The US economic calendar last week was extremely thin. The trade deficit for July came in far better than anticipated, possibly positively affecting GDP forecasts for 2010. Since it was such a slow news week, I spent a lot of time explaining how this arcane indicator sank the June GDP report and why it may reverse itself in the September quarter.
Initial unemployment claims fell dramatically last week, but these numbers have been volatile lately. Initial unemployment claims processing around holidays is always a bit suspect; I wouldn't be shocked to see the improvement reverse itself this week. Both the trade report and the claims numbers are a further reminder of the dangers of relying on just one month's worth of government data.
In other positive news, the Challenger Gray & Christmas report on announced corporate layoffs fell to its lowest level in a decade, and the number of announced layoffs has fallen by more than two thirds from its peak. The drop-off substantiates a government report of several weeks ago showing a sizable decline in mass layoffs (those involving more than 50 people). Apparently, small tuck-in layoffs and layoffs by small businesses are holding back the initial claims numbers, which are still running much higher than I would like to see.
And in the real world of railroads, railcar loadings set another record for 2010 for the second week in a row. Maybe the economy isn't sinking back into another recession after all.
July Trade Deficit Falls Dramatically
The trade deficit for July fell to a more 'normal' $42.8 billion from the very inflated level of $49.5 billion during the month of June. The deficit figure is constructed by taking US exports ($153.3 billion in July) and subtracting US imports ($196.1 billion in July). Prior to a huge jump in June, the deficit had been relatively stable in the very low $40 billion range. To give those numbers some perspective, the trade balance got as low as $26 billion in some months of early 2009 at the bottom of the recession and was as high as $68 billion in mid-2006.
Obviously, lower deficits are better than higher deficits. Recessions tend to reduce deficits, and expansions tend to see increases in the deficit. In fact, forced recessions are one of the techniques the International Monetary Fund prescribes to developing countries running excessively high deficits.
Net Exports Usually Don't Move the Economic Needle Very Much
Compared to a lot of countries, the US import and export accounts are relatively small compared to the overall economy. For example, US exports tend to run in the 10%-13% range of the US economy, while in Germany exports run as high as the mid-30s. US imports run higher at 14%-17%, and the net deficit is a rather paltry 2%-4% of the GDP.
Analysis of Consumer Spending Rightfully Gets Most of the Attention
Therefore, the consumption component that garners about 70% of GDP gets a lot more of economists' attention. Maybe that's why the massive hit to GDP from the normally small net exports account may have gone relatively unnoticed.
A Fluke Import Number May Have Distorted the June GDP Report
Below is a table showing the various components' contributions to GDP growth this recovery. As you can see, economic growth may be better than the world thinks, as second-quarter net exports really distorted the GDP calculation.
Contribution to GDP Growth by Category
Most economic commentators focus on total GDP growth and see a distinct pattern of decline. Economists, being highly skilled in the use of rulers and French curves, see the next number in this series as 1.0%-1.5% GDP growth for the next quarter or two.
However, last week's balance of trade report throws that estimate into question. It's a big if, but if the trade deficit stayed roughly in line with what it was in July during August and September, the net export number for the third quarter would be close to zero instead of the negative 3.4% it was last quarter. Even if the deficit jumped back to the record June number for the last two months of the quarter, the net export contribution to GDP would fall in the range of negative 2.0% to negative 2.5%, potentially a full percentage point better than the disastrous second-quarter figure.
So Why Do I Believe the July Deficit Number Is Normal and June Was an Anomaly?
Looking back 15 years or so, imports have never jumped as fast as they did in June. Overall, the balance of trade seldom moves more than a couple of billion dollars in one month, and yet it jumped $8 billion, and then reversed itself in July, falling $7 billion. The June increase seemed particularly odd given that both May and June were relatively slower months for consumption. Usually imports and consumption move in the same direction and with similar magnitudes. Some of the faster-growing June import categories seemed a bit suspect with meaningful jumps in diamond imports and pharmaceuticals that reversed themselves in July.
This Week's Economic Docket Is Full
This week the data flow picks up with the Census Department' Retail Sales Report, two regional purchasing managers reports, industrial production, and two inflation reports all rolling in.
Retail sales are expected to be up about 0.3% for August after a 0.4% jump in July. Both these numbers are consistent with consumption growth of 1.3%-1.6% for the third quarter. The retail sales forecasts are also quite consistent with the individual store reports of a week ago. However, this series has a volatile, restatement-prone history.
Anecdotal evidence and recent company comments suggest that the regional purchasing managers' reports may reverse their slowing trends when they come out this week. However, if the reports are unexpectedly poor, the market reaction could be terrible, considering the market's current fixation on the manufacturing economy.
Industrial production is likely to inch up 0.3% in August according to the consensus. That's a decent number, but lower than July's 1.0% rate, which was inflated by a strong auto number related to fewer summer auto shutdowns.
Keeping with the theme of 0.3%, both the consumer price index and the producer price index are projected to have grown at that level for the month of August. Those numbers are in line with what happened in July, but they strike me as being too high, especially given what I hear from our retail team on price discounting. The 0.3% number annualises to 3.6% if the consensus is correct. I can't help but think that two months in a row with relatively above-trend inflation numbers wouldn't begin to spook the bond market even more than last week's relatively poor bond auctions.
