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Federal Reserve staff project moderate recovery in US economic activity over the next two years; Unemployment will remain high
By Michael Hennigan, Founder and Editor of Finfacts
Feb 18, 2010 - 5:45:51 AM
President Barack Obama makes a statement to business owners on the anniversary of the Recovery Act signing in the South Court Auditorium of the Eisenhower Executive Office Building February 17, 2010. Behind him is Vice President Biden with an Ash Wednesday mark on his forehead
Minutes released on Wednesday in Washington DC, of the January rate setting FOMC (Federal Open Market Committee) meeting, show that Federal Reserve staff continued to project a moderate recovery in economic activity over the next two years, with economic growth supported by the accommodative stance of monetary policy and by a further waning of the factors that weighed on spending and production over the past two years. The staff also continued to expect that resource slack would be taken up only gradually over the forecast period and unemployment is expected to remain high.
The minutes included updated staff forecasts, which show inflation-adjusted GDP (gross domestic product) growth of between 2.8% and 3.5% in 2010 and 4% growth in 2011 and 2012. Inflation is expected to remain subdued and the unemployment rate, now at 9.7%, will hardly move for the rest of the year, then to drop to around 8.5% in late 2011 and to between 6.6% and 7.5% in 2012.
The US has lost 8.4 million jobs since the recession began in December 2007 when the official unemployment rate was 5.0%. Last month, the broad measure of unemployment was 16.5% and included persons marginally attached to the labour force who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the past 12 months; discouraged workers, a subset of the marginally attached, have given a job-market related reason for not currently looking for work; persons employed part time for economic reasons are those who want and are available for full-time work but have had to settle for a part-time schedule.
In December 2007, the broad measure -- total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons, as a percent of the civilian labour force plus all marginally attached workers - - was 8.8%.
Standard & Poor's, the credit ratings' agency, said in a recent commentary that the fourth quarter was much stronger than expected, with real GDP rising at a 5.7% annual rate, the strongest quarter since the third quarter of 2003. Although inventories accounted for most of the strength, domestic final sales were up 2.2%, a good if not spectacular performance. The economy is beginning to turn around, but S&P expects it to be a slow turn.
Consumers are gradually recovering but remain cautious about borrowing. Household debt has now dropped for five consecutive quarters. It has fallen to 126% of disposable income from the record 136% at the start of 2008. The saving rate is holding at 4.6%, still only half the pre-1990 average but well up from the record low 1.7% of 2007.
Construction remains a problem for the economy, but the problem is transitioning to commercial construction from residential. Home sales dropped off in December but still seem to be holding well above their early-2009 lows. Prices remained up from their lows, though S&P continues to expect a drop over the winter. However, nonresidential construction remains weak, with spending down 19.7% in 2009 and likely to be down the same in 2010.
Government spending will continue to boost the economy. The Administration's new budget calls for a $1.6 trillion deficit for fiscal 2010, up from last year's record $1.4 trillion. The plan calls for a reduction to $727 billion by fiscal 2013, but achieving that will require significant help from Congress, which might not be forthcoming, accord to S&P. It says the Federal Reserve has now exited from new purchases under the various quantitative easing plans. So far, the markets have taken the absence of new purchases well, and we expect spreads to remain stable over the coming months. No tightening is likely until the unemployment rate comes down for a few months in a row, which S&P does not think likely until late summer at the earliest.
Instant reaction to the FOMC minutes, with Jim Bianco, Bianco Research and CNBC's Steve Liesman:
Consumers hit the brakes
S&P says consumer spending is expected to slow in the first quarter after a better-than-expected holiday season. Although consumer confidence is continuing to improve and the labour market is getting better, car sales dropped back in January, to a 10.8 million unit pace from 11.2 million in December. However, the agency says the car sales drop was temporary, caused by the brake problems at Toyota. Once Toyota restarts full production, it expect sales to rise to 11.8 million for 2009 as a whole. That rate of sales would have been considered a disaster two years ago, but compared with the 9.5 million in the first half of 2009 (before the cash-for-clunkers rebate), it looks pretty good.
Non-auto retail spending will depend on employment. The agency says the January puzzle was that the household measure of employment rose 541,000, while payrolls dropped another 20,000. Although S&P says some of this might stem from seasonal adjustment problems. When companies begin to see more sales, they are reluctant to add permanent staff, instead hiring temporary and contract employees. Employment of temp workers rose 52,000 in January, more than accounting for the rise in private services. Although temp workers are counted in payrolls because they are hired through a temp agency and get a payroll check, contract workers are paid as contractors, receiving a 1099 at the end of the year rather than a W-2 and not having taxes withheld or benefits paid by the employer. Many of these should be reported as self-employed, but self-employment rose only 26,000. Many probably work for small companies that do not get picked up in the survey (though they might be when the survey is rebenchmarked), but others misreport their status because they consider themselves employed.
The weather problems might have aggravated the discrepancy. Although many construction workers didn't receive a payroll check during the week of Jan. 12, they still consider themselves employed. They just didn't have a job to work at that week because of the weather.
The analysis of the employment picture is further confused by the enormous annual revision, which lowered the level of December employment by 1.39 million. The payroll data are benchmarked to state unemployment tax receipts; as usual in a recession, the levels are revised lower because small firms close down and are lost from the survey, while start-ups decline. This pattern normally reverses during the upturn, when the payroll data underestimate job gains. The level of household employment was also revised lower, but by only 243,000, as a result of a re-estimation of the size of the population. Note that the unemployment rate is unaffected by the revision.
S&P expects the unemployment rate to climb during the spring, probably reaching a peak above 10% in June. However, the October 10.2% rate might be the peak for this recession, remaining well short of the 10.8% peak reached in 1982, which will remain the postwar record.
Deficit woes
The Office of Management and Budget (OMB) released its new estimate of federal spending and revenue for the next 10 years. Unlike the Congressional Budget Office (CBO) estimates released in January, the OMB budget takes into account the Administration's requests for new spending and tax changes. The result is a much higher deficit than the CBO estimate, which assumes, among other things, the sunsetting of President Bush's tax cuts after 2010.
Under the OMB proposals and projections, receipts would rise from 14.8% of GDP in 2009 to 19.3% in 2016. Outlays would fall to 23.1% of GDP from 24.7%, implying a drop in the deficit to 3.9% ($778 billion) from 9.9% of GDP ($1.4 trillion). Under current policies (which assumes continuation of the tax cuts), the deficit would be 5.0% of GDP in 2016. Government debt held by the public (excluding trust funds) would rise to 73.6% of GDP in 2016 from 53.0% in 2009.
The major policy changes proposed to reduce the deficit are tax hikes on upper-income families, including the sunsetting of some of the current tax cuts and partially offset by cuts in taxes for middle-income families, rising to $133 billion (net) in 2016. There are $88 billion of net cuts in discretionary outlays proposed. Health-care and climate-change legislation is assumed to be approximately neutral, except for some transition costs for health care.
S&P says the economic assumptions behind the report seem somewhat optimistic but not impossible. Real GDP is expected to rise 2.7% this year in line with the S&P estimate but then to average 4.0% for the next five years, compared with S&P's forecast of 2.9%. Growth is then assumed to slow to its long-term trend of 2.5% by 2019, which is in line with S&P's estimate of long-term potential, though the agency doesn't do year-by-year growth rates out that far.
