Business investment, which fell precipitously during the crisis, is improving and inventories are stabilizing, boosting faster than expected global growth this quarter and the next. Indicators of final demand, profitability, liquidity, and confidence all suggest that the economic drag created by investment and inventories may be fading.
Though consumer demand indicators remained mixed and were weighed down by record unemployment, the fall in consumption has clearly been broken, as it slowly rose again. Production indicators—which had fallen much faster and further than consumption—continued a strong recovery from low levels, even as stock market nerves overshadowed the good news from the real economy.
As evidence mounted that major economies are returning to growth, G20 finance ministers began discussing future exit strategies for their stimulus and financial sector support policies. However, they also stressed that the recovery is still fragile, and that withdrawal of stimulus now would be premature.
Investment is rebounding from low levels
New orders for capital goods increased in recent months, as did business confidence. National income accounts showed a much slower rate of decline in fixed capital formation in the second quarter as compared to the first quarter, while corporate profits in the United States and Europe rose, and financial conditions continued to improve.
- U.S. orders for non-defense capital goods increased 8.6 percent in July (m/m), after falling 0.4 percent in June and gaining a strong 9.1 percent in May. Euro area orders for capital goods were up 5.6 percent in June, following a 0.1 percent increase in May. German orders rose 3.2 percent in August. Japanese orders for machinery rose 9.7 percent in June, the first increase in four months.
- Fixed capital formation, a measure of physical goods purchased and investments made, fell by 2 percent in the United States, 1.3 percent in the Euro area, and 2.6 percent in Japan in the second quarter (q/q). This contraction is a large improvement from the previous quarter, when it fell by 9.9 percent, 5.3 percent, and 6 percent, respectively. The decline in investment reduced GDP growth by 6.6 percent in the United States and 4.4 percent in Euro area in the first quarter and by 1.8 percent and 1.2 percent, respectively, in the second quarter, all at annual rates.
- Chinese fixed assets accumulation jumped 32.9 percent in the year to July compared to the same period last year.
- U.S. corporate profits (after tax) rose 2.9 percent in the second quarter (q/q), following a return to positive territory in first quarter of 1.3 percent. European profits also improved. Meanwhile, though bank lending remains sluggish, financial conditions continued to improve across a broad spectrum, with corporate bond spreads having declined by 350 basis points since their peak, and bond issuance reaching record levels.
- Japanese Shoko Chukin business confidence improved by 5.8 percent in September and 0.7 points in August. The German IFO business confidence index, an indicator of economic expectations for the coming six months, rose 3.1 points in August, its highest reading since September. China’s macro-economic climate index jumped more than 8 percent in June and July (m/m).
Reduction of inventories likely to moderate
During the worst of the panic, starting in the fourth quarter of 2008, inventories were slashed, weighing heavily on GDP growth. Now inventory levels are finally approaching their historic norms relative to sales. Since final sales are now expected to rise, the steep declines in inventories are not likely to persist. Furthermore, several major economies reported better-than-expected GDP growth in the second quarter. Even a moderation of inventory reductions would provide a significant boost to GDP.
- In the United States, deep inventory downsizing and slowing sales declines have tempered the need for further cuts. Inventories fell by $159 billion, or 8.6 percent (seasonally adjusted at annual rates) in the second quarter, outpacing the $114 billion, or 6.1 percent, fall in the first quarter.
- Sales dropped only 1 percent in the second quarter, after losing 6 percent and 8 percent in the two previous quarters, helping to correct the inventory-to-sales ratio that spiked after consumers retreated.
- Changes in German inventories contributed -1.9 percent to GDP growth in the second quarter after contributing no change in the first quarter. Despite this sharp decline, Germany grew at an annual rate of 1.3 percent in the second quarter on the strength of final sales.
- Inventory reductions in Japan lowered GDP by 0.5 percent in the second quarter, over twice its 0.2 percent loss in the first quarter. Nevertheless, Japan grew 3.7 percent (saar) in the second quarter compared to a 14.2 percent (saar) contraction in the first.
- Like Germany and Japan, France emerged from the recession in the second quarter despite increasing inventory cuts. GDP grew 1.4 percent (saar), but inventory losses accelerated from 4.4 percent (saar) in the first quarter to 7.7 percent (saar) in the second.
Production improved further; financial markets are volatile
- U.S. manufacturing expanded for the first time in 19 months in August, as the Institute of Supply Management’s Index increased by 4 points to 52.9. In China, the purchasing managers index (PMI) rose from 52.8 in July to a 16-month high of 55.1. The UK’s manufacturing lagged as the PMI fell from 50.2 to 49.7 in August, signaling contraction.
- The Dow Jones, the S&P 500, and the Nasdaq rose between 2 and 3.2 percent from one week ago, as of mid-day September 8, after declining by between 0.5 percent and 1.2 percent the previous week. The Chinese Shanghai composite index surged 9.2 percent. The TED spread fell 2.4 basis points from a week ago, providing evidence that credit conditions continue to ease.
Consumer demand suggests that growth is resuming hesitantly
- European household spending rose 0.2 percent in the second quarter (q/q), marking the first increase in more than a year. German domestic demand jumped 10.3 percent in July (m/m). U.S. imports surged due to the Cash for Clunkers program and housing sales climbed to their highest annual rate since November 2007. Japan’s retail sales fell 2.5 percent from a year earlier in July. The U.S. services PMI grew to 48.4 in August, up from 46.4, indicating a slower rate of contraction.
- Euro area unemployment reached 9.5 percent in July, the highest level in over 10 years. Japan’s unemployment topped 5.7 percent, while U.S. unemployment climbed to 9.7 percent. The U.S. shed 216,000 jobs in August, fewer than any month since August of 2008.
Stimulative policies remain in place, but discussions about scaling down began.
- G20 finance ministers pushed for tighter bank regulation, including curbs on executive pay. Ministers also vowed to maintain support for the budding recovery.
- U.S. Treasury Secretary Timothy Geithner called for a globally coordinated exit strategy to be put in place once the recovery strengthens.
- The European Central Bank kept its rate at 1 percent. Indonesia maintained its 6.5 percent rate and Australia held steady at 3 percent. Israel’s central bank raised its interest rate 0.25 percentage points to 0.75 percent, becoming the first in the world to do so.
This analysis was produced by the editorial staff of the International Economic Bulletin, including Shimelse Ali, Vera Eidelman, Bennett Stancil, and Uri Dadush.