Monday, 6 October 2008

Signs of US recession are spreading

The debate over whether the United States economy is in or entering a recession is now almost over. The latest data show that the economy is weak on all fronts.

Market attention over the past week had been largely focussed on the package designed by the Treasury Department to rescue financial institutions by relieving them of troubled assets. That package was approved and signed into law at the end of the week.

Meanwhile, though, there were also a number of economic reports released last week that showed how much the economy is already weakening.

On 3 October, the Labor Department reported that non-farm payrolls fell 159,000 in September, the ninth consecutive month of job losses and the most in five years. The unemployment rate was at 6.1 percent, unchanged from August.

This pattern of persistent job losses has, in the past, been indicative of a recession (see "Surely a recession now").

Until recently though, most other indicators had not exhibited clear signs of a recession. The latest data show, however, that this is beginning to change.

Consumer spending is weak. On 29 September, the Commerce Department reported that consumer spending was flat in August. Although the Conference Board reported the next day that consumer confidence rose to 59.8 in September from 58.5 in August, it is still at a low level.

Businesses also appear to be increasingly reluctant to spend. On 2 October, the Commerce Department reported that factory orders fell 4.0 percent in August with orders for capital goods excluding defence and aircraft, a measure of future business capital spending, falling 2.4 percent.

That report was consistent with the numbers from the Institute for Supply Management (ISM). On 1 October, the ISM reported that its manufacturing PMI plunged to 43.5 in September, the lowest level since October 2001, from 49.9 in August. The new orders index plunged to 38.8 in September from 48.3 in August. The employment index plunged to 41.8 from 49.7.

The plunge in the ISM PMI in September in particular may be a signal that the US economy has entered or is about to enter a recession. In the months before September, the PMI had stayed relatively resilient, holding up around the 50 mark that indicates a flat performance for manufacturing. The plunge in the PMI to 43.5 in September decisively breaks that holding pattern.

As the accompanying chart shows, not since the 1960s has the PMI fallen to such a level without the economy entering a recession.

Doubts over a possible recession cannot be totally dispelled though. The ISM's report on non-manufacturing business on 3 October turned out somewhat better. The non-manufacturing index fell marginally to 50.2 in September from 50.6 in August. The reading indicates that the services sector is not contracting yet.

Credit markets, though, are showing so much distress that even if the economy has not entered a recession, it could do so soon.

According to Bloomberg, yields on Treasuries fell sharply last week, with the yield on the three-month bill falling 38 basis points to 0.47 percent, the yield on the two-year note falling 51 basis points to 1.58 percent and the yield on the ten-year note falling 25 basis points to 3.60 percent.

Interest rates on interbank loans, however, have gone in the opposite direction. The London Interbank Offered Rate (LIBOR) rose 47 basis points to 4.33 percent. The TED spread -- the difference between the three-month Treasury bill yield and the three-month LIBOR -- has now widened to 3.87 percentage points, the most since Bloomberg began compiling the data in 1984.

Meanwhile, yield spreads over benchmark rates on US speculative-grade bonds widened to 1,200 basis points last week, the highest on record, and 175 basis points more than last week, according to Merrill Lynch's US High Yield Master II index.

The turmoil in credit markets is hurting corporate bond sales. The value of such sales has declined to US$14.2 billion over the past four weeks, the slowest such period since borrowers issued US$12 billion of debt in the four weeks from 13 December 1999 to 17 January 2000. Sales were just US$1.25 billion last week.

So while reports on US gross domestic product have so far shown positive growth, this may not last for much longer. On 26 September, the Commerce Department had released the latest estimate of real GDP for the second quarter showing a quarter-on-quarter seasonally-adjusted annualised growth rate of 2.8 percent. However, the third or subsequent quarters could see the growth rate follow in the footsteps of the ISM PMI and turn decisively downward.

Little wonder then that the US government felt compelled to rush a rescue package for financial markets.

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