Vital Signs: Manufacturing Picks Up, But Consumer Spending Remains Weak

9:07 | 26/10/2011

On deck: retail sales, producer and consumer Prices, business inventories, current account, industrial production, homebuilders’ survey and housing starts

The economy is showing more signs that the rebound from the recession is starting out much stronger than anyone had anticipated only a few months ago. In recent weeks, economic researchers at most Wall Street houses have been raising their growth projections, especially for the second half. For example, economists at both J.P. Morgan (JPM) and Barclays Capital (BCS) now expect second-half growth in real GDP of 3.5%. And the folks at Barclays think their forecast might be too low.

The third quarter is already off to a good start in a number of areas, although consumer spending remains problematic. Real household outlays in July began the third quarter above the second-quarter level, and August spending should rise even higher. However, car-buying, reflecting cash-for-clunkers deals, accounted for all of that strength. In July, for example, real outlays excluding autos dipped slightly below the previous quarter’s level. This week’s government report on August retail sales, especially outside of car sales, will help to assess how much consumers are contributing to third-quarter GDP growth.

However, the new thinking on second-half growth goes beyond consumers. First of all, the solid upturn in manufacturing activity in July and August is strong evidence that companies are replenishing inventories after a record liquidation in the first half. Although demand was falling, businesses were cutting their production at an even faster rate. Now that demand has begun to edge up, companies have to order more goods.

Led by a resurgence in auto production, manufacturing output picked up sharply in July, and the August survey of manufacturers from the Institute for Supply Management implies another good gain last month. July data on business inventories, due this week, will guide economists’ thinking on the influence of stockpiles on third quarter GDP growth. Right now, analysts look for a reduced rate of inventory liquidation to contribute some three percentage points to the quarter’s growth rate.

Other data at the start of the quarter suggest additional support to growth. In particular, solid strength in home demand and housing starts, along with a big 2.3% rise in July residential construction outlays, almost guarantee a double-digit rise in the housing component of GDP. That would be the first time housing has contributed positively to economic growth in 3 1/2 years. In addition, July shipments of capital equipment, other than defense items and commercial aircraft, stood well higher than their second-quarter average. That’s a sign that the decline in business outlays for equipment, which have fallen for six quarters in a row, is ending.

Of course, the growth momentum now building cannot be sustained without at least a modest contribution from consumers. That will depend on when and how strongly job growth picks up. If monthly job losses continue to ebb at the pace of recent months, the drop in payrolls would come to a halt by yearend. That’s a real possibility, given economists’ expectations of second-half GDP growth in the range of 3% to 4%, a pace historically consistent with rising payrolls. However, amid subdued growth in demand and a keen desire among businesses to keep costs down and productivity up, hiring will most likely start off slowly.