Lift from Tax Rebates Fades in Third Quarter

MBA (9/15/2008 ) Velz, Orawin
The latest data confirmed that the economic growth seen in the second quarter is unlikely to be repeated in the third quarter. Retail sales decreased 0.3 percent in August, and July’s figure was revised downward to a drop of 0.5 percent from a previously reported 0.1 percent decrease.
This marked the first back-to-back declines in retail sales in more than two years While falling energy prices played a large role in the decrease in retail sales as they led to a huge drop in sales of gasoline, sales also fell in other major categories including building supply, electronics and department stores.

Retail sales account for about 40 percent of personal consumption expenditures with spending on services accounting for the rest. In July, Inflation-adjusted PCE fell for the second consecutive month. Declining August retail sales and a downward revision in July’s figure strongly suggested that real consumption expenditures could decline in the third quarter for the first time since the 1990-1991 recession.

While PCE accounts for roughly 70 percent of gross domestic product, the economy is likely to continue to grow slightly in the current quarter even with a decline in real consumer spending. Trade is expected to remain a support to the economy, but a weaker one given faltering overseas economies and the stabilization of the dollar, which should slow export growth. The July trade deficit in goods and services was the biggest in 16 months, largely reflecting a jump in oil import bills. Declining energy prices should slow import growth in the near term, offsetting the slower export growth and allowing trade to continue to boost economic growth.

The impact of falling energy prices, partly induced by concerns of slowing global demand, was also evident in August wholesale prices and import prices. The Producer Price Index fell for the first time this year and import prices posted the largest drop since the inception of the series in 1982.

Housing activity remained subdued. The drop in July pending home sales suggested that existing home sales should fall in the near term. One bright spot for the housing and mortgage markets was the sizable decline in mortgage rates, triggered by the Treasury’s announcement that Fannie Mae and Freddie Mac were placed into conservatorship under the control of the Federal Housing Finance Agency.

If mortgage rates remain low or drop further, they should spur housing demand and refinance activity. The impact will depend on the extent of the drop in mortgage rates, which is uncertain for several reasons. First, under the announcement, the Treasury will periodically purchase agency mortgage-backed securities but did not specify the magnitude of its purchases following the $5 billion initial purchase later this month.

Second, mortgage holdings of the two companies will be steadily reduced beginning in 2010. Third, the Treasury’s actions will raise the size of the federal debt, which could potentially cause on long-term Treasury yields to move up. Finally, it’s not clear if there will be changes to previous and future fee increases the two companies charge lenders to buy or guarantee mortgages. These fees are passed through to consumers. In any case, the Treasury’s plans have reduced the odds of a severe financial crisis associated with the possible failure of Fannie Mae and Freddie Mac that could have sent the overall economy into a protracted downturn.

Long-term Treasury yields were little changed. The yield on the 10-year Treasury note stayed around 3.73 percent by mid-Friday afternoon, seven basis points higher than the rate on the previous Friday. Despite little movement in the benchmark 10-year yield, mortgage rates dropped sharply. The spread between the yields on 10-year Treasury notes and conforming fixed-rate mortgages narrowed by about 40 basis points last week from nearly 270 basis points in the prior week. Thirty-year conforming mortgage yields averaged 5.93 percent for the week ending September 11, according to the Freddie Mac Primary Mortgage Market Survey, the lowest reading since mid-May.

Housing and Mortgage Indicators:
The National Association of Realtors Pending Home Sales Index was down 3.2 percent to 86.5 in July, reversing about half of the jump in June. The index was down 6.8 percent from last July, the smallest year-over-year decline since December 2006.

Responsible for the decline in the overall index were large drops in pending home sales in two regions of the country: 10.6 percent in the West and 7.5 percent in Northeast. Pending sales increased 2.8 percent in the Midwest and were flat in the South. Compared with a year ago, every region but the West posted declines. The West, which has experienced the largest home price drop over the past year, saw a robust 11.3 percent increase from last July.

The index is based on signed contracts for existing single-family homes, condos and co-ops. It is a leading indicator of NAR’s existing home sales, which are based on closings, as the signed contract for the purchase of a home generally precedes its closing by one to two months. Following the 6.8 percent pickup in the pending home sales index in June, total existing home sales were up 3.1 percent in July to a seasonally-adjusted annualized rate of 5.0 million. Since November 2007, total existing home sales have been in a narrow range of 4.8 million units to 5.1 million units. NAR will release the existing home sales figure for August on September 24.

Economic Indicators:
The trade deficit in goods and services widened to $62.2 billion in July from $58.8 billion in June. Both exports and imports of goods and services increased to record highs.

Imports rose 3.9 percent, reflecting purchases of crude oil, which averaged a record $124.66 a barrel for foreign crude oil. Exports increased 3.3 percent, led by a $1.4 billion jump in shipments of autos and parts, aircraft and machinery.

Adjusted for inflation, the trade deficit rose to $41.2 billion from $40.1 billion in June. June real trade deficit was revised higher and thus the contribution from trade to economic growth in the second quarter would be downwardly revised.

Import prices declined 3.7 percent in August. Declines in petroleum and industrial metals led the drop. Prices for petroleum dropped 13.0 percent in August, the largest month-to-month decline since 2003. Imported natural gas prices fell 16.4 percent after rising 4.9 percent in July.

Over the past year, import prices were up 16.0 percent, slowing from a 20.1 percent year-over-year gain in July. Import prices excluding fuels rose a tame 0.2 percent, following back-to-back gains of 0.6 percent.

The Producer Price Index fell 0.9 percent, following a 1.2 percent increase in July. Large declines in food and energy prices led the drop in the overall index. Over the past year, the PPI rose 9.7 percent, edging down from a 9.8 percent gain in July, which was the largest year-over-year gain since June 1981.

Excluding food and energy items, the core PPI was up a modest 0.2 percent, decelerating from a 0.7 percent gain in July. From a year ago, the core PPI rose 3.7 percent, the largest gain since May 1991.

Retail sales decreased 0.3 percent in August following a 0.5 percent drop in July. An increase in sales at auto dealers was offset by declines in sales at gasoline stations and building supply stores, non-store retailers, electronics stores and department stores. Sales excluding autos fell 0.7 percent, the first decline since February. Sales increased at grocery stores and sporting goods and hobby stores.

From a year ago, retail sales were up 1.6 percent, the weakest gain since 2002. Despite the expect drop in August, sales at gasoline stations were up more than 20 percent from last year. On the other hand, sales at auto dealers were down nearly 15 percent from last year.

Retail sales excluding autos, gasoline and building materials—the portions used to calculate the consumer spending component of gross domestic product (GDP)—dropped 0.2 percent after a 0.3 percent increase in July.

The preliminary estimate of the University of Michigan’s Consumer Sentiment Index jumped 10.1 points in early September, reaching its highest reading since January. This was the biggest monthly increase since January 2004. A 13-point surge in expectations, the biggest increase since March 1991, led the increase. Assessments of current conditions rose a more modest 5.5 points. Confidence has been improving since July.

Inflationary expectations dropped sharply in September because of declining energy prices. One-year expectations dropped to 3.6 percent from 4.8 percent in July and a peak of 5.2 percent in May. Five-year expectations dropped to 2.9 percent from 3.2 percent in July after peaking in May and June at 3.4 percent.