U.S. economy is muddling along
April 20, 2012
The economic data during the past month have been mostly in line with expectations, with one negative exception. At the same time, there continues to be no meaningful break-through on any of the major downside risks facing the economy. Once again, these may be situations of “No news is good news.” The upshot is that our view of the rest of this year remains slightly less sanguine, but basically little changed.
The “negative exception” mentioned above came in the labor market data for March. Private sector payroll employment rose by only 121 thousand, about 100 thousand below the consensus (and our own) estimate. The weakness was mainly in services, with a significant drop in retail trade jobs, and slower growth in business services and in health care. Manufacturing added 37 thousand, but construction fell slightly (-7 thousand). Government employment was flat. The household survey registered a decline in the labor force and a smaller decline in employment. This combination resulted in a decrease in the unemployment rate to 8.2%.
Other monthly data continue to be mostly positive, but not dramatically so. Households seem to be intent on spending, in spite of impediments such as slow income growth and high gas prices. Over the past six months real consumption has grown at a 2.9% annual rate. Consumer confidence fell a little in March, but is up significantly from last summer. Ditto for auto sales (through March) and housing starts (through February). The ISM manufacturing index rose a little in March, while their non-manufacturing measure was down a little.
There were more mixed signals in March and early April but enough positives to maintain our current outlook for the U.S. economy. Our estimate of GDP growth in the current quarter stands at 2.6%, just slightly below our estimate last month. Most economics are looking for something between 2.5-3.0%. Our outlook then calls for a slight deceleration over the rest of 2012. Growth will vary from quarter to quarter but we believe that it is likely to stay somewhere near the 2.5% mark for most of 2012.
We think our baseline forecast is relatively balanced in terms of upside versus downside risk. The small dip in the consumption component in the first quarter of 2013 is due to the expiration of the payroll tax cut – how that finally plays out is unknown right now.
Our GDP forecast calls for slow improvement for the next few years. GDP dropped 3.5% in 2009 and rebounded 3.0% in 2010. Growth slowed in 2011 to just 1.7%. We expect to see improved growth of 2.3% in 2012 with further gains of 2.6% in 2013 and 3.1% in 2014.
One issue to take note of is that since manufacturing has led this recovery (and construction remains very weak) the upside potential lies with the service and retail sectors. The impact on freight by stronger growth in these areas is much more muted unless it gets strong enough to lead to a momentum surge in the whole economy – a possibility, but one that we don’t see occurring yet.
The third release of fourth quarter NIPA data had only very small changes from the second release. The headline real GDP growth number was unchanged at 3.0%.
The labor market data have produced a little weaker outlook for the second quarter, but otherwise, there is little change from last month’s forecast. Our outlook for Residential Investment (i.e. housing) was pulled lower after a pretty sizable surge to end 2011. The only other segment that saw any real change in the forecast was auto sales. While still very strong, it is slightly below last month’s outlook.
The economy over the past several years has consistently shown an ability to disappoint. Especially, after a decent early year rebound. If job creation remains at the 100k mark, the economy will struggle to stay above 2%. We are optimistic that it won’t come to pass. However, in the background, both Europe and the Middle East remain very capable of producing a significant negative shock.
While the list of potential problems has remained essentially the same for several months, the near-term threats seem to be subsiding. At least for a few months. What to keep an eye on: Middle East oil, European debt, a Chinese slowdown, and U.S. fiscal policy.
The situation in the Middle East has eased and the price of oil has fallen slightly and stabilized. This is good news. In this type of environment we can expect fuel prices to increase as we get into the spring switch to summer fuels, but not see the large price spikes that can threaten the recovery. The oil markets can change in an instant but are currently looking more stable than at the start of the year.
Spain and Italy are next up on the Euro crisis. It looks like they are probably ok until the latter half of the year. After the summer we are likely to see a renewed focus on the Euro unless they have solved their key problems (don’t plan on it).
Chinese growth has slowed measurably as of late – although still well ahead of most countries. They have numerous risks to their economy but we still believe that they have enough resources to delay the full impact for several more years. If you are looking out 5 years or more you need to be looking at the impact of a shift in China’s economy. If you are trying to get through 2012, then China isn’t much of a concern.
We have stated that our optimism in the economy is improving – what would lead to better economic outcomes? Here’s a short list of possibilities: oil price recedes, export markets pick up, strengthening housing/construction markets, businesses spend their cash, consumers get back into the credit markets, local government stabilizes. In essence, it doesn’t look like there is any one thing that is likely to boost the economy. It would take a myriad of smaller improvements in many sectors. That’s what happens in a ‘normal’ recovery. We just haven’t had much of a normal recovery so far.
While the downside risks could lead to a significant reduction, we are more reluctant on saying that the upside possibilities lead to dramatically improved growth. We believe that the constraints in the market (consumers, banks, government) limit the upside potential.
We assign a probability to the main economic scenarios to highlight where your concerns and efforts should be most concentrated. Our upside potential remains greater than the downside risks. We are becoming more confident in the outlook for 2012 but the headwinds still persist. Below are our current thoughts:
- Strong Growth (GDP better than 3%): 25% probability
- Current Forecast (GDP between 2% – 3%): 60% probability
- Weak Growth (GDP less than 2% or recession): 15% probability
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