Red-hot US economy cools down

Slower growth in the nation's economic output could reduce the pressure on the Fed to hike interest rates again.

Someone's turned the air conditioning up on the nation's economy.

The overheated job machine and consumer spending that have been worrying federal regulators are finally taking a break.

The result: The economy - perhaps - has slowed to the point where the Federal Reserve won't have to raise interest rates again.

Consumers are spending less, the torrid housing sector is finally moderating, and business is getting fewer export orders.

This cooling was reflected yesterday when the government released the second quarter gross domestic product (GDP) numbers, which showed the economy grew at a modest 2.3 percent rate - down significantly from the 4.3 percent in the first quarter and its slowest pace in a year.

"This must be pleasing to Fed Chairman Alan Greenspan - bringing the economic growth down below 3 percent is in the tolerable range," says Scott Grannis, principal at Western Asset in Pasadena, Calif.

The slowing is coming at the right moment. Yesterday the government also reported that employment costs appeared to be increasing because of the tight job market - a short-term indicator of how strong the economy still is. This was underscored by statistics showing that the number of new workers filing initial claims for unemployment fell to the lowest level in two years.

Wall Street's early reaction to this news was negative. The Dow Jones Industrial Average was down more than 160 points at midday yesterday.

Many economists believe the slowdown is sufficient to keep the Federal Reserve from raising interest rates when it meets at the end of August. This week, however, Alan Greenspan again warned that the Fed would not be afraid of a hike if it believed inflation was coming back.

Former Fed governor Lyle Gramley believes the Federal Reserve remains divided over whether to raise rates. Yesterday's numbers, he says, won't change anything. "I think they will remain divided and will just sit still in their next meeting."

Despite the drop in GDP numbers, it's not clear if the economy will stay down. One of the main reasons for the drop was a decline in inventory. With demand still relatively strong, business is likely to build inventory back up. In addition, many businesses are expected to add inventory in the months ahead in anticipation of Y2K problems.

"There's room to grow here," says Robert Dederick of Northern Trust Company in Chicago. "I suspect it will act as spur to growth, and we'll rebound this quarter from the 2.3 percent level in a meaningful way."

Some of the key interest-sensitive segments have been the first to slow down. For example, in the first quarter, housing grew at a 15 percent rate, boosted by warm weather and low mortgage rates.

Since then, interest rates have moved up by about one full percentage point, reducing the number of people who qualify for loans. In the second quarter, new home construction is down 1.6 percent, estimates Dave Seiders, chief economist for the National Association for Home Builders in Washington.

"It looks like a real slowdown, but homebuilders are still operating at a high rate," he says.

That's the case with Kaufman and Broad, California's largest home builder. They report brisk sales - up 25 percent compared with last year. But earlier this year sales were up 50 percent. "We've gone from red hot to very good," says Mary McAboy, a company spokeswoman.

Today, the government will report new home sales for May. They're also expected to be relatively strong as home buyers rush to lock in their current mortgage rates, fearing they might climb even higher.

Economists are not surprised that consumer spending is starting to tail off. In the first quarter, retail sales rose a strong 6.7 percent but in the latest quarter fell to about 4 percent. By historical standards, "real consumer spending will still be robust," says Rosalind Wells, chief economist for the National Retail Federation, based in Washington.

Reflecting low unemployment and growing incomes, consumer confidence has been high all year. But this week, the Conference Board, a business research group, reported the consumer confidence index dropped for the first time in nine months.

The biggest drop was in consumer expectations for the economy over the next six months. For the moment, economists are viewing the drop as more of a speed bump than a stop sign. They will get a better view of consumer spending today, when the government reports on June personal income and spending. Wall Street economists expect a modest slowing.

There's already been a small slowdown in the durable goods sector - producers of such items as automobiles and airplanes. On Wednesday, the government reported orders increased by only 0.3 percent, less than expected by Wall Street economists.

The drop is a sign of a "mild" slowdown, says Gordon Richards, chief economist for the National Association of Manufacturers in Washington. The largest drop is in industrial capital goods, such as the machines used to turnout other machines. Mr. Richards believes this might indicate that factories are operating with some slack.

(c) Copyright 1999. The Christian Science Publishing Society