U.S. economy: Coming down off the ledge
This post is a guest contribution by David Greenlaw and Ted Wieseman of Morgan Stanley.
We have made only minor adjustments to forecasts this month. While growth has slowed since the plunge in confidence and market weakness in August, so far the deceleration seems to have been modest. We see 3Q GDP rising 3.2%, and while this to a significant extent reflects improvement in June and July as the economy rebounded from some temporary 1H drags, data since the turmoil began in August have held up fairly well. We see 4Q slowing not too severely to +2.2%. This would leave 2H growth at +2.7%, slightly better than the +2.5% we expected a month ago. Along with the government’s upward revision to 2Q, this boosted our 2011 GDP forecast to +1.8% from +1.6% (on a 4Q/4Q basis).
We continue to forecast growth near 2% over the four quarters of 2012, with a sub-1% reading in 2Q12, assuming expiration of the payroll tax cut. Bear case recession risks remain significant, but it has been encouraging that US growth has slowed but not rolled over in the past two months. And while the crisis in Europe has worsened, there are at least now potentially important plans being formulated to try to support the European banking system and avoid a deepening European credit crunch that would likely have substantial further negative knock-on impacts on the US.
The basic story for the US economy remains relatively straightforward. Growth should be much better in the second half of the year than it was in the first half. But this is largely attributable to special factors – namely, a sharp rebound in motor vehicle production as supply chain disruptions abate and a plunge in gasoline prices. The key to generating a sustained economic recovery at this point is income support tied to the performance of the labor market.
We had been getting increasingly nervous on this front in the wake of some terrible jobs figures during the summer months. However, September’s results have talked us down off the ledge. Friday’s report showed payrolls rose 103,000 last month – very close to our estimate but well above the consensus of +60,000 (note that the return of striking Verizon workers added 45,000 to September payrolls, as anticipated). Most importantly, there were significant upward revisions to July and August (totaling 99,000) as well as a rebound in the average workweek. The upward revisions were scattered across a number of categories, with the sharpest adjustments coming in government and temp help. Last week, the BLS announced that its preliminary estimate of the annual benchmark revision to payroll would be approximately +200,000 (or +0.1%). This means that when the official figures are released next February, there will be upward revisions averaging about 16,000 per month during the April 2010 to March 2011 benchmark interval.
Meanwhile, the household survey showed a very sharp jump in employment (+398,000) during September. This follows a 331,000 gain in August. However, it’s important to recognize that this is a very volatile series based on an extremely small sample size. Moreover, the advances seen in the past two months merely offset the declines posted during the April through July period.
The only negative surprise in Friday’s report was some weakness in manufacturing. Still, some technical considerations imply that industrial production will post a modest rise in September.
The September payroll results might have been even better were it not for the impact of Hurricane Irene. We like to use the “Not at work due to bad weather” measure from the household survey as a proxy for weather-related influences on payroll employment. Using an admittedly crude relationship developed over the years, we estimate that Hurricane Irene had about a -20,000 impact on September payroll employment.
The employment data are key at this stage of the economic cycle because productivity growth appears to be experiencing some underlying moderation. This is quite normal a couple of years into economic recovery, but the deceleration now is likely being exacerbated by extremely low net business investment over the past three years. So, we need income support from the labor market in order to sustain domestic demand and output. The employment report showed that aggregate weekly payrolls – a gauge that serves as a proxy for wage income since it captures the impact of changes in employment, hours and wage rates – posted a solid 0.6% rebound in September. This follows on the heels of a 0.5% decline in August, which represented the worst performance since the end of the recession in June 2009.
While this report was much better than consensus expectations, it still points to a weak labor market. Indeed, excluding strike effects, private payroll employment growth has been below 100,000 in four out of the past five months. If this trend continues, we are likely to soon see a slow but steady rise in the unemployment rate – especially after factoring in the ongoing declines in state and local government jobs. Assuming a stable participation rate, the economy needs to generate about 125,000 jobs per month just to keep the unemployment rate steady. Unless job growth starts to improve, we could be back near a 10% unemployment rate in 2012.
We remain concerned that pessimism tied to government economic policy will be revisited in the days leading up to the November 23 deadline for the so-called Super-Committee. This could reinforce the cautiousness that makes employers reluctant to hire. Indeed, recent data showed that sentiment regarding government economic policy registered only a very slight uptick in September on the heels of the all-time record low seen in August.
Continued fiscal gridlock will mean that the problem of dealing with a faltering US economy will be left at the doorstep of the Federal Reserve. The Fed is not out of ammunition but the options that appear to be available at this point are not all that exciting. Friday’s employment report was the last one that will be released before the November 1-2 FOMC meeting. The better-than-feared results should – at least temporarily – take some pressure off the Fed to do more.
We remain convinced that the best option available to the Fed at this point is to team up with the Treasury Department for a streamlined mortgage refinancing program. We estimate that nearly half of outstanding agency-backed mortgages that are still current do not meet standard qualifications for a refinancing because they have a loan-to-value ratio in excess of 80%. Moreover, the share of mortgages that are blocked from a refi has started to rise quite a bit in recent months. This means that much of the economic stimulus associated with declining mortgage rates is not making its way through the pipeline.
In our view, two things will have to happen to bring about implementation of a streamlined refi program. First, the FHFA will have to take a broader view of its responsibilities in regulating the GSEs. Second, mortgage rates will have to continue to move lower, making the potential benefit of a refi wave more and more obvious. We suspect that these developments will play out over the course of time, but we are probably still months away from outright action.
Source: David Greenlaw and Ted Wieseman Morgan Stanley, October 11, 2011.
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