April 10, 2009

U.S. Recession Drags On

Recently released data reflect a continued contraction of the U.S. economy. The downturn deepened as industrial capacity fell to new lows and the labor market weakened further. Meanwhile, financial markets continue to make uneven progress, inflation appears to have stabilized and recent durable goods, retail sales and housing reports were not as weak as markets had expected.

GDP Contracts at Faster Pace
Real gross domestic product (GDP) contracted at a revised 6.3 percent annualized rate in fourth quarter 2008, notably steeper than the 3.8 percent rate estimated in February’s advance release. While the downward revision was widespread, the largest contributors were private inventory investment, exports and personal consumption expenditures, or PCE (Chart 1). Real personal consumption expenditures fell again in February as real disposable income declined for the first time since August, falling 0.5 percent. Corporate profits plunged 16.5 percent in fourth quarter 2008, or $250 billion, the largest drop in over 50 years.

On a positive note, durable goods orders surprised market analysts in February as new orders increased 3.5 percent, bringing a halt to six months of consecutive declines. Nondefense capital goods orders rose 7.9 percent, and retail sales excluding autos came in better than expected, increasing 0.8 percent. While the Institute for Supply Management’s index of manufacturing-sector growth has slowly trended upward since its historic low in December, the service-sector index again shows an increasing rate of deterioration. The levels of both indexes continue to reflect significant pullbacks in output. Industrial production fell an additional 1.5 percent in February and is now down more than 12 percent from its December 2007 peak, the start of the current recession (Chart 2). Both manufacturing (66.8 percent) and total industry (70.2 percent) capacity utilization broke their 1982 historic lows in February.

The Conference Board’s index of leading economic indicators declined 0.4 percent in February, continuing a general downward trend that began in July 2007. Given the lack of significant improvement in the main components behind February’s decrease—high initial jobless claims, a weak manufacturing sector, volatile stock prices and record low consumer expectations—the U.S. economy is unlikely to start recovering from recession in the very near term.

Job Losses Continue Mounting
The labor market has rapidly deteriorated and will likely remain weak over the next year. Job losses in March were slightly higher than expected as nonfarm payroll employment fell by 663,000. While no revision was made to February’s decrease of 651,000 jobs, January’s losses were revised substantially upward to 741,000 from 655,000. The U.S. economy has now lost over 5.1 million jobs since the start of the recession in December 2007—1.3 million of which were initially underestimated (Chart 3). The near-term employment outlook is grim, with all major sectors posting significant declines, initial claims for unemployment insurance rising to very high levels and unemployment at its highest rate in a quarter of a century—8.5 percent in March, up from 8.1 percent in February.

Some Credit Markets Thawing; Mortgage Rates Low
Interest rate spreads in the interbank and commercial paper markets continued to edge down through March. Short-term credit markets are showing steady improvement. However, longer-term bond markets are still showing considerable signs of stress. The benchmark yield spread between Baa- and Aaa-rated corporate bonds has trended up since mid-February, climbing almost 40 basis points and reflecting firms’ continued difficulties in obtaining financing. The junk bond yield spread has come down about 250 basis points since mid-March, albeit to elevated levels experienced at the start of the year. Despite these wide yield spreads, however, corporate bond issuance improved somewhat over first quarter 2009, thanks in large part to issuance of debt backed by the Federal Deposit Insurance Corporation.

Mortgage rates have retreated, responding positively to the Federal Reserve’s residential mortgage-backed security facility and breaching record lows of the early 1970s. The substantial drop in the 30-year conventional mortgage rate since the start of the year has spurred refinancing activity (Chart 4). The jumbo mortgage rate also came down significantly, dropping 42 basis points following March's Federal Open Market Committee (FOMC) announcement that the Fed would purchase up to an additional $750 billion of agency mortgage-backed securities.

Is Homebuilding Nearing a Bottom?
Some positive signals have recently emerged in residential construction. In February, total building permits increased 3 percent as a result of a 16.1 percent increase in single-family permits, ending a nine-month streak of single-family declines. Total housing starts leapt by 22.2 percent, almost entirely due to an 82.3 percent spike in multifamily starts. New-home sales rose another 4.7 percent, and existing-home sales rose 5.1 percent, reversing January’s decline. While February’s gains were somewhat encouraging, new- and existing-home sales are still down 75.7 percent and 34.9 percent, respectively, from their 2005 peaks. The same is true of permits and starts; despite gains in February, inventories of unsold homes are very high in a still-flooded housing market (Chart 5). As reflected in persistent declines in the S&P/Case-Shiller Composite Home Price Index, there is still a considerable imbalance between supply and demand.

Inflation Stabilizes at Low Levels
After six months of rapid disinflation, inflation rates stabilized at low levels in February. Headline Consumer Price Index (CPI) inflation was up only 0.1 percent from a year ago, after registering negative (deflationary) numbers in the prior two months. Headline PCE inflation was up 1 percent from a year ago, an increase from 0.8 percent in January. Year-over-year core CPI and PCE inflation rates rose at about a 1.8 percent annual pace in February from January’s low of 1.7 percent (Chart 6). Rising unemployment, growing global slack, declining consumption and business investment, wage cuts and the tenuous condition of the banking system should make it difficult for inflation to register at high levels over the next couple of years.

Despite persistent economic contraction in recent months, efforts to repair the financial system, coupled with fiscal and monetary stimulus, should spur an eventual economic recovery.

—Jessica J. Renier

About the Author Renier is a research analyst in the Research Department at the Federal Reserve Bank of Dallas.