The Week's Economic Reports

Following is a summary of last week's economic reports. Surprisingly strong GDP growth, steady employment gains, and a weakening manufacturing sector highlighted a busy week of news on the economy. For the week, the S&P 500 Index rose 1.8 percent to 1,448 and the yield of the 10-year U.S. Treasury note fell 5 basis points to 4.83 percent.


Consumer Confidence: Confirming the multi-year high reported by the University of Michigan two weeks ago, the Conference Board's consumer sentiment indicator reached a 56-month high, rising to 110.3 in January. The optimism was driven mainly by the present outlook for labor market conditions, where, the "jobs hard to get" category fell from 21.3 percent to 19.7 percent and the "jobs plentiful" category rose from 26.6 percent to 29.9 percent. The labor report on Friday confirmed this rosy outlook.

Gross Domestic Product: Exceeding expectations, the advance estimate of fourth quarter real GDP rose to an annualized rate of 3.5 percent from the 2.0 percent pace seen in the third quarter. This is the first of three readings for Q4 GDP - the preliminary estimate will be released at the end of February, followed by the final reading at the end of March. Based on this first measure of fourth quarter growth, real GDP rose 3.4 percent for the year 2006.

An annualized 4.4 percent increase in personal consumption drove total output higher, however, the bottom line benefited greatly from lower inflation readings during the quarter. The GDP price index fell to an annualized rate of 1.5 percent from 1.9 percent in the third quarter, largely a result of lower energy prices.

Residential investment continued to be a drag, falling at a rate of 19.2 percent following a decline of 18.7 percent in the third quarter, however, at less than six percent of total output, this large drop had only a minor impact on overall economic growth.

Increased government spending, up 3.4 percent, along with a narrowing trade deficit (again aided by falling oil prices) helped to boost GDP. Recall that net imports are subtracted from GDP, so the reduction in the trade deficit to $581.4 from $628.8 in the third quarter contributed to the better than expected total.

The advance estimate is subject to sometimes large revisions and the final tally will not be known for two more months, but it seems clear at this point that the combination of lower energy prices and a confident consumer are driving this traditional measure of economic growth to levels that many would not have envisioned just six or eight months ago.

Whether this will continue or not is an entirely different question - it all seems to hinge on energy prices. When energy prices go up, both inflation and the trade deficit go up, consumers pull back on spending due to higher energy costs and a falling sentiment, and economic growth slows. When energy prices go down, the opposite happens. If energy prices remain contained in 2007, don't be surprised to see continued strong economic growth at least for the first part of the year. So far, weakness in housing has not materially affected the outlook of consumers.

Chicago PMI: The Chicago purchasing managers' index fell to 48.8 in January from 51.6 in December, largely a result of a sharp decline in new orders. Readings below 50 indicate contraction for this measure of manufacturing activity for the Chicago area - this is the first sub-50 reading since April of 2003.

Construction Spending: Construction spending fell 0.4 percent in December after an upwardly revised 0.1 percent increase in November. Once again, private residential construction led the overall index lower, falling 1.6 percent in December after a decline of 1.4 percent in November, paced by slowing activity in the construction of single-family housing.

ISM Manufacturing Index: The Institute for Supply Management's manufacturing index fell to 49.3 in January after a reading of 51.4 in December. This is the second time in the last three months that a sub-50 level has been reported, an indication of contraction in manufacturing activity in the U.S. as a whole. After peaking in early 2004 the pace at which manufacturing has expanded had steadily declined until November of last year when outright contraction was indicated as the index registered 49.5, the first sub-50 reading since April of 2003.

Personal Income and Spending: The savings rate for all of 2006 dipped to a 74-year low registering -1.2 percent, indicating that consumers spent all of their after tax income and either tapped savings or added debt to fund the additional purchases. The 2006 level was the lowest since the depths of The Great Depression in 1933, when the savings rate registered -1.5 percent, and comes after a level of -0.4 percent during 2005.

The details of the December report show robust spending (up 0.7 percent), healthy income growth (up 0.5 percent), and moderate inflation (up 0.4 percent). For the year, personal income was up 5.9 percent while spending rose 6.0 percent - a number of other factors account for the much larger negative savings rate of -1.2 percent than that indicated by simply subtracting the annual change in spending from the annual change in income.

Pending Home Sales: The National Association of Realtors reported a higher than expected 4.9 percent increase in pending home sales for December. This was the largest monthly increase since March of 2004, however this report comes during an unusually warm December in what is a very slow time of the year for real estate sales and should not be interpreted as confirmation of a housing rebound. Nothing of substance regarding the condition of the nation's real estate market will be learned until March or April due to seasonal factors that render the winter data almost meaningless.

Labor Report: Nonfarm payrolls increased by 111,000 in January following upwardly revised gains of 206,000 in December (from 167,000) and 196,000 in November (from 154,000). Once again, the revisions from prior months are of roughly the same magnitude as the new data, making the most recent data all the more difficult to interpret.

The unemployment rate rose slightly, from 4.5 percent in December to 4.6 percent in January, and remains at what is essentially full-employment. Both wages and the average workweek contracted slightly.

Gains in nonfarm payrolls were led by Education and Health Care (up 31,000), Professional and Business Services (up 25,000), Leisure and Hospitality (up 23,000), and Construction (up 22,000). A total of 11,000 positions were lost in residential construction, however, this was easily offset by 27,000 new jobs in the nonresidential building. Manufacturing employment declined by 16,000.

The report also included benchmark revisions for the birth-death adjustment model going back to April of 2005 - a total upward revision of 754,000 jobs has now been added to the Bureau of Labor Statistics (BLS) database showing an average of almost 200,000 new jobs per month over the last three years.
It is hard to argue with the statistics from the BLS as there are no real indicators to contradict their reports. Unlike inflation, where the "man on the street" would more likely differ with the government's account of rising prices, jobs appear to be plentiful in most parts of the country as confirmed by numerous consumer confidence surveys and anecdotal evidence. Whether the available jobs pay enough over the long-run to support rising prices is another matter.

Consumer Sentiment: Consumer sentiment has rebounded rapidly in the last few months, since energy prices came down and the mid-term elections were held. The final January reading of 96.9 from the University of Michigan was up from December's 91.7 and confirms a similar good mood amongst consumers as reported on Tuesday by the Conference Board.

Factory Orders: Factory orders exceeded expectations rising 2.4 percent in December after a 0.9 percent gain in November. The increase was driven largely by orders for civilian aircraft and energy prices that rose during the reporting period.

FOMC Meeting: The Federal Reserve's Federal Open Market Committee left short-term interest rates unchanged at 5.25 percent on Wednesday in a unanimous vote (Richmond Fed President Jeffery Lacker, who had dissented during the last three meetings, is no longer a voting member of the policy setting committee). While maintaining the same hawkish statement "The Committee judges that some inflation risks remain", the balance of the policy statement indicated that inflation had "improved modestly" and that "tentative stabilization" was seen in the housing market. Equity and commodity markets interpreted this as an indication that the Fed may stand pat on interest rates for the remainder of the year.

Summary: The mood of the Federal Reserve, as evidenced by their policy statement, along with reportedly low inflation and solid GDP growth have made the term "Goldilocks" one of the most widely used words in the financial world in recent months. The usage may have hit new all-time highs last week.

It's hard to disagree with that assessment given the raft of good economic reports over the last three months. An emboldened consumer and a steady jobs market make for a robust economy as long as energy prices stay low, the housing market does not crash, and the manufacturing sector does not slow dramatically. That appears to be the case so far.

The Week Ahead

This week will be relatively light for economic news. The Institute for Supply Management's non-manufacturing index will be reported on Monday, consumer credit and productivity costs on Wednesday, and wholesale trade on Thursday.

Charts courtesy of The Wall Street Journal and Northern Trust.