capacity utilization

Today has seen a flurry of normal data releases about the economy. There is news about housing, industrial production, business investment, and employment. With all this we should find it possible to discern whether all the hoopla about green shoots is justified. Unfortunately not. We have arrived at the point in the recession when the news provides a decidedly mixed message. Interpretation becomes key, and that depends on taking a view of the longer term trends and the imbalances that created this mess to start with.

So with some trepidation here we go:

1. Housing. Depending on the bias of the reporter today’s news is excellent, good, or a blip. New home sales grew very slightly, by 0.3% in April after a drop of 3.0% in March. The good news here was the signs of recovery in the south. Unfortunately sales in the west dropped by 3.8% and almost totally offset that recovery. Even with this April growth, sales are 34% down from a year ago and 75% down from the peak of activity they reached back in 2005. Housing starts grew dramatically, by 17.2% in May. The problem is that they had dropped by 12.9% in April to a post-war low. So the apparent strength is something of an illusion. Yes it’s better to grow than to contract, but when you have scraped the bottom any optimism should be tempered by the hill yet to climb back to normality. And: who knows what the ‘new normality’ will turn out to be? I always urge you to look at trends: the average starts figure over the last four months is now very positive. That’s the first such positive for three years. The bottom has been reached and we are moving up slowly. There’s a long way to go though: the unsold inventory of homes is still above ten months supply. Until that is worked back down to less than six months, which is roughly where it has been during ‘normal’ years home prices will remain under downward pressure.
2. Industrial Production. This is bad news. Industrial production dropped much more sharply than anyone expected, by 1.1% in May. And factories are operating at very low capacities as well, capacity utilization is 68.3% which is the lowest level on record. Clearly manufacturing is still mired deep in recession with little obvious sign of recovery.
3. Business Investment. Having said that, businesses increased their orders of capital goods last month. Purchases of equipment has now risen 5.8% over the past three months. Normally this a good indicator of future production. Given that the run down in inventories has to end sometime, it seems highly likely that production will tick up a little later in the year. I doubt that this uptick will be very robust – it will be more of a technical adjustment as businesses react to the very low levels they will have reached by then. Durable goods orders also rose last month, up 1.9%. Again I doubt the signifies much: they had dropped by a revised 2.1% the previous month, and the upturn an housing is always associated with durable goods orders also rising. Although the orders usually precede the actual construction increase.
4. Employment. The big one. Until employment stabilizes and improves the economy will remain fragile. This morning’s release shows a continuing moderation in the number of initial claims for unemployment assistance. This is one of our most important pieces of data since it is released weekly. This frequency makes it very valuable as an indicator of activity. So the drop of 13,000 in the data to a weekly level of 623,000 is good news. Better yet: the four week moving average [always look at trends!] has also improved very slightly, by 3,000 to 626,700. The implication is obvious: the economy is bottoming out. Employers have done the majority of downsizing and the pace of contraction seems to be tapering off.

What to make of all this data?

Well as I said initially: lots of data but little new information.

The key point resides in that employment trend. We have hit are are close to the bottom. But that doesn’t mean much beyond the fact that we do not seem to be plunging into depression. This is still the mother of recessions. By any standard that 623,000 initial claims figure is appalling. That means that well over half a million people applied for unemployment aid last week alone. It is very difficult to turn that into a ‘green shoot’. Although in the depths of winter any sign of green is welcomed as a harbinger of spring.

We must keep the context in mid for any of these figures: this recession is extraordinary. We only just, narrowly, avoided a full depression. The cost of digging out will be astronomic.

And problems abound.

The slight improvement in the claims for unemployment aid is nice to see. But when compared with past recessions it is very poor. Typically the improvement is much more pronounced and leads quickly to an end to the rise in unemployment and then to a burst of job creation. Both those appear to be way off. Which means that the ‘knock on’ effects of lingering high unemployment – lower consumption, unusually high savings, debt reduction etc. – will remain with us and will thus dampen, and perhaps even prevent, a recovery.

For those of you who like to look at charts of these trends I highly recommend the summary put together by Paul Schwarz at the Council on Foreign Relations – I came across it at the Baseline Scenario.

Taking all this data together and then trying to make sense is difficult. The amount of information revealed by the data is small. But: it seems we are at the bottom. Things are getting worse, but at a slower rate of decline. Eventually this will translate into growth and the end of recession.

Everything hangs on the word ‘eventually’.

That could be later this year. I have said before that a ‘normal’ inventory cycle would imply a return to growth in the fourth quarter. The capital goods data this morning provides a hint that cycle is underway. But it looks very weak and may not be sustainable without a stronger job outlook. That seems to be a long way off. So a better bet on the return to growth is sometime next year. With the emphasis on ‘sometime’.

We are left grasping at green shoots.

That doesn’t fill me with confidence.

Addendum:

The inflation data also came out this morning. There was no news in it other than the fact that both consumer and producer price increases were lower than expected. Usually we would applaud low inflation, and the good news here is that there is no sign of the ‘surge’ in inflation that some commentators have been talking about as a consequence of the stimulus. I wouldn’t expect there to be such a surge. There isn’t. So hyped up chatter about the ‘disastrous effects of all that government debt is just that: hype.

But.

Low inflation is also a sign that the economy isn’t springing back to life either. There is no room for businesses to raise prices because demand is so low. What price pressure there is will most likely come from quirky things like the dollar changing value and therefore altering imported oil prices, and not from more regular sources such as growing demand. There is simply too much slack in the economy – think about those capacity utilization figures I mentioned above – for inflation to appear just yet.