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US economy: Conflicting signals

Feb 8, 2001

Fears of slowdown or even a possible recession in the US economy have plagued the bourses for quite sometime. Tech firms failing to meet quarterly earnings estimates further fueled the fears. Finally mighty Cisco, that never missed a forecast in six years, joined the list giving more standing to the fears. We felt the tremors at home too. With at least two of the foreign brokerage house downgrading the Indian success story, Infosys. The argument was that weakening of the US economy would lead to lower it spend. But there are some who believe that economy is beginning to pick up in the US and they have reason to believe so. Some of the indicators of positive growth are

Positive health show
Recovery in retail sales -
Positive gain in auto sales in January Up by 1.8 m (annualised)
New home sales up in January Up 13.4% on month on month basis

These trends seem to indicate the consumer spending will show positive growth in the first quarter of 2001. Consumer spending represents about two-thirds of the US economy is a very critical indicator of its health. Considering this, the picture seems quite positive.

However, some other reports paint a totally different picture.

Annual consumer credit increase in December was 2.4%. This was down from a breakneck 11.1% in November. This indicated that in December, consumers curbed use of credit. According to the University of Michigan index of consumer sentiment, confidence fell in January on the heels of a sharp plunge in December. The index is measure of consumer confidence has shown a drop as consumers have become increasingly pessimistic about their future income and job prospects.

The U.S. unemployment rate edged up to 4.2% in January, as the slowing economy triggered big layoffs in the auto and other manufacturing industries. However, data show that the employment softness seems to be confined primarily to the manufacturing sector, and has not spilled over to the rest of the economy.

The National Association of Purchasing Managementís (NAPM), gauge of the U.S. economy's non-manufacturing sector, indicated that the sector had slowed to its most lacklustre pace since the surveys inception in 1997. The services index came days after NAPM's report on manufacturing, which showed the sector is now in recession, having contracted for the sixth straight month in January.

Last year, the Fed was worried that the economy was growing too fast. Between June 1999 and May 2000, the central bank boosted interest rates six times to slow growth. Now, the Fed and analysts believe those rate cuts may have gone too far in cooling the economy hitting interest sensitive manufacturing sectors hard. This has led to a ripple effect and has hit the service sector.

The slowdown that was visible could have been due to additional factors like severe winter weather and a prolonged presidential election. Due to the severe winter the people did not venture out and buy, therefore the drop in sales. The confusion in the presidential election was something that the country (US) was certainly not used to. This might have shaken consumer confidence. All these together had a negative impact on consumer spending. But the thing that might have hurt the economy the most was the high cost of energy that reduced fuel for the economy. In 2000, energy drove overall consumer prices up 3.4% (or 2.6% excluding food and energy).

Now with the Fed having already cut rates by 100 basis points, the confidence may just about pick up sometime in mid 2001. Also energy prices are expected to stabilize. First the manufacturing sector has to pick up, which might take up to about two quarters and then the effect will be cascaded into the service sector. Therefore, we might just see the US economy standing still for the first half of the year before its starts growing again.

This ultimately brings us to the question how what will be impact on the Indian software industry be. If the US economy stands still for the next two quarters and then positive signs begin to show, then the impact on the Indian software companies could be marginal.

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