Image: Factory worker
Timothy Jacobsen  /  Associated Press AP
U.S. manufacturing activity slowed sharply in the spring, a trend that can have a significant negative spillover effect for the rest of the economy, analysts say.
updated 6/3/2005 9:27:02 PM ET 2005-06-04T01:27:02

Friday’s disappointing employment numbers added to concerns that the economy, which has been giving off wildly mixed signals, could be headed for a slowdown over the next several quarters.

The economy added only 78,000 jobs last month, far fewer than the 175,000 expected by forecasters. By itself that one-month shortfall is probably nothing to worry about, economists say.

When smoothing out the volatile monthly numbers, the economy has added an average of 180,000 jobs a month so far this year, only a bit less than the average 190,000 created last year. And in a bit of positive news the government reported that the unemployment rate, which is measured in a separate survey, fell to 5.1 percent last month, its lowest level since September 2001.

But non-government payrolls remain below their peak levels from before the recession nearly five years ago, rather than snapping back quickly as they have after past recessions. And other recent figures indicate that the factory sector is slowing, a trend that usually has a significant negative spillover effect for the rest of the economy.

“We’ve never had a downturn in manufacturing that hasn’t spilled over to the service sector,” said Scott Anderson, senior economist at Wells Fargo. “If industrial production is heading lower, then GDP growth will certainly follow.”

The widely watched manufacturing index published by the Institute of Supply Management has declined for six straight months, the trade group reported this week, suggesting that the factory sector is running out of momentum. Other figures show that manufacturing activity slowed sharply in the spring, at least partly in response to a sharp hike in oil prices.

Other analysts say the impact of higher short-term interest rates and higher energy prices are continuing to work their way through the economy in a way that could lead to slower growth into 2006.

Still, Federal Reserve Chairman Alan Greenspan and his colleagues are almost universally expected to raise short-term interest rates this month, acting for the ninth time in a year to keep a lid on inflation, which is slowly creeping higher.

And most analysts expect more rate hikes before the cycle  is over despite the comment of Dallas Fed President Richard Fisher this week that policy-makers are in the “eighth-inning” of the campaign.

“Clearly he doesn’t speak for the broader Fed,” said Lehman Bros. chief U.S. economist Ethan Harris, a former Fed staffer. “It is possible the Fed could stop in June if the economy were to soften significantly, but it doesn’t seem too likely.”

Another signal that seems to be pointing to an economic slowdown is the unusual decline in long-term interest rates. Even as the Fed has pushed its benchmark overnight lending rate to 3 percent from 1 percent over the past year, long-term interest rates set on the open market have moved stubbornly lower.

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“This is the only time in modern history that a rate-hike cycle from the Fed didn’t  push up rates at the long end of the yield curve,” said Harris. “It’s not just that yields are low, but they are way out of line with historical behavior.”

The yield on the key 10-year bond touched its lowest level in more than a year this week and ended Friday below the key 4 percent level. Those low long-term rates, which Greenspan has dubbed a “conundrum” are throwing fuel on the fire of a red-hot housing market and undoing much of the Fed’s anti-inflationary campaign.

Anderson and many other economists believe it is inevitable that long-term rates rise, especially as the Fed pushes short-term rates steadily higher. If overnight rates end up going higher than long-term rates the yield curve would be “inverted” a condition generally seen only when bond traders expect a recession.

That is an outcome that almost nobody expects, although analysts struggle to come up with a convincing explanation for the persistent low long-term rates, which fallen back into territory that could trigger a fresh surge in mortgage refinancing, offsetting some of the slowdown in production.

One explanation for the latest bond market rally that drove down long-term rates: “No” votes in France and the Netherlands that cast doubt on the fate of Europe’s new constitution and common currency, the euro.

“I think bond yields will stay low, but I don’t think it signals a recession,” said David Wyss, chief economist at Standard & Poor’s. “What has happened in the last 15 years or so is bond markets have become much more global. Bond markets may be telling us more about the global economy, not the U.S. economy.”

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