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SUMMARY: 2002 ECONOMIC FORECAST
The U.S. economy entered recession in March 2001, according to the National Bureau of Economic Research (Nov. 26), which follows four indicators: current employment, industrial production, wholesale-retail trade and real income. The Arkansas Policy Foundation (APF), in its 2001 forecast, issued last February, predicted recession. APF’s forecast was based on inversion of the yield curve in Summer 2000; contraction of industrial production; declining credit standards and credit structure issues; and unsustainable consumer wealth-effects from equity valuations based on a new and unrealistic metrics.
Evidence the recession is ending will occur when 1) the yield curve spread is positive and exceeds 200 basis points; 2) employment data, especially the four-week moving average of individuals seeking first-time jobless benefits, improves; and 3) industrial production stops contracting. Among these three the yield curve is showing the most positive indication of recovery. Employment data has been positive of late, and will provide more evidence of recovery if the four-week moving average continues to fall. Conclusive evidence the recession has ended will occur when industrial production, which has contracted 15 of the last 16 months, expands again. This data is released mid-month for the preceding month (ex. mid-March for February).
Credit structure issues, in recession or recovery, will remain problematic in 2002. The Enron Corp. bankruptcy illustrates that they are more important today (Feb. 22) then when APF first referred to them.1 Corporate bond defaults set records in 2000 and 2001. The problem can be addressed through increased transparency. Examples include stating GAAP2 and pro-forma earnings simultaneously, and reporting off-balance sheet derivative transactions by notional dollar amount. Arkansas' manufacturing and agricultural sectors have been effected by producer price "rolling deflation” and a strong U.S. dollar. APF does not see the widely followed Consumer Price Index (CPI) turning negative in 2002 but “rolling deflation” in the PPI bears watching. The Producer Price Index (PPI) has fallen three of the last five years.3 Postwar, the PPI has not been negative so often in a period characterized by the "severe deflation of equity asset values" described by Federal Reserve Chairman Alan Greenspan (Jan. 11, 2002).
POSITIVE INDICATOR: POSITIVE YIELD CURVE
"It suffices that the yield curve can predict future macroeconomic developments without necessarily causing them." ("Intermediate Targets and Indicators for Monetary Policy," 1990; Federal Reserve Bank of New York)
"The yield curve is perhaps the most important market-based indicator of recessionary expectations. It is a graph illustrating maturities and yields of treasuries. The yield curve's normal slope is positive, or upward sloping with short maturities at yields less than long treasuries. Until recently the bellweather long treasury was the 30-year bond. The U.S. government's decision to gradually purchase outstanding 30-year bonds means the 10-year note has emerged as the new bellweather in the market.' (APF memo, 'The Case For Recession,' Summer 2001)
The yield curve (three-month Treasury bill and 30-year bond) inverted in Summer 2000. On June 6, 2000, the three-month bill yielded 5.99 percent and the 30-year bond was at 5.91 percent.(4) On July 5, 2000, the three-month bill yielded 5.99 percent and the 30-year bond was at 5.86 percent. The yield curve remained inverted, providing a strong signal of recession. On Sept. 29, 2000, the three-month bill yielded 6.23 percent and the 30-year bond was at 5.88 percent. The 10-year note yielded 5.80 percent on that date. At year-end 2000 (Dec. 29), the three-month bill yielded 5.27 percent and the 10-year note was at 5.12 percent.
Today, the yield curve has a positive slope with a spread of more than 300 basis points between short and long maturities. For example, on Feb. 1, 2002, the three-month bill yielded 1.76 percent and the 10-year note was at 5.02 percent. The yield curve's positive bias of more than 200 basis points is a positive sign for recovery.
POSITIVE TREND: FOUR-WEEK MOVING AVERAGE OF FIRST-TIME JOBLESS CLAIMS
“Employment reached a peak in March 2001 and declined subsequently. Through December, the decline in employment has slightly exceeded the average over the first 8 months of earlier recessions. The cumulative decline is now 1.1 percent, equal to the total decline in the average recession.” (NBER memo, Feb. 11, discussing employment)
Jobless claims are a weekly indicator of unemployment. They track the number of individuals applying for first-time state unemployment benefits. Weekly reports can be misleading for various reasons, including seasonal factors so data is tracked on a four-week moving average to develop a more accurate view of the underlying trend. In this recession the four-week moving average increased twice as frequently as it fell from March 2001 to the week ending Oct. 20, when it peaked at 505,000. The moving average has declined 12 weeks since Oct. 20. Increases were registered in only four weeks with two attributable to seasonal factors.
The four-week moving average has nearly retreated to where it stood in March 2001 when the recession began. It's decline since Oct. 20 is a positive trend.
NEGATIVE TREND: INDUSTRIAL PRODUCTION
"A peak occurred in June 2000 and the index declined over the next 17 months by 7.1 percent, far surpassing the average decline in the earlier recessions of 4.6 percent." (NBER memo, Feb. 11, discussing Industrial Production)
Postwar, in 90 percent of recessions, industrial production stopped contracting prior to or in the month later declared by the NBER as the end of recession. The lone exception was the 1981-82 recession, which ended in November 1982, one month before industrial production stopped contracting in December.(5) Expansion of industrial production, when it occurs will provide evidence the recession has ended or is ending.
Industrial production data for January 2002 showed a 0.1 percent decline. This decline follows December 2001's modest fall of 0.1 percent.
Capacity utilization measures slack in the economy. It is calculated by dividing industrial production by industrial capacity. A higher or increasing percentage reading indicates less slack, and is a positive trend for recovery. A lower percentage reading means more slack, and, coupled with other monthly declines, is a negative trend.
Capacity utilization of U.S. industry, between 1967 and 2001, has averaged 81.9 percent. The Federal Reserve reports, "Because investment is expected to remain weak, capacity is projected to expand only 1.0 percent in 2002, the lowest rate of increase for this statistic since it began in 1967.
Following is the January 2002 capacity utilization number compared with the troughs for the post-1967 recessions, from least to most severe:
78.510 (July 1980) 78.078 (March 1991) 77.661 (November 1970) 74.227 (January 2002) 72.614 (March 1975) 71.875 (November 1982)
Capacity utilization is lower than in the January-July 1980; September 1990-March 1991; and December 1969-November 1970 recessions. Starting in July 2000, it has fallen 18 months (one month was neutral). January’s reading was the worst since April 1983, and provides more evidence of a weak domestic manufacturing sector.
(1) 'Derivatives & The Transparency Of Government Retirement Systems,' (May 2001); 'The Case For Recession,' (Summer 2001).
(2) Generally accepted accounting principles
(3) Seasonally adjusted PPI (1997-2001), Federal Reserve Board.
(4) Treasury Constant maturities. Yields on actively traded issues adjusted to constant maturities. Source: U.S. Treasury Department.
(5) 'Today's Industrial Production Data,'(Feb. 15, 2002).