Thursday, May 29, 2014

One negative quarter does not make a recession

Real growth in the first quarter was revised down to -1%, more than expected (-.5%).  The economy shrunk by about $40 billion in the first quarter, which in the great scheme of things is equivalent to a rounding error. These things happen occasionally, as you can see in the chart below. It hasn't been a jolt to the equity market because it was most likely only a temporary dip in economic activity.

The thing to focus on is not the weak first quarter, which is almost certainly weather-related, but the indicators that show the economy is very likely continuing to grow at a 2-3% pace. As a supply-sider, I think the things that drive growth are changes in work, output, incentives, and investment. A quick look at key indicators of the supply-side of the economy shows everything still pointing up.

First-time claims for unemployment last week fell to just about their lowest level ever: 300K. If the economy were unraveling, businesses would be stepping up the pace of firings. Instead, the pace of layoffs is about as low as it has ever been. 

With the expiration of "emergency" unemployment benefits early this year, there has been a huge increase in the incentive for the unemployed to find and accept a new job. In the past year, the number of people receiving unemployment insurance has dropped by almost half (-46%). So far this year, 2.2 million people have lost their long-term unemployment benefits. This is a significant change in incentives on the margin that will most likely work to strengthen the economy.

Industrial commodity prices have been rising for the past 8 months and are at relatively high levels from an historical perspective, suggesting that global industrial activity continues to improve.

U.S. manufacturing production rose at a 2.8% annualized pace in the first four months of this year.

The private sector added 840K new jobs in the first four months of this year. That works out to about a 2% annualized pace, which is in line with the trends of the past several years. With average productivity gains of about 1% per year, this pace of jobs growth can deliver 3% real growth over time.

Bank lending to businesses—presumably to finance expansion plans—is up at strong double-digit rates so far this year. Outstanding C&I loans have increased by $90 billion year to date (through mid-May), as shown in the chart above. Banks are more willing to lend and businesses are more willing to borrow; that's a good sign of rising confidence and a leading indicator of more jobs to come.

Capital goods orders—a good proxy for business investment—are up this year, and have been rising at about a 4% annual pace for the past year.

Corporate credit spreads are at post-recession lows. The bond market does not reveal any concerns about the future of corporate profits. Moreover, swap spreads, an excellent and leading indicator of systemic risk, are very near all-time lows.

First quarter growth was disappointingly slow, but that that was very likely just a temporary, weather-related dip in economic activity. Key indicators of current and future growth remain positive. Growth is likely to rebound in the current quarter.


Sid Pools said...

Scott - re: bank lending being up - I work in a CA community bank, and generally we (and many bankers I talk to) see very tepid loan demand - and most of what we see is the remaining few in-market CRE transactions looking to lock in a long-term fixed rate. Is there a way to understand where the loan growth is happening? Is it regional? Maybe a the very upper end of the market (Syndicated deals? Shared National Credits? Leveraged Loans?) For most of the community banks focusing on small to medium sized businesses, growing loans is a real challenge currently.

Scott Grannis said...

I haven't seen a breakdown of C&I Loans, but what you report is interesting. I note that C&I Loans have only recently exceeded their 2008 high, so the banking industry in general has not enjoyed a lot of loan growth. What you say confirms my belief that this recovery has been slow in part because of a relatively high level of risk aversion. Lots of deleveraging translates into weak loan demand. This also helps explain why banks have been accumulating excess bank reserves at the Fed.

I do think however that things are changing for the better, that confidence is slowly returning.

Benjamin Cole said...

Excellent post.
Yes, only one quarter, but it sure raises questions about the Fed's inflation-fixation. We have -1 percent growth and 1 percent inflation on the PCE deflator...does this sound like Japan?