Stronger Jobless Recovery Ahead for U.S.
Lakshman Achuthan
A Step-up in Growth
In the three quarters following its cyclical low in the third quarter of 2001, U.S. GDP grew at a 3.4% annual rate. In the next three quarters, GDP growth slowed to half that pace. The tempo is about to pick up once again.
The contours of the impending shift are mapped out by ECRI's array of leading indexes. The latest readings show growth in the U.S. Long Leading Index close to a one-year high, and growth in the U.S. Short Leading Index rising in its wake to a six-month high. But growth in the Weekly Leading Index, which is more sensitive to market-related indicators, is hovering around a 20-year high - its fastest pace since the first Reagan administration. Growth in the Leading Services Index has rebounded significantly in recent months, and the Leading Construction Index is also in a clear upswing, but the U.S. Leading Manufacturing Index (USLMI) has risen more modestly. Growth in the Leading Employment Index has also seen a relatively mild upturn.
Moving from a Job-loss to a Jobless Recovery
The implication is clear. While market indicators are more optimistic than those related to the real economy, the signs of an imminent pickup in growth are unambiguous, especially outside the manufacturing sector. There will also be a positive impact on employment, which, as measured by the establishment survey, has declined throughout the business cycle recovery that began in November 2001. What this implies is a transition from what some have called a job-loss recovery to the more familiar jobless recovery.
The main reason for this lopsided recovery - more in GDP, less in jobs - is the combination of stronger productivity growth and outsourcing of jobs abroad necessitated by the lack of pricing power of many firms. Such firms must cut costs in order to survive, and are reluctant to add payroll costs when they can be lowered through higher productivity and cheaper foreign labor. That does not mean that no domestic jobs will be added, merely that stronger output and sales growth will be followed by a disproportionately slow pickup in job growth.
Crosscurrents in Manufacturing
Growth in the USLMI has risen to a six-month high, anticipating some recovery in the sector, based on scattered strength in the USLMI components. Among those components, one of the most promptly available is the JOC-ECRI Industrial Materials Price Index.
As Chart 1a shows, growth in this index recovered strongly by mid-2002 from its late 2001 recessionary lows before easing in the second half of the year. A subsequent advance from late 2002 to early 2003 was aborted by war-related worries, which, by mid-May, had pushed the indicator down to a 14-month low.
Since then, however, the index has seen a significant recovery. What is interesting is not just that the latest advance has been pronounced, with the growth rate rising from -0.3% to 17.1% in just two months, but that it has also been quite pervasive, with almost all components participating in the advance. While a two-month advance does not count as being all that persistent, it is a start.
The pervasiveness of the advance is a telling sign of macroeconomic strength. This is because only a broad upturn in the industrial sector, rather than idiosyncratic factors driving individual commodity prices, can cause such an across-the-board increase.
If the advance continues, it would be a clear sign of revival in industrial demand. But because industrial commodity prices are determined by global supply and demand, the question still remains as to the source of this revival in demand. In particular, given the tremendous upsurge in Chinese manufacturing activity accompanying the rapid shift in industrial capacity to China, it is at least plausible that the strength in the JOCECRI Index may reflect demand from China rather than the U.S.
An intriguing piece of evidence is consistent with such an interpretation. For five straight months, the ISM manufacturing survey has reported that corrugated cartons have fallen in price. This is a sign of industrial weakness, not strength, because those are the boxes in which products are shipped to stores.
In fact, until a decade or so ago, the price of old corrugated boxes was one of the components of the JOC-ECRI Index. The reason we discarded this sensitive economic indicator is that during the 1990-91 recession, a combination of slack demand and the introduction of mandatory recycling made the price level plunge into negative territory. What that meant was that supermarkets now had to pay people to take away their old cardboard boxes, but a negative price makes it difficult to use in an index.
The current weakness in the price of cardboard cartons in the U.S. may imply that the demand driving the rise in broader industrial commodity prices is more global, and not a clear sign of revival in the U.S. manufacturing sector. If so, there may be less to the USLMI upturn than meets the eye.
This is not to suggest that the USLMI upturn is misleading. In fact, ECRI's leading indexes are all fairly broadbased, and the JOC-ECRI Index is not the only indicator driving the USLMI upturn. Thus, there is likely to be some revival in manufacturing activity, only not a robust one.
A Smooth Handoff or a Fumble?
A couple of months ago, deflation fears had driven bond yields down to generational lows. Since then, the bond market appears to have belatedly realized what we pointed out in our publication last May, that such fears are largely unfounded, the Fed's oblique hints notwithstanding. The recent snapback in bond yields reflects that understanding in some measure.
But the resultant rise in mortgage rates has raised the concern that the boom in housing that has helped sustain the U.S. economy thus far could be choked off abruptly, hurting home prices and endangering the recovery. If so, the vital housing sector in particular, and the consumer in general, may weaken before a smooth handoff to the manufacturing sector.
As Chart 1b shows, however, fears of an imminent decline in home prices may be overdone. The chart shows ECRI's Leading Home Price Index (LHPI), which is designed to anticipate turning points in inflation-adjusted home prices. As the chart shows, the LHPI has recently rebounded, suggesting that home prices will keep rising in the near term.
Under the circumstances, the housing market is unlikely to weaken soon. Meanwhile, the manufacturing sector should begin to see a modest revival, while the rest of the economy experiences a more robust recovery. In other words, the performance of ECRI's leading indexes suggests that a new recession is virtually impossible this year in the absence of a truly massive shock.
The problem is that job growth will not pick up strongly any time soon. Until that happens, the soft labor market will remain a drag on confidence.
Lakshman Achuthan
Managing Director
Economic Cycle Research Institute (ECRI)
+1.212.557.7788, www.businesscycle.com
August - 2003
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