U.S. Economic Forecast: An Apple A Day Keeps Recessions Away
|Publication date: 16-Mar-2012 03:48:30 HKT|
It looks like the U.S. economy has been taking its vitamins. The labor market is getting stronger, with three straight months of job gains over 200,000. Both business sentiment readings and initial jobless claims reports are encouraging, despite the still-high 8.3% unemployment rate, and the extension of the payroll tax holiday will also keep households flush with a little extra cash.
But while a healthier job market is good news for household incomes and purchasing power, it may only be temporary. Most indicators of aggregate demand haven't kept up with job gains until recently, keeping GDP growth at just 1.7% in 2011. And the jump in oil prices means that some of those new paychecks will end up in the pump and not at the mall. While the boost from the earned income tax credit has given some people more money to spend on gas, high oil prices will still weigh on overall growth.
Federal Reserve members are already planning how they will cushion the fall if the recovery weakens again. If nothing changes, rising labor costs, with only modest gains in final demand, will ultimately slow productivity growth and squeeze corporate profits. Fortunately, the recent gains in retail sales suggest that people are finally opening up their pocketbooks. Overall, Standard & Poor's Ratings Services is feeling a little more positive about the recovery: We're now putting the risk of another recession at 20%, down from 25% previously.
Last March, turmoil in the Middle East threatened production in many critical oil producing nations. A year later, the story remains the same. Rising geopolitical tensions with Iran have pushed oil prices over $100 for West Texas Intermediate or $115 for Brent Crude. Since Iran is the world's fourth-largest oil producer and has strategic access to the Strait of Hormuz—through which one-fifth of oil traded worldwide passes—we have reason to worry.
We believe the U.S. could slip into another recession if prices reach around $150 per barrel for WTI (about $170 for Brent). And if the disruption in the Persian Gulf gets much worse, prices could go as high as $200, in our view. We expect that each $10 rise would take about 20 basis points (bps) off GDP growth in each of the first two years of the price hike. This is a bit less than in the past because cheap natural gas and coal prices now are good substitutes for pricey oil products. Natural gas pricing, in particular, no longer reacts significantly to oil prices.
The economic damage from rising oil prices is no small matter. Consumers will have to spend more on energy and less on other items (see chart 1). The drop in demand for other items will slow revenues and push operating costs up, forcing businesses to limit their workforce. This will put an even tighter squeeze on consumers, slowing spending further and giving the economy less to grow on.
And the higher oil prices go, the more households will have to cut back elsewhere. Gasoline, motor fuels, and fuel oil account for 5.5% of household spending, and that's also rising. Already a gallon of gasoline, currently at $3.80, is a dollar higher than it was in March 2010. This is before the high-driving summer season, and oil threatens to breach the $4.00 threshold in just a few months. A $10 rise in crude oil prices will raise gasoline prices by about 25 cents (8%) and cut consumers' purchasing power by about 0.4%. "Staycations" could come back with a vengeance.
Private employers were confident enough that business was heating up to take on more hires this winter. The Bureau of Labor Statistics (BLS) reported a further pickup in nonfarm payrolls this February, on top of sharp upward revisions in the prior two months. Mild weather can't fully explain the creation of 227,000 jobs, which was just above the 210,000 most market participants seemed to have been expecting. The BLS revised the prior two months' results to add a net 61,000 new jobs to the rosters.
The unemployment rate, however, held at 8.3% after five consecutive declines. But while the labor force rose by 476,000, household employment also gained 428,000 jobs, which helped keep the unemployment rate at a two-year low. The U6 labor underutilization rate slipped to 14.9% from 15.9% last February, another good sign of an improving job market. We expect the unemployment rate to tick up again by the end of 2012, but this time for a more encouraging reason: People who had given up and dropped out of the labor force should come back, believing that they'll have better luck now. However, there's no guarantee that the job market is stabilizing. We saw an average of 200,000 new jobs in each of the first four months of last year, and that didn't last.
Bulkier wallets from the tax credit and the improving job market seemed to have encouraged people to open their pocketbooks a little wider this winter. Retail sales jumped 1.1% month-over-month in February, near market expectations. Excluding auto sales, retail sales were up 0.9% over January, near our forecast but better than the 0.7% increase the market expected. Anyone who has been at the gas pump knows that higher gas prices have taken more out of their wallets in February. But while the 1.6% and 3.3% jumps in auto and gas station sales help explain the overall gains for retail, sales were up across most retail segments. Sales, excluding autos and gas station sales, were up another 0.6% after January sales jumped by a revised 1%. The results fall in line with our consumer spending growth estimate for the first quarter of 1.7%. The jump in retail sales also helps offset our worries (and the Fed's) that the gains in job growth haven't spurred a pickup in final demand.
The Politics Of Recovery
At least people won't suffer from a near-term squeeze by Uncle Sam, even if the money they've saved ends up going toward gas. Last month, Congress finally extended the payroll tax holiday and emergency unemployment benefits through 2012. Both measures would have expired at the end of February, and together they add about $1,000 to the median household annual income. While our forecast had already assumed the extension, it certainly does remove some downside risk.
The extensions also add a few more bucks to the government's spending bill. Together with the extension of the Medicare "doc fix," which delays cuts to doctors' pay, they will likely add a few hundred billion to the overall fiscal deficit in 2012. But they also reduce the risk of a sharp fiscal contraction this year considerably, which would have impaired economic growth. The extensions may add more drama to fiscal 2013 decision-making as well, if Republicans use this spending as a reason to extend the Bush tax cuts in their political platforms.
The national debt level will also be close to its ceiling when we reach Election Day on Nov. 6. While politicians would surely play up the drama, the Treasury Department will likely be able to extend the day of reckoning by a few months, just as they did last year, to avoid any pre-Election Day fireworks.
Uncertainty over U.S. fiscal policy will likely remain high throughout 2012, keeping a lid on consumer confidence and economic growth as the election approaches. If nothing changes, automatic spending cuts will kick in and the Bush tax cuts will expire at the beginning of 2013, as will the payroll tax cut and emergency unemployment insurance. We expect the government to finally reach a compromise on entitlement spending cuts and tax increases, phased in over a number of years—but, as usual, only at the midnight hour, when all hope seems lost. What the compromise will look like will depend on the balance of power in Washington after the November elections, which still remain a close call, as the Republican primaries have made clear.
Europe Is Still Feverish
Risks have diminished across the European Economic and Monetary Union (EMU or eurozone), though they haven't disappeared. The European Central Bank's (ECB) Long-Term Refinancing Operations have pumped about 1 trillion euros into the fragile European banking system. Since then, most of Greece's private creditors have accepted a proposed restructuring of Greek sovereign bonds and the accompanying losses, and the second Greek bailout, valued at 130 billion euros ($170 billion) has been approved. With the Greece worries easing over the near term, concerns about Portugal's debt burden remain. Should Portugal default on its debt, the risk of a fallout spreading across the eurozone would increase. The meltdown could possibly cause a major European banking crisis and make it harder for other debt-burdened countries, like Italy and Spain, to tap the bond market. While the eurozone debt crisis continues, we remain concerned about how existing and future austerity measures in Europe and any contagion from the crisis will affect the U.S. economy.
Our European Chief Economist, Jean Michel Six, forecasts a mild recession in the eurozone, with a 40% risk of a more severe outcome. We expect only a modest slowing in U.S. growth. But if European policymakers are unable to curb a meltdown of their financial markets, we can kiss the U.S. recovery goodbye. The interconnections of banks throughout the world would spell tighter credit in the U.S. As further austerity measures kick in and European consumers and businesses rein in their spending, U.S. exports to the eurozone, which account for about 13% of total U.S. exports, would likely dry up. U.S. exports to other regions would also erode if investors run to U.S. safe-haven assets, leading to a stronger U.S. dollar. And although U.S. banks would have the opportunistic potential to gain further market share in Europe, corporate earnings for foreign investors in the eurozone would drop, as would U.S. business spending and equity prices. Given that about one-third of the U.S.'s total foreign direct investment is in the eurozone, these events would hurt U.S. growth. Unfortunately, the Fed has little ammunition left to help boost U.S. growth and shield the economy from a financial and economic disaster in Europe.
The Right Medicine
That doesn't mean that the Fed hasn't given up on trying to find new ways to fight inflation and promote growth. It's well aware that the run-up in oil prices can challenge its current policies for growth and inflation.
The Fed has recently discussed what's being called the sterilized bond-buying program, in which it would print new money to buy long-term mortgage or Treasury bonds and "sterilize" the trade by borrowing the money back for short periods at low rates. In theory, the program should keep the liquidity from flooding into the broader economy. This approach is likely to relieve anxieties that money printing could fuel inflation down the road. However, the Fed doesn't seem to be in any rush. Its statement to the Federal Open Market Committee meeting on March 13 was silent on the subject. Given the better tone of the data, the Fed can take its time.
Recession fears are alive and kicking in 2012. Higher oil prices from increased turmoil in the Middle East are now the largest near-term threat to the U.S. recovery. Risk of a collapse of the Greek sovereign debt negotiations has ebbed, though the eurozone crisis is far from over and the risk of near-term U.S. austerity is very real. Regulatory uncertainties going into 2013, the large overhang of excess housing supply, and struggling consumers also point to murky prospects this year. We expect real GDP to rise 2.1% in 2012, a bit stronger than in 2011, though much weaker than the 3% rate in 2010. This will likely keep the unemployment rate above 8% through 2012. For 2013, we expect just 2.3% growth. Hopefully the economy will have recuperated after that.
Contributor: Sonika Tyagi
|Standard & Poor's Economic Outlook|
|Nonfarm Unit Labor Costs||1.2||2.3||2.1||2.5||2.5||(0.7)||(2.0)||1.1||1.4||2.2||1.6||2.1|
|Payroll Employment (mn)||132.0||132.6||133.1||133.5||134.1||130.8||129.9||131.4||133.3||135.4||137.7||140.0|
|Federal Funds Rate||0.1||0.1||0.1||0.1||0.1||0.2||0.2||0.1||0.1||0.1||0.1||1.2|
|10-Yr. T-Note Yield||2.0||2.0||2.2||2.3||2.4||3.3||3.2||2.8||2.2||2.7||2.9||3.6|
|AAA Corporate Bond Yield||3.9||3.8||4.2||4.2||4.3||5.3||4.9||4.6||4.1||4.4||4.6||5.1|
|Mortgage rate (30-year conventional)||4.0||3.9||4.0||4.1||4.1||5.0||4.7||4.5||4.0||4.3||4.4||5.0|
|3-month T-Bill Rate||0.0||0.1||0.1||0.1||0.1||0.2||0.1||0.1||0.1||0.1||0.1||1.3|
|S&P 500 Index||1226||1355.3||1335.4||1365.5||1388.5||947||1139||1269||1361||1395||1457||1533|
|S&P Operating Earnings ($/share)||23.71||25.32||25.51||26.58||26.25||56.86||83.77||96.42||103.67||109.77||118.47||125.52|
|Current Account ($bn)||(467)||(511)||(566)||(564)||(526)||(377)||(471)||(471)||(542)||(480)||(464)||(493)|
|Exchange rate (maj trade part)||86.3||86.8||86.9||87.3||87.5||92.6||89.8||84.6||87.1||88.0||87.7||86.6|
|Crude Oil ($/bbl, WTI)||94.04||105.19||102.67||103.17||107.01||61.69||79.41||95.07||104.51||114.77||115.43||112.71|
|Housing Starts (mn)||0.67||0.69||0.73||0.77||0.77||0.55||0.58||0.61||0.74||1.00||1.40||1.68|
|Unit Sales of Light Vehicles (mn)||13.4||14.6||13.9||13.8||14.1||10.4||11.6||12.7||14.1||14.8||15.7||16.2|
|Federal Surplus (FY. unified, $bn)||(322)||(397)||(68)||(260)||(273)||(1,416)||(1,294)||(1,297)||(1,047)||(750)||(623)||(528)|
|e--Estimate. WTI--West Texas Intermediate.|
|Primary Credit Analyst:||Beth Ann Bovino, New York (1) 212-438-1652;|
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