The week's economic reports

Following is a summary of last week's economic reports. Developing weakness in consumer spending in second quarter economic growth along with two more abysmal housing reports sent equity markets reeling around the world. Stocks and bonds ended the week with the S&P 500 Index down a whopping 4.9 percent to 1,459, now up only 2.8 percent on the year, and the yield of the 10-year U.S. Treasury Note down 17 basis points to 4.79 percent.


Existing Home Sales: Once again, existing home sales declined for the month reaching a new five year low at a seasonally adjusted annualized rate of 5.75 million units in June after a downwardly revised total of 5.98 million units in May. Sales of single-family homes plunged at a 30 percent annual rate in the second quarter, the steepest decline in 28 years, and overall existing home sales are down 11.4 percent from year-ago levels.

Though the inventory of unsold homes dropped slightly, due to fewer sales, supply remains at historically high levels of almost nine months. Median prices remain firm at $230,100, up 0.3 percent year-over-year, however, this has more to do with the mix of homes being sold rather than relative prices for comparable properties sold in 2006 versus 2007. The Case-Shiller Home Price Index shows broad mid-single-digit home price declines across major metropolitan areas.

New Home Sales: The nation's homebuilders reported more bad news on residential construction as the deceleration in new home sales quickened in June. New homes sold at an annualized rate of 834,000 in June, from a downwardly revised level of 893,000 in May. The June total just barely exceeds the result of three months ago but will likely become a new seven year low after next month's revision. Downward revisions of prior month's data are now routine - April and May sales were revised lower by 39,000, wiping out the gain that was reported last month.

Like the inventory of existing homes, the supply of new unsold homes remains historically high at 7.8 months and, with the growing troubles in mortgage lending, it is only a matter of time before price cuts accelerate as builders are forced to move inventory. From year-ago levels, the median price for new homes is down just 2.2 percent, however, incentives totaling many thousands of dollars have been masking large price declines for over a year.

Durable Goods: Orders for durable goods snapped back in June growing 1.4 percent after an upwardly revised 2.3 percent decline in May. This result came in below expectations, but more importantly, new orders excluding the volatile transportation category fell 0.5 percent, the second consecutive monthly decline, in what is most likely an early indication that the manufacturing boom of early 2007 is about to come to an end.

Gross Domestic Product: As expected, inflation adjusted economic growth rebounded in the second quarter to an annualized growth rate of 3.4 percent after a very weak first quarter pace of 0.6 percent. While the headline number was greeted warmly by some economists, the underlying trend in personal consumption has led many to believe that trouble lies ahead despite the second quarter improvement in nonresidential construction, higher exports, and a decline in imports.


Gross domestic product measures the total output of an economy or the combined value of all goods and services and is the most important indicator of economic health. There are four major categories:

• Personal consumption expenditures
• Gross private domestic investment
• Net exports of goods and services
• Government consumption expenditures and gross investment

As shown in the chart below, consumer spending (in blue) has contributed the lion's share of growth in recent years but contracted sharply from a 2.56 percentage point contribution to overall GDP in the first quarter to just 0.89 percentage points in the second quarter. With the exception of the Hurricane Katrina affected fourth quarter of 2005, this was the weakest period of consumer spending since the second quarter of 2001, roughly half of the average for the last four years.


You can see what might happen above based on the lagged effect of the housing boom on consumption. Private domestic investment (in red), of which one-third is residential construction, began to wane early in 2006 and then turned negative - now consumer spending drops precipitously. Where will consumer spending go from here?

The last time consumer spending detracted from economic growth was back in 1991, but just maintaining the current level will likely be enough to post a negative overall growth number given the volatility in the other components. Consumer spending, driven in large part by the housing boom and increased debt, has been a prop under the U.S. economy for years - it may be that the prop is about to be removed.

There was good news on the inflation front as the PCE deflator slowed to a 2.7 percent annualized rate after increasing 4.2 percent in the first quarter. The core PCE price index, excluding food and energy, slowed from 2.4 percent in the first quarter to 1.4 percent in the second, however, the bad news is that energy prices have been soaring so far in the third quarter - oil prices are about 10 percent higher in July than the average of April-May-June - so easing price pressures will probably be short-lived.

Consumer Sentiment: The Reuters/University of Michigan index of consumer sentiment rose from a June level of 85.3 to a 90.4 in July, down slightly from a mid-July reading of 92.4. One-year inflation expectations remained steady at 3.4 percent and five-year inflation expectations rose slightly, up to 3.1 percent. Inflation expectations, as represented in this survey, remain fairly well contained as consumers have apparently accepted $3 gasoline - from the looks of oil prices recently, there may be another test coming with $4 gasoline.

Summary: By far, the most significant development of the week was the pullback in consumer spending as seen in the report on second quarter economic growth. Though the overall annualized growth rate of 3.4 percent was quite good, particularly when compared to the first quarter reading, the slowdown in consumer spending bodes ill for economic growth during the second half of the year given that it accounts for more than two-thirds of total output.

The housing market continues to plumb new lows, but this is nothing new. What was new last week were early signs that the manufacturing rebound may have about run its course with the second consecutive decline in durable goods, excluding transportation. Next week's ISM survey will shed more light on the state of domestic manufacturing.

The Week Ahead: Economic reports in the week ahead will be highlighted by the ISM manufacturing report on Wednesday and the labor report on Friday. Also scheduled for release are reports on personal income/spending, construction spending, and consumer confidence on Tuesday, ADP employment and pending home sales on Wednesday, factory orders on Thursday, and the ISM non-manufacturing index on Friday.