Economic Research:
U.S. Economic Forecast: Gale Warning
Credit Market Services: Beth Ann Bovino, Deputy Chief Economist, New York (1) 212-438-1652; [Link]@[Link]
Table Of Contents
Hoisting The Mizzenmast Battening The Hatches Staying Afloat Heading Leeward Making Waves
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Economic Research:
U.S. Economic Forecast: Gale Warning
Perhaps with an eye toward the America's Cup yacht sailing races set for September, U.S. financial markets have ventured into rough seas. Volatility has returned as investors try to gauge what mixed reports mean for the economy in the midst of cooling headwinds coming out of Washington. Overview We now expect Congressional gridlock through year-end, and have revised our GDP growth forecast to 2.0% this year, from our June estimate of 2.4%. We expect GDP growth of 3.1% in 2014, near our 3.3% June forecast. We assess the overall risk of another recession in the next year at 10%-15%. We see the chance of a quick turnaround at 15%-20%.
Varied signals are making it harder for investors to decipher whether the recovery meets the Federal Reserve's measures for a "sustainable" economic rebound with "substantial improvement" in the jobs market--in other words, a recovery strong enough for the central bank to start tapering its bond purchases as soon as September. (We still expect a December move.) The sharp downward revision in the first-quarter GDP estimate from the Bureau of Economic Analysis (BEA) to a paltry 1.8% indicated that fiscal shocks (the sequestration and January tax hikes) hurt the economy more than many economists and investors thought. Market participants are increasingly worried that Congress and the Administration will not reach a compromise, which would likely make for even slower growth this year. The Fed may take comfort from news that the private sector is staying warm despite dysfunction in Washington. The strong June jobs report shows that monthly gains have averaged about 200,000 jobs in the six months through June--something the Fed could gauge as "substantial improvement." And while consumers didn't open their wallets as much in the first quarter as earlier reported, spending was at its fastest pace in almost two years, and retail sales data remained robust in the second quarter. Americans may have been busy shopping for items to fill their new homes, since the housing market continues to improve. However, signs of weakness showed up elsewhere. Businesses have cut back on stocking their shelves, with the outlook cloudy. They may have been wise to hold off on building inventory, with manufacturing activity and sentiment readings down sharply since the start of the year. Slower economic expansion across the globe has hurt U.S. export growth, while modest domestic activity has restrained imports. The longer that sequestration drags on, the harder it will be for the private sector to sustain a strong recovery. So it looks like another year of subpar U.S. growth is in store for 2013. Although we expected the biggest effects of federal spending cuts would be felt in the second quarter of this year, it now looks to us that no compromise will be reached to reverse sequestration. No action through year-end means our forecast for 2013 GDP growth would fall to 2.0% from our 2.4% forecast in June.
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It could be worse. Last year, the Congressional Budget Office projected that a full year of sequestration would mean recession. Now they, and we, see merely slow growth if sequestration remains in place.
Hoisting The Mizzenmast
Despite these headwinds, Americans continue to spend--just not as much as the BEA thought. The BEA revised down first-quarter GDP growth to only a 1.8% rate (annualized) from a 2.4% pace in its second estimate. At this rate, it's hard to imagine a scenario where, according to Fed Chairman Bernanke, the unemployment rate would be "in the vicinity of 7%, with solid economic growth supporting further job gains" before the Fed ends its bond-buying program. Although the report shows that the fiscal shocks are having a bigger impact than the BEA first estimated, the private sector keeps investing and spending. With government spending flat, GDP growth was an annualized 2.8% in the first quarter after it was 1.8% in the final three months of last year. That's not surprising because, after four years of building financial reserves, the private sector has squirreled away enough to weather a Washington winter. The BEA initially estimated that first-quarter consumer spending rose 3.4%. Its revised estimate showed growth of just 2.6%. Still, that's a reasonable rate and the fastest growth in almost two years. Meanwhile, core retail sales, which we track in order to measure the spending component of GDP, were strong this spring and positive for the last six months. And June auto sales hit the highest level since 2007. They're happier, too. The University of Michigan's Consumer Sentiment Index edged down by 0.2 points to 83.9 in the preliminary July reading, drifting further away from the May surge to a cycle high of 84.5, though miles away from the over three-decade low of 55.7 in August 2011 during the debt ceiling confrontation. The improving jobs picture is one reason why. Six months of strong jobs growth has offset some, though not all, of Americans' disappointment from higher taxes. The unemployment rate has ticked up to 7.6% from 7.5%, but for the right reasons: As people got jobs, even more began looking for work, encouraged that they'll find employment (see chart).
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The housing sector continues to gain momentum, with May existing homes sales up to 5.18 million, the strongest pace since the homebuyers' tax credit boost in November 2009. What's keeping the sector from climbing even higher isn't lack of demand but rather supply constraints. The months' supply of inventory of houses on the market is well below the 5.5 months' average--5.1 and 4.1 months for existing and new homes, respectively. Given the low inventory, an improving jobs market, higher buyer expectations for home price increases, rising investor demand, and a smaller share of foreclosed homes to total sales, we now expect home prices (according to the S&P Case-Shiller 20-City Home Price Index) to climb 11% this year. The improvement in the residential housing market is a major component of our forecast for a strengthening economic rebound. For every single-family house built, the economy adds two to three jobs--not just in construction but in related businesses such as home furnishings. And though bank-lending standards are still stricter than before the financial crisis, there are signs that lenders have eased the stringent conditions of 2008-2010. If that continues, it will likely help home sales to surge.
Battening The Hatches
While the private sector is adding jobs, the economy has barely grown, expanding just 0.4% and 1.8% in the fourth and
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first quarters, respectively. Most of the drag has come from the government, which lopped off a total 2.3 percentage points of growth in those two quarters. If government spending had been flat, growth would have been 1.8% and 2.7% in those quarters, respectively. Part of the disconnect is probably because businesses were playing "catch-up," to quote Fed Chairman Ben Bernanke, after sharp job cuts during the recession. We think more is involved in the surprising strength in jobs creation. In the three months through June, the federal work force shrank by about 22,000 positions. That was, in part, because federal offices have instituted hiring freezes and taken other steps to ratchet down their spending. Many more federal workers are also seeing their hours cut through mandatory furloughs and bans on overtime. But that data isn't really showing up in the jobs report. Furloughed workers aren't counted as unemployed, and the data on hours worked is for private-sector employees, not public-sector ones. That the pace of jobs growth will continue in the face of sequestration is unlikely. The government is already trimming contracts with private firms, and businesses are beginning to pull back on investment plans as the year continues. We expect furloughs to take a significant bite out of income and consumer spending. That means diminished revenue for private businesses and so less need to hire employees. Meanwhile, nonresidential construction took a beating in the first quarter, dropping 8.3% in the third BEA estimate (it was down just 0.3% in their second estimate). We expected some pullback, given nonresidential construction surged by 16.7% in the fourth quarter, but not that much. Businesses are holding back on expanding their capacity given the gridlock in Congress, and problems abroad make the outlook uncertain. We expect modest gains of 5.5% this year, accelerating to 8.9% in 2014. Businesses are also slowing their investment in capital equipment. After growing 11.8% in the fourth quarter of last year, capital equipment investment rose a much smaller 4.6% in the first three months of 2013. Part of the reason is that businesses moved up a significant chunk of investment into last year to take advantage of the bonus depreciation that expired at year-end. At any rate, spending is showing signs of fatigue in the second quarter as Congressional deadlock and sequestration weigh on investment decisions. We expect gains later this year once the fiscal fog clears, and we forecast growth of 6.8% for the full year and 9.5% in 2014.
Staying Afloat
Based on early reports, the storm swirling out of Washington hasn't unmoored consumer spending. Real consumer spending rose 0.2% in May, erasing April's 0.1% drop. Car sales have been stronger than expected, surging 4.2% month over month to 15.9 million units in June, a near-six-year high, thanks to pent-up demand and favorable credit conditions. However, service-sector spending was weak, as people decided that they could forgo a few meals at the mall in order to afford that new TV. Despite the bounce in spending, people have still been able to save. The 0.5% jump in real disposable income in May (despite tax hikes) probably allowed people to spend more freely and still have some money left to deposit in the bank. The saving rate increased to 3.2% in May from a 3.0% rate in April--the highest reading since last December.
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Economic Research: U.S. Economic Forecast: Gale Warning
The improving jobs market boosted consumer confidence and spending in June, as did soaring stock prices and the recovering housing market--all of which helped offset tax hikes, sequestration, and ongoing political dysfunction in the nation's capital. At the same time, higher gasoline prices are now sapping that confidence. Americans seem more willing to spend than they were a year ago but remain much more cautious than during the boom years. We expect the savings rate to remain relatively high, though the reversal of the January tax cut next year and the expected partial reversal of the Bush tax cuts will eat into disposable income.
Heading Leeward
Not everyone expects smooth sailing ahead. Worldwide business confidence has fallen back to its financial-crisis lows, according to Markit's Economic Sentiment Index. Darker outlooks in the U.S. and China can explain a large part of the overall weakness, which suggests any talk of imminent tapering of the Fed's stimulus may be a little premature. Still, given capacity-utilization rates remain low, firms are investing to replace worn-out equipment and to improve productivity. And firms are more willing to move production back to the U.S.--cheap natural gas helps to reduce production costs, and a location closer to final demand helps trim transportation costs while gasoline prices remain high. Companies also have the money to invest. Even though firms are now paying more above-benchmark rates to borrow money, Treasury yields are still very low--and so the cost to borrow remains palatable. But though companies have enough money to do whatever they want, the key word here is want. Capacity utilization, at 77.6%, is well above the all-time low of 68.3% in June 2009, but still below the 80% benchmark needed to induce capacity additions. Although we expect capacity utilization to remain below 80% through 2013, the need for replacement and modernization will keep companies spending. We expect that equipment spending will increase 6.1% this year after rising 6.9% in 2012.
Making Waves
Perhaps just to avoid the summer doldrums, the Fed made a splash in June. Mr. Bernanke and co. sent out a call that the Fed planned to change course sooner than markets thought. Starting with the statement and press conference at the end of the two-day Federal Open Market Committee meeting on June 19, the central bank indicated that it may begin tapering its asset purchases as soon as September, though it made it clear that it could reverse course to increase bond purchases "as the outlook for the labor market or inflation changes." The statement also deemed recent signs of disinflation as "transitory," with Mr. Bernanke pointing to the impact of sequestration on Medicare pricing as one reason. Not every Fed member agreed. St. Louis Fed President James Bullard dissented, saying, "a more prudent approach would be to wait for more tangible signs that the economy was strengthening and inflation was on a path to return toward target" before announcing its plan to taper. Markets unraveled after the news, pushing the 10-year Treasury yield up to a 52-week high of 2.76% on July 8. The
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mortgage rate also climbed and, with it, speculation that the housing market's spring had been nipped in the bud. Two days later, Mr. Bernanke took a different tack, telling the National Bureau of Economic Research on July 10 that weakness in the jobs market and soft inflation suggested that more Fed stimulus was needed. At any rate, the minutes from the FOMC's June meeting showed that "about half" of the members supported ending quantitative easing this year. Keep in mind that this included all participants: voting and nonvoting members. Although the Fed has indicated that the economy may be strong enough to start tapering bond purchases sometime this year, two quarters of subpar growth--and this year's second quarter not looking much better--may mean the Fed should rethink its plan. For now, we're sticking with expectations for a December start date, but if growth remains slow, tapering may not come until next year after all. Standard & Poor's Economic Outlook
July 2013 2012 Q4 (% change) Real GDP Real final sales Consumer spending Equipment investment Nonresidential construction Residential construction Federal government State and local government Exports Imports CPI Core CPI Nonfarm unit labor costs Nonfarm productivity (Levels) Unemployment rate (%) Payroll employment (mil.) Federal funds rate 10-year Treasury-note yield 'AAA' corporate bond yield Mortgage rate (30-year conventional) Three-month Treasury-bill rate S&P 500 Index S&P operating earnings ($/share) Current account (bil. $) Exchange rate (major trade partners) Crude Oil ($/bbl, WTI) Saving rate 7.8 7.7 7.5 7.4 7.3 9.3 130.9 0.2 3.3 5.3 5.0 0.2 947 56.86 (382) 92.6 61.69 4.7 9.6 129.9 0.2 3.2 4.9 4.7 0.1 1,139 83.77 (449) 89.8 79.41 5.1 8.9 131.5 0.1 2.8 4.6 4.5 0.1 1,269 96.44 (458) 84.5 95.07 4.3 8.1 133.7 0.1 1.8 3.7 3.7 0.1 1,380 7.5 136.1 0.1 2.2 4.1 3.9 0.1 1,593 6.9 138.7 0.2 2.7 4.4 4.4 0.1 1,780 6.3 141.2 0.4 3.1 4.9 4.9 0.4 1,850 0.4 1.9 1.8 11.8 16.7 17.9 (14.8) (1.5) (2.8) (4.2) 2.2 1.7 11.8 (1.7) 1.8 1.2 2.6 4.1 (8.3) 14.1 (8.7) (2.1) (1.1) (0.4) 1.4 2.1 (4.3) 0.5 2.1 1.3 2.5 3.8 (0.8) 22.5 (6.6) (1.5) 5.0 7.8 (0.1) 1.3 0.3 1.9 3.7 3.4 3.6 10.9 14.4 18.0 (2.7) (0.3) 5.2 8.1 1.3 2.0 1.2 1.1 3.1 2.8 2.6 14.8 9.7 20.5 (2.4) 0.4 6.5 10.3 1.8 2.1 2.4 0.4 (3.1) (2.3) (1.9) (16.4) (21.1) (22.7) 6.1 2.2 (9.1) (13.5) (0.3) 1.7 (1.4) 2.9 2.4 0.9 1.8 8.9 (15.6) (3.9) 4.5 (1.8) 11.1 12.5 1.6 1.0 (1.1) 3.1 1.8 2.0 2.5 11.0 2.7 (1.6) (2.8) (3.4) 6.7 4.8 3.1 1.7 1.9 0.6 2.2 2.1 1.9 6.9 10.8 12.3 (2.2) (1.4) 3.4 2.4 2.1 2.1 1.1 0.9 2.0 1.9 2.4 6.1 2.9 16.9 (5.8) (1.1) 1.7 2.3 1.3 1.8 1.1 0.8 3.1 3.1 2.8 10.9 5.4 18.9 0.0 0.5 5.1 6.9 1.6 2.1 2.1 0.8 3.0 3.2 2.2 7.2 4.3 19.3 (0.9) 0.9 5.8 3.1 1.8 2.0 2.1 1.2 Q1e --2013-Q2e Q3e Q4e 2009 2010 2011 2012 2013e 2014e 2015e
134.5 135.1 135.7 136.4 137.1 0.2 1.7 3.5 3.4 0.1 0.1 2.0 3.9 3.5 0.1 0.1 2.0 3.9 3.7 0.1 0.1 2.4 4.2 4.2 0.1 0.1 2.4 4.2 4.2 0.1
1,418 1,515 1,578 1,624 1,657 23.15 25.77 26.84 27.61 27.74 (409) 87.2 (425) 89.1 (423) 91.1 (423) 92.7 (442) 92.4
96.82 107.97 114.53 118.25 (440) 87.6 94.21 4.1 (428) 91.3 94.53 2.5 (469) 91.1 89.74 3.3 (456) 90.2 89.80 4.1
88.17 94.35 94.24 95.91 93.62 5.3 2.5 2.7 2.3 2.5
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Standard & Poor's Economic Outlook (cont.)
Housing starts (mil.) Unit sales of light vehicles (mil.) Federal surplus (fiscal year unified, bil. $) e--Estimate. 0.90 15.0 (293) 0.96 15.3 (307) 0.90 15.6 9 0.98 15.9 (150) 1.05 16.3 0.55 10.4 0.59 11.6 0.61 12.7 0.78 14.4 0.97 15.8 (742) 1.25 16.2 (593) 1.56 16.2 (518)
(198) (1,416) (1,294) (1,297) (1,089)
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