Auto inventory restocking only thing between US and recession now
Retail sales are at recessionary levels right now, having dropped for a third consecutive month. I need to flag the inventories data that came out this morning in the US as the only thing between us and outright recession.
The background here is that ECRI has made a big splash of late with their prediction that a new recession would be dated starting right about now when data revisions come in and the recession dating committee has a chance to review these. ECRI’s thesis is controversial particularly because they have been predicting a recession for the better part of a year. And the evidence seems to suggest they originally believed the recession had started in the Fall of 2011. (see here).
I have yet to update the data series that I like to use for macro business cycle forecasting, but the last time I saw the data it did not look like recession was imminent because production and employment numbers in particular were holding it up. I look at second derivatives i.e. – the change in the change – to gauge cyclical directionality. So when we talk about weakness in numbers like wage growth, we are talking about a fall in the rate of increase.
From a cyclical perspective, what you are looking for is real earnings growth (and not debt accumulation) underpinning retail sales and leading to increased production, capital spending and employment. So in expecting a recession, what you would need to see first is weakness in wage growth after inflation or changes in debt accumulation that allows consumers to spend in the absence of real wage growth. We have had this throughout the recovery. But, disposable income has been boosted by government stimulus and tax breaks while debt accumulation has continued due to lower interest rates. So the first chink the armor has been in effect throughout the cyclical recovery in the US.
In the last recession, it was the decline in house prices which triggered the slowdown. Wage levels did not drop in real terms on a year-over-year basis until recession was upon us but the change in real personal income went negative in 2006 right when house prices began to drop.
This decline in disposable income should at first lead to a decline in savings as households attempt to maintain their living standards and ride out what could be a mid-cycle inventory correction or transitory inflation impulses. But eventually the decline in disposable personal income growth feeds through to retail sales. That’s where we are now.
The numbers came out for June and the results were grim.
Not only did sales decline by 0.5% in June rather than rise 0.2% as the consensus expected, but the April data were revised. The measure used for GDP calculations, excludes gasoline, auto and building material sales fell 0.3% for the second consecutive month.
While the May data was unrevised, April’s 0.2% decline turned into a 0.5% fall. April’s ex-auto sales were off 0.6% rather than -0.3%. Economists will likely cut Q2 GDP forecasts and market participants will anticipate additional easing measures by the Federal Reserve.
Now I don’t thinking the Fed makes any difference here whatsoever. But they will try to do what they can. What would make a difference is fiscal policy but we are more concerned about tightening fiscal than loosening it. So fiscal won’t be an aid to preventing recession – and it certainly isn’t in the republicans’ political interest.
Now that retail sales are weak, the key to making this a mid-cycle slowdown and not a recession is inventories. So we have to look to production then. Here’s what we learned about inventories this morning:
Inventories increased 0.3 percent to $1.58 trillion, after rising by an downwardly revised 0.3 percent in April.
Economists polled by Reuters had forecast inventories rising 0.2 percent in May.
Inventories in May were lifted by a 1.9 percent rise in restocking by auto dealers, in line with strong demand for motor vehicles from households earlier this year.
Inventories are a key component of gross domestic product changes. Retail inventories outside of autos – a measure which goes into the calculation of gross domestic product – rose 0.6 percent.
However, inventories at manufacturers dipped 0.2 percent in May. That was in line with recent signs of weakness at American factories.
My read here is that auto manufacturers are skewing the inventories (and jobless claims) numbers higher because usually they have a yearly pause in production but they are building inventories this year to meet anticipated continued strong demand. One reason that initial jobless claims have trended lower is that auto plants have not idled and so this effect is felt in that data as well as in the inventories and output data. Outside of autos, the manufacturing sector is already in recession. (see here). And the gobal manufacturing index hit a three-year low two weeks ago as well.
Nouriel Roubini said on Twitter that US Q2 2012 GDP growth looks like it will come in at 1.2% at best. He also said that Q3 looks even worse since retail sales were down and inventories have been overbuilt. I agree. The only thing keeping the US out of recession is the auto industry. If auto sales fall and they start cutting inventory expect to see a spike in jobless claims along with lower production and inventory numbers that will feed through into recession. We are on a knife’s edge here and any exogenous shock will mean recession.
ECRI are looking a bit more prescient today. Much more data coming later this week.
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