The US economy is facing strong headwinds currently as data this week showed manufacturing faltering in July and consumers retrenching in June. While those factors impact current growth and give us a sense the 3rd quarter is starting off weak, in 2012 the economy will face the unwinding of government stimulus measures that will shave off around 1.5% of growth during the next year.
1. Gov't Stimulus Spending to Come to an End
While the debt deal envisions only small cuts from the 2012 and 2013 budgets with most of the initial $917 billion in spending cuts backloaded- it would reduce government outlays by $21 billion in the fiscal year that begins Oct. 1st and by $42 billion in the following year - the deal does not have attached to it any stimulus measures that may help an ailing economy.
That means that the economy will have to cope with the phasing out of a 2% cut in the payroll tax as well as the end of extended unemployment benefits. Both of these measures help put money into the economy and into consumers hands. Without them, it takes away aggregate demand and will make it tougher for businesses and for growth overall. The end of this year will also see the end of the stimulus plan signed by Obama around two years ago, taking away another lever of government spending.
According to JPMorgan Chase, the combination of these factors may shave 1.5% off in 2012. Weaker growth means less new jobs, which means weaker spending, which perpetuates a negative feedback loop.
The Obama administration will try and at least get the payroll tax extended before the end of the year.
With fiscal measures off the table, it will be up to the monetary policy side to help stimulate things, which means Bernanke and the FOMC are likely to keep rates low for a long time, a negative fundamental factor for the USD.
2. Manufacturing Continues to Struggle
In the more immediate time-frame we are seeing one of the leading sectors for the US economy slowing - manufacturing.
The relief rally in US equities yesterday (after the details of the debt plan were announced) was cut short by a very weak manufacturing figure, which showed activity barely registering growth.
The ISM Manufacturing PMI came in at 50.9 for July, down from 55.3 in June.
- New orders turned negative at 49.2, showing contraction in that key leading indicator.
- Production and Employment, while still above the 50 level separating expansion from contraction saw declines as well, with the Employment sub-gauge down 6.4 points.
- One positive from the report is that prices cooled considerably, down 9 points to 59.0.
- Backlog of orders, another leading indicator for future production contracted for a second straight month.
Here is a graph of the ISM Manufacturing Index:
Looking at the graph we see the dip in activity over the past 3 months, and its hard to blame the continued weakness on supply-side disruptions from Japan anymore. Therefore this important sector is seeing a genuine slowdown that may be prolonged, especially considering the leading indicators within the July index are pointing to further weakness.
The manufacturing sector had spearheaded the recovery, but has now become part of the worry.
3. Consumer Spending, Incomes Weak
Weak domestic demand was confirmed today as we had June personal spending data come in negative. Households are being squeezed by higher inflation and small wage gains, as well as the concern of a weak labor market - with the UMich consumer sentiment for July down to its weakest reading since March 2009.
Let's see what today's data showed us:
- Personal spending for June was down 0.2%, the first decline in 2 years. Since consumer spending makes up about 70% of the economy, this does not set things up well for the start of the 3rd quarter.
- When spending is adjusted for inflation, which is the measure used for GDP calculations, spending was flat, after dropping 0.1% in May.
- Incomes grew a meek 0.1%, the slowest rate since last November. The figure for May was revised lower to show a 0.2% gain instead of the originally reported 0.3%.
- The savings rate rose to 5.4% in June from 5% in July, which brings the savings rate up to the highest level since last September. It's yet another sign that consumers are becoming more concerned about the economy and the labor market.
- The Core PCE price index, rose 0.1% on the month, lower than expected, while the annual core PCE price index climbed 1.3%, the same rate as in May.
Here is a graph of Personal Spending:
The past 4 months have seen spending decline, and if that trend continues, its going to be tough for the US recovery to pick up any kind of steam. In the 2nd quarter GDP data we saw that consumer spending grew a very tepid 0.1%. We'll see if the end of the summer driving season can bring down gasoline prices (which are hovering at near $4 in much of the country) and alleviate one of the pressures on consumers. Any improvement in jobs data can help turn this around as well.
Key US Data to Watch the Rest of the Week:
1. ISM Services Tomorrow
As shown above the US manufacturing sector stumbled in July, but the services sector is more important to the economy (making up around 2/3rd of economic activity), and we will see what type of reading we get in the ISM non-manufacturing report slated for tomorrow.
Expectations are for a 53.9 reading, an increase compared to June's 53.3. If services can show improvement it will be a positive sign for the recovery.
2. July Non-Farm Payrolls on Friday
The end of the week will bring our main measure for the US labor market, July's non-farm payroll jobs report. We are trying to move away from the very weak readings we had seen in May (25K) and June (18K). Expectations are for something in the order of 90K jobs to be created for the month of July, with the unemployment rate staying steady at 9.2%.
If we can meet those expectations, its at least an improvement on the environment seen the previous 2 months, though the economy needs to create 150K jobs or more to keep up with new entrants into the labor force and to have any chance of bringing down the unemployment rate. A disappointing figure would hurt the USD.
The focus in Washington has been primarily on debt and deficit reduction and has not touched jobs, and even though its the most important subject for the American people, we shouldn't hold our breaths that politicians will act to help job creation at this point.
Chief Market Analyst