If it's the second quarter, we must be in an economic slowdown.
In each of the last two years, economic growth slowed sharply during the second quarter, prompting speculation that the long-awaited slowdown had finally arrived. But, both years, the economy came roaring back in the final two quarters of the year. Is it faking us out for a humiliating third time?
Signs of a slowdown abound.
posted their first back-to-back declines in April and May since July and August 1998.
Building permit issuance
slipped to its lowest level since December 1997 in May. And the May
detected the first drop in private-sector payrolls in more than four years.
And why not? Over the last year, the
Fed has hiked the
fed funds rate by a total of 1.75 percentage points in order to slow down the economy and keep inflation low.
Evidence that the hikes are working has swelled the ranks of forecasters who believe the Fed is done hiking the fed funds rate, and that its eventual next move, though it may not come for months, will be to lower the key short-term interest rate.
Believers in the slowdown also note that the stock market has been idling for the first time since 1994, which may be reining in consumer spending, the economy's main driving force.
But here's the counterpoint that makes some economists wary of jumping aboard the slowdown bandwagon just yet: The forces that temporarily depressed growth during the second quarter in 1998 and 1999 are with us this year as well.
Also, while interest rates are higher and stocks are stuck in neutral, there are countervailing forces, most notably, according to
Morgan Stanley Dean Witter
economist Bill Sullivan, faster economic growth abroad. U.S. consumption may be slowing, but foreign consumption could pick up the slack.
The second-quarter-slowdown pattern has two key causes, economists say.
The first is electronic tax filing, which accelerates the payment of refunds. According to the
, there were 34.9 million electronic filers this year, up from 18.9 million in 1997.
When returns are filed by mail, refunds are received in April or May. When they are filed electronically, refunds are received in February or March. The acceleration of tax refunds is behind the extraordinarily high rates of consumer spending in the first quarters of this year and the last two years, and for the second-quarter slowdowns, economists say.
"It's clear there's been a shift in timing away from the second quarter to the first quarter," Sullivan says. "Individual taxpayers are receiving tens of billions of dollars in IRS refund payments in February and March that they didn't before. That's encouraging more aggressive consumption early in the calendar year, giving the economy a lift in the first quarter, and taking away from household outlays in the second quarter."
Unseasonably warm winters have also shifted economic activity -- construction in particular -- from the second quarter to the first quarter in the last few years, economists say.
The last time the second-quarter
GDP growth rate exceeded the first-quarter rate was in 1997. In 1998, the economy grew at a seasonally adjusted rate of 6.9% in the first quarter and 2.2% in the second quarter. Last year it grew at a 3.7% rate in the first quarter and 1.9% in the second. This year, the economy grew at a 5.4% rate in the first quarter, and economists polled by the
expect it to grow at a 4.2% rate in the second quarter.
Another Head Fake?
* Philadelphia Fed Livingston Survey estimate
The fact that the first signs of the long-awaited slowdown are coming during the second quarter make them inherently suspect, some economists say. "It's premature to say the Fed has engineered a sustained slowdown," Sullivan says. "We have to reserve judgment because this is a recurring pattern."
People who are more willing to believe that this time is for real are counting on the combination of higher interest rates and stagnant stock prices to do the job. "On net,"
senior economist Ethan Harris observes, "financial conditions are tighter than they were during previous slowdowns, which gives you the sense there's going to be more sustained slowing."
The economy has been racing over the last two years because consumer spending has been growing faster than incomes have, points out James Glassman, senior economist at
. That, he says, "tells you people have been boosted by the stock market. So if we had more of a situation where the stock market settles down, you'd expect spending to slow in line with income."
Lehman's Harris also notes that the rise in energy prices over the last year and a half ought to "act like a tax on consumer spending" by leaving consumers with less money to spend on other things.
The skeptics say it isn't yet clear whether stock prices have come down enough to put a lasting dent in consumer spending. Morgan Stanley's Sullivan notes that the major indices remain well above their year-ago levels.
As for interest rates, they're not all that low,
chief economist Michael Moran adds. "Interest rates, including the fed funds rate, are higher than they were a short time ago, but still not extraordinarily high relative to history," he says. Mortgage rates, for example, "are not as high as they were at points in the past when housing has truly slowed."
At the same time, Moran says, the housing market -- a secondary driver of economic growth -- appears to have become less interest-rate sensitive, perhaps because the fees associated with refinancing have come down. Homebuyers "are not backing away from high interest rates as much as in the past," he says.
A Lower Bar to Refinancing
Source: Federal Housing Finance Board
Meanwhile, global growth appears to be accelerating, providing an offset to slowing demand on the part of U.S. consumers. The
Organisation for Economic Co-operation and Development
is forecasting a global growth rate of 4.0% this year, up from 3.0% last year and 2.4% in 1998.
"The Fed is only one influence on the economy's potential," Morgan Stanley's Sullivan says. "I'm not sure 6.75%
the fed funds rate level some economists expect to see later this year represents tight money when credit is widely available, there's still a tremendous amount of equity wealth, the jobless rate is at a 30-year low, income growth has been spectacular, and the global economy is much more vigorous. It's not a foregone conclusion that a tighter monetary policy pushes the economy into a significant slowdown for the rest of the year."