Monday, March 26, 2007

Business-Spending Slowdown May Sap Job Growth, Surprising Fed

By Joe Richter, Simon Kennedy and Rich Miller

March 26 (Bloomberg) -- A slowdown in business investment that the Federal Reserve expects to end without much damage to the economy may instead linger long enough to hurt job growth.

Business spending may be a significant overlooked risk to the Fed's forecast of moderate economic growth this year, economists say. When spending growth tapers off, a slowdown in hiring almost always follows, according to researchers at Commerzbank AG.

``The weakness in capital spending is alarming,'' says Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York. ``If capital spending is weak and getting weaker, the next thing companies will do is slow hiring.''

Fewer new jobs would mean less consumer spending, deepening the malaise in a U.S. economy already burdened by slumping housing demand. The combination might force the Fed to shift its focus more toward shoring up growth.

Fed policy makers, led by Chairman Ben S. Bernanke, last week stuck to their view that the economy will keep expanding ``at a moderate pace.'' Their most recently published minutes, from the January meeting, indicated that while business investment had proven weaker than anticipated, they still expect improvement before year's end.

Private economists may not be so sanguine. They have cut their forecasts of business spending three times since December, and now expect it will grow this year at the slowest pace since 2003, according to surveys by Blue Chip Economic Indicators. That's after expenditures on equipment and software fell last quarter by the most in four years.

`Under the Radar'

``With so much attention on the housing market, this is perhaps a serious risk that's flying under the radar,'' says Brian Sack, a former Fed economist and now vice president of Macroeconomic Advisers LLC in Washington. ``We still think business spending will grow at a solid pace this year, but recent data has alerted us to the risks.''

The Fed's statement last week said inflation remains the main risk to the economy, even as policy makers dropped their bias toward raising interest rates. The change gives them room to maneuver in case the economy slows more than they expect.

Some suppliers of business equipment say the Fed's optimism about investment may yet be borne out.


``I've seen a significant change in optimism recently,'' says Roland Chalons-Browne, chief executive officer of Iselin, New Jersey-based Siemens Financial Services Inc., the commercial- finance unit of German engineering company Siemens AG. ``The hesitancy that has been in the marketplace is disappearing.''

U.S. businesses have no shortage of funds to invest, thanks to a five-year surge in earnings that took profit margins at non- financial corporations to the highest level in 37 years in the third quarter of 2006, according to the Commerce Department.

Some companies would rather use their cash to purchase their own shares than invest it in new plants or expanding payrolls. Last year, non-financial companies retired a record $602.1 billion of equity through buybacks and other means, according to Fed statistics. That's up 66 percent from $363.4 billion retired in 2005.

Houston-based ConocoPhillips, the third-largest U.S. oil company, plans to quadruple share buybacks this year to $4 billion while cutting its capital budget 25 percent.

This year, profit growth is slowing as margins shrink. Analysts surveyed by Bloomberg News see per-share earnings growth among S&P 500 companies slowing to 6.8 percent this year from 16.6 percent in 2006.

Seattle-based Inc., the world's biggest online retailer, announced this month that it will slow spending on technology after its profit margin fell to the lowest since 1999.

Defending the Economy

``When earnings growth slows and margins narrow, American business is very quick to cut back on expenses,'' says Allen Sinai, chief global economist at New York-based Decision Economics Inc. ``If this turns out to be a case of business- sector-initiated weakness, the Fed will be late in defending the economy.''

Interest-rate futures show a 28 percent chance the Fed will lower its target lending rate a quarter percentage point to 5 percent by June 28, compared with 10 percent odds a month ago.

Deutsche Bank's LaVorgna says the Fed's latest statement shows policy makers are ``acknowledging risks to the economy. But they're still not going to leap to cut rates.''

The Blue Chip survey shows business fixed investment may rise 4.3 percent this year, the slowest pace since 2003. That forecast is down from a 6.2 percent rise estimated in December.

Job Growth

``Once investment spending slows, job growth tends to follow,'' says Patrick Franke, an economist at Commerzbank in Frankfurt. He says capital spending is ``decisive'' in any change in direction for the economy ``because it is closely connected with trends in the labor market.''

LaVorgna says he expects monthly payroll growth to slow to an average 50,000 to 75,000 by year-end, from 189,000 in 2006, pushing the unemployment rate up to 5 percent from 4.5 percent now. A Manpower Inc. survey of 14,000 companies this month showed employers plan to slow hiring next quarter. Construction companies and makers of durable goods plan to trim hiring the most, according to Milwaukee-based Manpower, the world's second- largest provider of temporary workers.

The U.S. economy will probably avoid a collapse in capital spending like the ones that occurred in 1982, 1991 and 2001, says Franke. Still, ``a significant flattening'' is likely, with investment growth of around 4 percent this year, he says.

Offsetting the Slowdown

For the global economy, increasing business investment in Europe and Japan may offset the slowdown in the U.S.

Japan's largest manufacturers, encouraged by the lowest interest rates in the industrial world, plan to spend the most this quarter since 1991, according to the Bank of Japan. Sharp Corp., the country's largest maker of liquid-crystal displays and mobile phones, is spending 200 billion yen ($1.66 billion) to triple output of the panels.

``Companies have yet to spend as much as they want,'' says Yasuo Yamamoto, an economist at Mizuho Research Institute in Tokyo. ``Business investment will remain solid.

European companies are also spending more amid signs the economy of the 13 euro nations will sustain its best expansion since the single currency began trading in 1999. The European Central Bank reported in January that business demand for fixed investment loans was the strongest since it began surveying banks in April 2003.

``The business investment cycle has been slow to get going, but is now firmly positive,'' says James Nixon, an economist at Societe Generale SA in London and a former ECB forecaster. ``We're pretty upbeat about the outlook.''

Even some U.S. companies that have cut spending at home are still investing abroad. Rajiv Gupta, chief executive officer of Philadelphia-based Rohm & Haas Co., the world's biggest maker of acrylic paint ingredients, says half the company's capital spending will be overseas, and it will boost its global workforce while cutting U.S. jobs.

``Demand has been very robust in Asia and we have been positively surprised by the turn in Europe,'' he says. ``We have seen a slowdown in the U.S.''

To contact the reporters on this story: Joe Richter in Washington at ; Simon Kennedy in Paris at ; Rich Miller in Washington at .

Last Updated: March 25, 2007 19:07 EDT

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