Wilting Manufacturing vs. Vibrant Housing

By: Paul Kasriel | Sat, Jun 25, 2005
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This is the economic dichotomy that FOMC members will be contemplating next week. Today's economic releases exemplify this dichotomy. Although the headline figure of a 5.5% increase in new orders for durable goods in May suggested that U.S. manufacturing was anything but wilting, once you began to examine the internals of the report, you came away with a different impression. The May surge in new orders was all about Boeing's nondefense book. Excluding civilian aircraft and parts, new orders for durable goods declined 0.3% in May. New orders for "core" (ex civilian aircraft) nondefense capital goods plummeted 2.3%. The April-May average of new orders for core nondefense capital goods is running at annual rate of minus 5.1% vs. the Q1 average, which, itself, advanced an annualized 21.8% vs. the Q4 average. This has ominous implications for Q3 GDP growth in capital spending. Even Q2 capital spending is looking shaky based on the shipments of core nondefense capital goods. The April-May average of these shipments is running at an annualized rate of 2.3% above their Q1 average. In Q1, shipments of core nondefense capital goods grew at an annual rate of 14.0%. These orders and shipments data of capital goods corroborate my view that Corporate America has low expectations for the real return on capital here in the US of A. This helps explain the low level of bond yields and corporations preference to use its cash flow to buy back their own stock or someone else's stock in an acquisition rather than expand their own physical plant. The downward trend in the ISM manufacturing index also corroborates this view.

But, on the bright side, we still build and sell houses here, thanks to Wall Street's ability to peddle risky mortgages. According to Loan Performance Inc., an outfit that does mortgage data analysis, 9% of new mortgages granted in Q1 were of the negative amortization type. Back in 2003, only 1% of mortgages granted were of this type. Real estate brokers are teaming up with mortgage brokers, posing the question to the potential buyer: "What's it gonna' take to put you into this McMansion?" So what if the amount you owe on the house keeps going up each month if the market value of your house keeps rising. And the market value can keep rising so long as exotic mortgage products can be created to allow subsequent potential buyers to keep bidding up the prices of homes. Oops! Better create some new exotic mortgage products because increases in the prices of new houses are slowing down significantly, as shown in the chart below. After hovering in the double-digit range for most of 2004, the year-over-year percent change in the 3-month moving average of the median price of a new single-family home was only 4.8% in May. The "carry" profit on new homes seems to be diminishing. Maybe sales price increases have to be moderating to continue to move the "lumber." New home sales increased by 2.1% in May to an annualized unit pace of 1.298 million units - just narrow lot line from the record unit sales pace of 1.306 million set back in October 2004.

This economic dichotomy will not give the FOMC any trouble in reaching a policy decision on June 30. It is going to raise its funds rate target by 25 basis points to a level of 3.25%. But it might give them some pause for thought about a pause after the June 30th rate hike. I would not be surprised if the FOMC removed the phrase "even after this action, the stance of monetary policy remains accommodative" from its policy announcement of the June 30th funds rate hike. If policy is no longer accommodative, it might be approaching "neutrality." The removal of this phrase sets the stage for the FOMC to pause either at the August 9 meeting or the September 20th one.


Paul Kasriel

Author: Paul Kasriel

Paul L. Kasriel
Director of Economic Research
The Northern Trust Company
Economic Research Department
Positive Economic Commentary
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675

Paul Kasriel

Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community. The Northern's economic website was listed as one of the top ten most interesting by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets.

Paul began his career as a research economist at the Federal Reserve Bank of Chicago. He has taught courses in finance at the DePaul University Kellstadt Graduate School of Business and at the Northwestern University Kellogg Graduate School of Management. Paul serves on the Economic Advisory Committee of the American Bankers Association.

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