The Index of Leading Economic Indicators rose 0.1% in March following a revised 0.6% decline in February and a 0.3% drop in January. The quarterly average of the LEI fell 0.58% on a year-toyear basis in the first quarter. This is the first decline in the LEI since the third quarter of 2001 when the U.S. economy was in a recession. Historically, a drop in the LEI on a year-to-year basis is associated with a recession (see chart 1). Unless there are major revisions of the current estimates of the LEI and/or the LEI in the second quarter posts a sharp increase, the current LEI is signaling a noticeable weakening in economic conditions in the near term. On a monthly basis, the LEI fell 0.8% from a year ago, the third consecutive monthly reading that is negative. According to the Conference Board, ???weaknesses among the indicators have become increasingly more widespread than strengths over the past few months.???
Among the ten indicators in the index, initial jobless claims, manufacturing workweek, vendor performance, money supply, building permits (reputed for large revisions) and orders of durable consumer goods (a forecast is used for this indicator, the actual estimate is available only on April 25) made positive contributions. Interest rate spread, consumer expectations, orders of nondefense capital goods (a forecast is used for this indicator, the actual estimate is available only on April 25), and stock prices declined in March.
Sluggish Labor Market Conditions Continue
Initial jobless claims fell 4,000 to 339,000 during the week ended April 14. The four week moving average of initial jobless claims at 328,750 has moved around the 325,000 level for several weeks. Continuing claims, which lad initial claims by one week, rose 6,000 to 2.531 million and the insured unemployment rate held at 1.9%.
The year-to-year change in seasonally unadjusted initial jobless claims has remained positive for thirteen out of fourteen weeks (see chart 2). The underlying trend of initial jobless claims is essentially indicative of continued soft labor market conditions.
Canada: Gasoline Pushes Up Headline Inflation, But Core Levels Ease
Ahead of the Bank of Canada??™s (BOC) April 24th monetary policy meeting, Canada??™s headline inflation index posted its highest monthly reading since September 2005. The Consumer Price Index (CPI) rose 0.8% in March, following a 0.7% increase in February, and was up 2.3% compared with a year earlier (2.0% pace in February). According to Statistics Canada, the monthly rise was largely attributable to the 12.5% March surge in gasoline prices while the 12-month change was a result of both rising gasoline prices (+10.0%) and higher costs associated with owned accommodation.
On a quarterly basis, the all-items index moved up at an annual rate of 4.06% after a 2.01% increase in all of 2006. The year-over-year quarterly figure (+1.8%) exceeded BOC projections (+1.2%) and has raised concerns that the bank will introduce a note of caution into next week??™s rate announcement and subsequent updated outlook (to be published on April 26).
The BOC??™s preferred measure of inflation, CPI-ex the eight most volatile components and indirect taxes, rose 0.3% in March, compared to a 0.5% increase in February, and was up 2.3% on a year-over-year basis (+2.4% in February). The modest deceleration, however, did not prevent the quarterly reading (+2.3%) from also exceeding BOC projection??™s of a first-quarter average of just 2.1%.
Next week analysts will be combing BOC press releases for any change in language that suggests the bank has altered its neutral stance. The overnight interest rate has been held at 4.25% for the past six straight meetings, and accompanying statements have uttered the now all-too-familiar phrase: ???the current level of the target for the overnight rate is judged, at this time, to be consistent with achieving the inflation target over the medium term.??? Like most analysts we expect the BOC to hold the benchmark interest rate steady at 4.25% next week. And although we recognize that price pressures seem to be lingering, we must once again note that inflation is a lagging indicator and that the future of Canada??™s economic growth is fraught with substantial downside risks. Including, but not limited to: the effects of a still-strong Canadian dollar, a cooling domestic housing market and moderating growth in the US ??“ Canada??™s largest trading partner.
China: Strong Growth, Rising Inflation Put Monetary Officials In A Corner
In the week before today??™s Q1 GDP figures, officials in Beijing had taken efforts to say that economic growth, while strong of late, was being well-managed and was under control. Presumably, this was a concerted attempt to ease market fears that the economy was overheating and could possibly boil over this year, but the popular response was for analysts to ratchet up their Q1 forecasts and prepare for some distressing data. The consensus for Q1 GDP year-over-year rose to 11.0%, and even that fell just short of the robust 11.1% growth posted in today??™s GDP release. And to make matters worse, March CPI was also announced today, and the year-overyear increase touched 3.3% ??“ a two-year high and a continuation of a disturbing trend that started in late 2005. Beijing markets quickly turned pessimistic, and that sentiment took little time to spread throughout Asia and into America??™s markets.
The big concern in American and European markets is that the People??™s Bank of China (PBoC) will take significant measures (read: aggressive monetary tightening) to cool down an economy that might be growing out of control. In theory, this would set the stage for an economic hardlanding to start playing out in late-2007 or the beginning of 2008. We feel that this possibility is not the most likely scenario for China, but this does not mean that the alternatives are altogether bullish.
The PBoC is not known for being particularly aggressive in implementing any policies that could raise controversy ??“ a side-effect of having no autonomy from a government that is expressly interested in social stability. In the span of almost three years since the PBoC started showing concern about the possibility of economic overheating, it has only raised the prime lending rate by all of 108 basis points. It has applied other liquidity-draining instruments as well, primarily increasing bank reserve ratios, but these are blunt instruments of monetary policy compared with the more precise tool of rate hikes. And considering how economic performance has responded since 2004, the results have not had the effect the PBoC intended.
We expect the PBoC to offer forth another customary 27-basis point rate hike before the end of May, and quite likely a similar increase during the next two quarters as well. However, an additional 81 basis points of tightening, along with another increase in the reserve ratio, are unlikely to be enough to sufficiently cool this economy. This means that a boiling-over could occur in 2008 if this policy tightening is not enough.
There is one big unknown about next year that is hard to fully incorporate into figures and forecasts ??“ the Olympics. Foreign investment in China may be on the decline by next year, but for a brief period, the rest of the world will be sending tourists to China to rent hotel rooms and buy souvenirs ??“ basically propping up the domestic market. Whether this will be a serendipitous economic boost or a one-month delay of the inevitable is hard to determine. However, we can say with some certainty that unless the PBoC takes stronger action than it has in the past, next year could witness a severe economic slowdown.