard work done by the Fed, and provides even more reason to hesitate before we call the recession near and end.

This morning’s report also hints at more reason for concern: commodity prices have begun to turn.

All last year we benefitted from a worldwide drop in commodity prices. This was reflected in our trade balance. Not only were import volumes down, but prices were too, so the total cost of imports fell strongly. The early signs of economic recovery have now started to push commodity prices back up: the price of oil in particular has risen quite sharply and is now back over $60 a barrel. This means the data has mixed messages in it that we need to interpret carefully: even though oil prices jumped 15.4% in April, they were still over 50% lower than a year ago.

This means that the gains we saw throughout the end of 2008 and into early this year in terms of GDP resulting from lower import prices is ending. Lower imports totals from here on out will result entirely from low domestic demand, not lower prices.

Plus, the ‘disinflationary’ or deflationary pressure lower commodity prices exerted in that period is now waning. We cannot expect future prices to be as quiescent as those in the immediate past.

Add all this together and the message is a little worrying.

The reduction in disinflationary price pressure due to the shift in commodity prices will hurt us as long as wages are falling: it will further cramp consumers ability to go out and spend. So consumption will be reduced. That cuts into GDP and so slows the recovery.

Likewise as long as commodity prices now turn back upward, any benefit flowing to GDP from reduced import prices is also gone. This also could, potentially, slow the recovery.

This is one of those moments when the data tells many different stories at once. The plus we had from import prices last year isnow be ending. That part of the deflation threat therefore is noweasing. Except wages remain under pressure. So the ebbing of the deflationary threat heightens the damage to consumption that weak the wage outlook represents. Either way GDP growth will likely take a hit from both consumption and imports in the second quarter.

Buckle up. This thing is a long way from being over.

Addendum:

Also released today, and also in the ‘cold water’ category was the news that inventories are stuck. One of the key factors many of us expected to help lift the economy out of recession later this year was the ratio of inventories to sales. A high amount of inventory is always bad, and especially if sales are slow or declining. The widely held presumption was that sales to inventory ratios were bound to fall below normal levels this year because production has been cut severely. Eventually businesses will be forced to increase production, even if sales are still weak, because there is not enough inventory available. So today’s news that inventory to sales ratios remain stubbornly higher than they were a year ago is not something we want to hear. Yes inventories fell. But sales fell even more quickly.

At this rate the recovery is unlikely this year.