United States Forecast Summary
February 2012
Overview
The U.S. economy ended 2011 on an ambiguous uptick. The headline GDP number for the fourth quarter, although at the low end of expectations, was still the best since the second quarter of 2010. But below the top line the picture was less positive. The labor market situation, on the other hand, continued to look positive from virtually any perspective. Overall, the data have been consistent with our view that this year will see continuing growth, but at a rate that is only in line with potential.
NIPA Data
The advance release of fourth quarter National Income had overall output growth for the quarter at 2.8%. This was very close to our November forecast, but was below the 3.3% growth we forecast in January. More disturbing, at a disaggregate level nearly every component of aggregate demand came in below our expectation. The only exception was residential investment, perhaps an indication that the housing sector has finally bottomed.
At the component level the fourth quarter also fell short of the third quarter. Business investment, international trade (net exports), and government all contributed significantly less to growth in Q4 than they had in Q3. The latter two actually fell in Q4. Consumption and housing both accounted for slightly more growth. But the really big change was a large swing in inventory accumulation (from -$2 billion to +$59 billion). Looked at differently, final sales in the fourth quarter grew at a very disappointing 0.8% rate, far below the 3.2% rate in the third quarter. The picture is disturbing even if you discount the drop in government spending as mostly a temporary anomaly.
Labor Market Data
While the NIPA picture is ambiguous, the labor market data are nearly all positive. In the January household survey, the string of decreases in the unemployment rate extended to five months. Over that span the rate has dropped from 9.1% to a January level of 8.3%. This latter value was 0.2% below December. Moreover, the January decline was not due to shrinkage in the labor force.
The data from the establishment survey were even better. Private sector employment rose 257 thousand in January, continuing an acceleration in the rate of job creation that began in October. The average monthly increase in total employment during this period (201 thousand) is well above the 125 thousand that we estimate is needed to keep up with growth in the labor force. Disaggregate results for January were also encouraging. The only private sectors with decreased employment were finance and information, and these were small. Manufacturing added 50 thousand, and even construction was up by 21 thousand.
Finally, the BLS also released its annual benchmark revisions. These affect establishment data back to 2007, but the most significant changes begin in mid 2010 and are uniformly upward. The December estimate of the level of total payroll employment was raised by 266 thousand.
Other Recent Considerations
Other monthly data have been generally consistent with an economy that has halted its first half slide, but with growth that is inadequate to do much more than maintain the status quo.
Real disposable income growth continues to be disappointing, suggesting that the cautiousness exhibited by households in their spending is likely to continue in the near term. Consistent with this, consumer sentiment, while up from late summer, remains quite low. Auto sales, however, were strong in January. Both ISM indices rose in January – manufacturing to 54.1 and non-manufacturing to 56.8 – although both are below their level a year ago.
Finally, inflation remains relatively well contained. Partly in response the Federal Reserve announced that it intends to keep short-term interest rates at their current low levels until at least 2014. That will mean nominal rates close to zero (and real rates that are negative) for a total of six years. Although we think this policy is badly misguided, we have incorporated it into our forecast.
To summarize: Neither the fourth quarter NIPA data nor the recent labor market results are cause to pop the champagne (although the latter is getting close). They are basically consistent with the “in line with potential” trajectory that the economy has been on since the recession hit bottom during 2009. Given that we were then in a huge hole, one might hope for better. On the other hand, as Europe is demonstrating, things could be worse. Looking ahead, we basically expect more of the same.
Baseline forecast
The data reviewed above do not significantly change our view of the most likely path for the economy over the next year. As shown in Figure 2, we continue to expect fluctuations around a path that approximates the long-run growth potential of the economy. The recent string of good data has improved our forecast for the labor market. We now expect that unemployment will be below 8% by the end of the year. Our current fourth quarter forecast is over four-tenths percent below that in November.
Some other features of the baseline forecast:
- The forecast for real GDP growth in the current quarter is now 2.5%, which is 0.3% down from the fourth quarter. However, final sales are forecast to grow by 2.3%, nearly triple the fourth quarter. Forecast growth for all of 2012 is 2.3%, up 0.6% from 2011.
- The strongest growth comes from business investment in equipment, from exports, and from housing. The first two are expected to rebound from the fourth quarter, while housing is off some from its very strong last quarter performance.
- Consumer spending is comparable to the fourth quarter, but with more of the growth coming in services and less in goods. Government spending is up in total due to a rebound in defense expenditures (from a 12.5% drop in the fourth quarter). Spending continues to decline at the state and local level.
Commentary
Our baseline forecast is that the U.S. economy will manage to muddle through the next year. While this is far from an optimistic forecast, we think it is middle-of the-road relative to the probabilities on either side. This represents a definite improvement from November when we thought there was considerably more downside risk. The list of potential problems has three repeat elements, and one new entry. The repeats are (1) European debt, (2) U.S. political deadlock, and (3) potential Chinese slowdown. The new component is the possibility of a conflict with Iran.
As far as we can tell, the situation in Europe has changed very little over the past few months. In a way, this is positive, since it means that things haven’t gone downhill. But it also means that not much progress has been made in dealing with the very real problems that must be confronted for the continent to return to anything approaching economic health. Our baseline is predicated on a continuation of the status quo – no fundamental solutions, but also no collapse.
In the U.S. everything policy-wise is probably on hold until the election. As already mentioned, we think that the payroll tax cut will be extended through year-end, but beyond that there will be nothing but posturing.
Similarly, our baseline assumes that Chinese growth continues to be quite strong, although perhaps down a little from the extraordinary results of the past two decades.
Finally, the situation in the Middle East looks to us increasingly worrisome. The Iranian situation seems to be headed toward a crisis point. Given increased instability in Iraq and Syria to the west, and Afghanistan to the east the whole region is primed for trouble. If it occurs, all bets are off.
But our baseline is that the potential disasters that are out there remain just potential. If so, the economy should manage to produce at least adequate results. And if there are some constructive developments, a more positive outcome is possible.
