Falling Revenues Fuel Layoffs
Employment losses have deepened considerably in recent months and revisions to previously published data suggest that total job losses for this recession will now top 6.5 million. Nonfarm employment plunged by 598,000 jobs in January and the unemployment rate rose 0.4 percentage points to 7.6 percent. Both numbers were slightly worse than consensus estimates.
The January employment data also included revisions to previously published data going all the way back to April 2007. The new figures bring total job losses to slightly over 3.5 million since employment peaked in December 2007. The heaviest losses by far have occurred during the past five months, a period during which nominal GDP has been negative.
Nominal GDP reflects the volume of goods and services produced throughout the economy and the price at which they were sold. In short, nominal GDP is the revenue of the entire economy. With total revenue declining at its worst pace since the late 1950s, many businesses and governments are in survival mode and have no choice but to cut jobs.
Widespread Job Losses Should Continue in Early 2009
Job losses continue to be exceptionally broad based. Virtually every major industry category shed jobs in January, a trend that has become all too common. The heaviest job losses continue to be in the goods sector, where construction firms shed 111,000 jobs in January and factories cut 207,000 positions. Some of the largest cutbacks were in the motor vehicle sector, where extended plant shutdowns led to huge drops in employment and hours worked. Other areas with particularly large cutbacks in January include fabricated metals and industrial machinery. In all, durable goods producers slashed 157,000 jobs in January accounting for just over three-fourths of the loss in manufacturing jobs.
Cutbacks in the durable goods sector are likely to continue. Factory orders declined more than expected in December. Overall orders fell 3.9 percent, following declines of 6.5 percent in November and 6.0 percent in October. Orders for non-defense capital goods excluding aircraft were down 6.3 percent in December and plunged at a 34.1 percent annual rate over the past three months. Shipments for this same key category fell at less than half that pace, declining at a 14.9 percent pace, indicating that further production cutbacks will be needed to bring production and inventories back in line with demand.
There was very little cheer in this week's other economic reports. Weekly first time unemployment claims rose by 35,000 to 626,000 in late January, suggesting that February's employment data will once again post a hefty drop. Unemployment will also likely trend higher from January's 7.6 percent.
Motor vehicle sales came in lower than expected, with cars and light trucks selling at just a 9.6 million unit annual rate. That pace was more than half a million units below the consensus estimate and marked the weakest pace for motor vehicle sales since 1982. The weakness in sales will make it even more difficult to clear out bloated inventories of domestic and imported vehicles, which means declines in production and imports will likely extend for a few more months.
The only good news this week is that nonfarm productivity rose at a 3.2 percent annual rate during the fourth quarter, as businesses slashed 'hours worked' at an even faster rate than output declined. While stronger productivity is a generally a good thing, much of the recent gain is likely coming out of necessity. Moreover, the flip side of this report is that businesses have been slashing jobs and hours worked. While these cutbacks are a necessary evil in a capitalist society, they are a very bitter pill to swallow.
U.S. Outlook
International Trade Balance • Wednesday
The trade deficit narrowed considerably to $40.4 billion in November from $56.7 billion, dropping to a five-year low. A collapse in the value of oil imports explains much of the decline. However, non-oil imports weakened sharply as well, reflecting weakness in the domestic economy. Meanwhile, foreign recessions are causing exports to decline.
It is clear that the combination of a global recession and the global credit crunch is causing worldwide trade to dry up. The trade deficit should continue to improve due in part to the decline in oil prices. Crude oil prices came off roughly 18 percent in December. We expect the trade deficit to continue to narrow to $36.0 billion in December. The real trade balance, which is used to calculate real GDP, should also narrow.
Previous: -$40.4 B Wachovia: -$36.0 B Consensus: -$36.4 B
Retail Sales • Thursday
Retail sales plunged 2.7 percent in December, the sixth consecutive decline. Revisions were substantial with November falling 2.1 percent. Core retail sales, which excludes gasoline stations, building materials and autos, fell 1.4 percent. The biggest drop was in gasoline station sales, which fell 15.9 percent.
We expect retail sales will decline 0.2 percent in January with motor vehicle sales continuing to pull down the headline number. Light vehicle sales registered 9.6 million units in January, the lowest since 1982. Same store sales continue to show consumers pulling back on discretionary items with department store sales down sharply. Retail sales excluding autos should increase 0.6 percent due in part to a slight uptick in prices at the pump.
Previous: -2.7% Wachovia: -0.2% Consensus: -0.4%
Business Inventories • Thursday
Business inventories declined for the third consecutive month in November providing further evidence of a tough fourth quarter for business spending. The inventory-to-sales ratio continued to climb as sales fell faster than business owners could cut production.
We expect business inventories to continue to decline in December due to the abruptness and depth of the current economic weakness which caught many producers, wholesalers and retailers by surprise. As a result, many had far too much raw material, work-in-process and finished product. Wholesalers and retailers alike will look to curtail orders for new products, and manufacturers will have to continue to cut back output. Unintentional inventory increases during a weak growth period pose a considerable risk to production activity. We expect production will fall through the next three quarters.
Previous: -0.7% Consensus: -0.6%
Global Review
Further Monetary Easing Abroad
A number of major central banks held policy meetings this week and some, but not all, cut rates further. The Reserve Bank of Australia (RBA) kicked things off on Tuesday by slashing its policy rate by 100 bps, bringing the total amount of easing since September to 400 bps (see chart at left). Commodity exports are important to the Australian economy, and the deep global recession that is in train will surely exert a slowing effect on economic activity down-under. The RBA is cutting rates to cushion the blow to the domestic economy.
Despite the deep global downturn, the Australian economy appears to be holding up better than most other major economies, at least so far. For example, retail sales in Australia shot up 3.8 percent in December from the previous month, bringing their year-over-year rise to a respectable 5.6 percent. (In contrast, total retail spending in the United States plunged 9.8 percent in December.) Tax rebates that were legislated last autumn helped to boost Australian retail sales in December. But that's exactly the point. Australian policymakers (both monetary and fiscal) are taking aggressive steps to stimulate the economy. Although Australia may yet slip into recession, the downturn down-under probably will be less severe than in most other major economies.
As widely expected, the Bank of England cut its policy rate by another 50 bps on Thursday. In its statement announcing the move, the Bank said that output thus far in the first quarter continues to contract at a very sharp rate. Indeed, real GDP in the fourth quarter declined at an annualized rate of 5.9 percent, the sharpest rate of contraction since the very deep recession of the early 1980s. As shown in the top chart, the purchasing managers' indices for the manufacturing, construction and service sectors all edged a bit higher in January. That said, the indices remain in territory that is consistent with sharp contraction. In our view, the Bank of England will cut its main policy rate – which already stands at an all-time low of 1.00 percent – even further in the months ahead as the British economy remains mired in deep recession. The European Central Bank probably has more cutting to do as well. However, it did not exercise that option at its policy meeting this week, choosing instead to keep its policy rate unchanged at 2.00 percent. The ECB said that it had anticipated the sharp drop in economic activity that has occurred since it last met in early January, and it had responded to that anticipation by cutting rates last month. By that logic, the ECB would be on hold unless the economy weakens more than anticipated.
As noted above, we believe the ECB will eventually cut rates further. Although the purchasing managers' indices for the manufacturing and service sectors edged higher in January, they both remain in deep recession territory (see middle chart). Economic weakness likely will cause CPI inflation to decline further. Indeed, the overall rate of CPI inflation fell to 1.6 percent in December, and the preliminary estimate for January printed at only 1.1 percent, the lowest rate in nearly 10 years. In our view, severe economic weakness and rapidly declining inflation will give the ECB scope to ease policy further in the months ahead.
Global Outlook
U.K. Unemployment Rate • Wednesday
British real GDP fell at an annualized rate of 5.9 percent in the fourth quarter, the sharpest sequential rate of contraction since 1980. Indeed, the current slump appears to be the deepest recession that Great Britain has suffered since the very painful downturn of the early 1980s. The unemployment rate already exceeds six percent, and the only question seems to be: “How high will it go?”
The Bank of England will also release its quarterly Inflation Report on Wednesday. The Bank's forecasts for GDP growth and CPI inflation over the next two years will help investors judge how much more monetary easing the Bank may undertake. Data on house prices in January, which are on the docket for Monday, and the trade balance in December, which are slated for release on Tuesday, round out a busy week in terms of U.K. economic data.
Previous: 6.1% Consensus: 6.3%
Euro-zone Real GDP Growth • Friday
Real GDP in the Euro-zone declined 0.2 percent (not annualized) in the third quarter, and most monthly indicators suggest that the rate of contraction rose significantly in the fourth quarter. Indeed, we estimate that real GDP fell one percent in the fourth quarter. Not only did exports fall sharply, but growth in consumer spending probably turned negative as well last quarter. The Euro-zone appears to have slipped into its first recession, which incidentally is a deep one, since the inception of European Monetary Union in 1999.
Most major countries in the Euro-zone also release their individual GDP growth figures on Friday, and the results are not expected to be pretty. We project that the German, French, and Italian economies (among others) all contracted markedly in the fourth quarter.
Previous: -0.2% (not annualized) Wachovia: -1.0% Consensus: -1.3%
G-7 Meeting • Friday
Finance ministers and central bank governors will gather in Rome next weekend for their semi-annual meeting. With the global economy mired in its worst recession in the post-World War II era, investors anxiously await steps that governments can take on a coordinated basis to help bring the current financial crisis to an end. G-7 meetings often serve as forums in which policymakers from major countries pledge cooperation to tackle pressing economic and financial problems.
It is expected in many corners that U.S. policymakers will announce steps next week to buy toxic assets from U.S. banks and place the assets in a “bad bank.” If so, pressure will be on other countries to announce similar steps. In addition, more fiscal stimulus measures could be announced next weekend.
Point of View
Interest Rate Watch
Weak Jobs Suggest Continued Fed Easing
Today's weak employment report reinforces our view that the Fed will keep the funds rate in the 0-25 basis point range. Moreover, given the weakness in consumer spending, we expect that the Fed will continue to support consumer related asset backed facilities by buying commercial paper and asset backed paper. Financial stability and economic recovery continue to be the primary intermediate-term policy targets for the Fed. The recession will continue at least through the first half of this year.
Because of continued economic weakness we expect that the Fed will maintain its expanded balance sheet to support financial markets. The Fed will continue with its outright purchases of Government Sponsored Enterprise (GSE) debt and Agency mortgage backed securities and asset-backed paper. Monetary policy continues to adjust to an environment of economic recession, lower inflation expectations and the imbalance of asset valuations.
But Weak Jobs Also Raise Credit Concerns
Credit quality will be challenged. Weak jobs suggest weak consumer spending and rising delinquency rates for all consumer-related debt. For many businesses top line revenue declines will reflect lower consumer spending. For many firms, the hit to cash flow and ultimately profits dictates wider credit spreads in the marketplace.
Finally, weaker economic growth dictates weaker public sector revenues and thereby a squeeze on public finances. Longer dated federal and state debt will begin to reflect this credit/revenue issue in a steeper yield curve and perhaps even credit downgrades al lá California.
Topic of the Week
Economic Downturn Challenges State and Local Tax Revenue
The recession is taking a heavy toll on state and local tax revenue. With roughly 77 percent of total tax revenue nationwide coming from income, property and sales tax receipts, revenues are under pressure on nearly every front. Layoffs are cutting into income tax receipts, while falling home prices and the faltering stock market are hitting a whole variety of taxes and fees.
Personal income tax receipts will likely be reduced considerably during the coming year due to a weakened labor market. The economy has shed more than 3.5 million jobs since the recession began, with more than 1.5 million jobs eliminated during the fourth quarter alone. With layoff announcements picking up at the start of the year, we expect total job losses to eventually reach more than five million.
To meet balanced-budget requirements, many state and local governments are either pulling back on spending, raising taxes or both. Spending cuts are one of the few options open to state and local governments in the short term, and many have cut spending dramatically. Unfortunately, more cuts are likely unless funding can be secured from the federal government. Raising taxes in a recession often creates more problems than it solves.
The recovery for state and local tax revenue should lag the overall economic recovery as the unemployment rate tends to peak well after the recession ends. We expect the unemployment rate to peak in early to mid-2010, which means state and local tax revenue will likely remain challenged until 2010.
Wachovia Corporation http://www.wachovia.com
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