NEWS / Foreign Exchange

Weakness in Capital Spending In Addition to the Housing Sector Will Be a Force to Reckon With

The FOMC??™s view on capital spending in the economy will be an important aspect to look for in the minutes of the March meeting in addition to the reasons for the change in monetary policy stance. Capital spending fell at an annual rate of 1.4% in the second quarter and a 4.4% pace in the fourth quarter of 2006 (see chart 1). The minutes of the January meeting mentioned that ???business fixed investment overall continued to be weaker than anticipated, suggesting some caution on the part of businesses in expanding capacity. Nonetheless, participants expected that, going forward, favorable financial conditions, strong corporate balance sheets, high profitability, and growth in sales would support a firming of investment spending.???

The fourth report on corporate profits shows that before-tax corporate profits have slowed considerably in 2006 and turned negative in the fourth quarter of 2006 (-0.3%, see chart 2). Therefore the optimistic expectation of profit growth promoting capital spending needs to be re-evaluated.

Also, capacity utilization in the factory sector appears to have peaked in the third quarter of 2006 (see chart 3). Based on the deceleration of corporate profit growth and significantly slowing economic conditions, the likelihood of a rebound in capital spending in the near term is small.

Shipments and orders of non-defense capital goods excluding aircraft, a proxy for capital spending in the GDP report, from a year ago show significant slowing in recent months (see chart 4). Comparable weakness in orders and shipments of non-defense capital goods excluding aircraft was last seen in the late-2003/early-2004 period.