Evidence of Further Economic Q2 Weakness Might Highlight Latitude Offered by Operation Twist

Empire State Index rises but has weakness, Kansas City Fed Index looks good among few

Fed regional indicators are again pointing to softness in Q2. Empire State Manufacturing Index reported May 15 and is showing considerable volatility. February's Empire result was at 19.5, March at 20.1 and in April dove to 6.56. Such a deep dive contrasts with May's steep increase to 17.1

Overall, Empire showed substantial declines in all areas in April. May showed overall business conditions improving, but new orders, unfilled orders and delivery times remained flat, as they have for a year. Driving the Index is a steep increase in shipments, growing trends in inventories and employment. Empire region appears to have a tight supply structure with short lead times. Such a dynamic can perhaps discount delivery times and unfilled orders.

Not good with the Empire Index are forward indicators reflecting expectations six months in advance. All such indicators are down for May versus April, except prices paid being up. Prices received are flat and capital expenditures fell from 31.33 in April to 19.28 for May.

Gains in the Empire Index are betrayed by noted declines in longer term expectations. Technology spending on Empire's forward index, for example, has been in decline since the March to April period. Compare these results with April's Durable Good's report that showed nondefense capital goods, excluding aircraft falling by -1.9%, despite an overall gain.

Kansas City Fed Manufacturing Index is like Empire, but shows more sustainability and greater optimism in the future. Previous Kansas City Index numbers showed an overall result for February of 13, March 9 and April of 3—a progressing decline. May results moderately reversed with an increase to 9, like last March.

Elements in the index revealed very strong increases in production, shipments and new orders increasing from -8 in April to 10 in May. Only elements that still showed decline, but improvement are backlog of orders going from -5 for April to -3 in May and employee work week seeing April at -10 and May at -2. Even forward looking indicators, revealing six month future expectations, picked up considerable strength.

Other regional Fed Indexes remain in decline, if not contraction

Remaining Fed regional indexes continued their downward path of slowing activity. Philadelphia Fed Survey went from decline into outright contraction. March saw the survey at 12.5, April at 8.5 and May showed -5.8. Dallas Fed Manufacturing Survey showed further contraction in its business activity component with it going from -3.4 in April to -5.1 in May. The Dallas Survey’s production component, however, held fairly steady moving from 5.6 in April to 5.5 in May. Previously, the production component declined from 17.8 in February to 10.8 in March. Richmond Fed Manufacturing Index fell in May after exhibiting volatility. Index results for March were 7, April 14 and May revealed a fall to 4.

Economic volatility is demonstrated by these indexes falling substantially followed by a gain, or gaining followed by a marked fall. Philadelphia and Dallas have been in persisting decline, entering contraction. Most concerning is that GDP for Q1 has been revised down to 1.9% from 2.2%. Suggesting current indicators are leads on a disturbing down trend.

Reasons for GDP’s Down Revision, and a Switch in Demand for Cars to Increased Caution

According to the Bureau of Economic Analysis (BEA) declines in Q1 GDP are attributed to “deceleration in private inventory investment, an acceleration in imports, and a deceleration in nonresidential fixed investment that were partly offset by accelerations in exports and in PCE [personal consumption expenditures].”

Also noted by the BEA is motor vehicle output added1.12% to Q1 results while only adding .47% in Q4. Still PCE drove away from consuming autos into a slight rate of increasing nondurable items. Overall, Q1 showed less cash flowing and a decline in growth rates.

BEA said PCE “increased 2.7 percent in the first quarter, compared with an increase of 2.1 percent in the fourth. Durable goods increased 14.3 percent, compared with an increase of 16.1 [in Q4]. Nondurable goods increased 2.3 percent, compared with an increase of 0.8 percent [in Q4].”

Cars have carried the economy but are perhaps experiencing declining demand, what will compensate: QE3 or energy exports with the effects of Operation Twist

While vehicles have lead economic growth in the U.S., it now looks like production of cars have outpaced demand reflected in the 1.8% decrease in rate of durable goods Personal Consumption Expenditure (PCE).

Essentially durable goods consumption by American consumers is declining from their focus on cars to nondurable goods, but not at an offsetting rate of consumption.

Add to this the Durable Goods report showing a decline of -1.9% in its non-defense, non-aircraft capital goods component.

Car production offers upstream and downstream job creation, production and other demand in production. Real estate is very similar with its upstream and downstream ramifications. Real estate, through the country, has remained less than influential.

Natural resource production also offers very broad economic benefit….but it does appear foreign countries are also slowing. Could the U.S. relieve pressure on energy costs and inflation experienced by developing countries by exporting more energy. Such a step would create considerable jobs in the U.S., spur U.S. domestic demand and also foreign exports. American capital and current account balances appear to have the dynamics to absorb increased exports.

Aside from energy, it’s hard to see catalysts for renewed U.S. growth, apart for QE3. In an environment that could teeter on deflation and progressively slowing growth, QE3 seems more and more likely. But with Operation Twist dulling the yield curve, bond purchases could drive down yields. This could tell of what bonds the Fed might have the latitude to purchase, if any.