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News : International Last Updated: Jul 8, 2010 - 6:20:49 AM


US Economy Growth Scare: Still on track for moderate, sustainable growth
By Finfacts Team
Jul 7, 2010 - 5:40:23 AM

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President Barack Obama leads Senate Majority Leader Harry Reid, centre, and Vice President Joe Biden on a tour of the White House Kitchen Garden following their meeting in the Oval Office, July 1, 2010.

US Economy Growth Scare: The United States economy is still on track for moderate, sustainable growth according to Morgan Stanley economists, Richard Berner and David Greenlaw. They say that despite market turmoil and softer incoming data, the economy remains on track for moderate (3-3.5%), sustainable growth. However, they have trimmed their second-half 2010 growth outlook fractionally in response to slightly more restrictive financial conditions and now expect a slower rise in underlying inflation.

In response, the economists have substantially changed their expectations for Treasury yields and the Fed: They now think that 10-year Treasury yields will probably trade in a 2¾-3½% range for the balance of this year.  While a significant rise in yields over the course of 2011 isn't expected, Fed officials will raise rates in 2011 a bit more cautiously than the economists expected in May/June, to 1.75% by the end of 2011, or 50bp lower than the MS earlier forecast.

However, the MS economists say cyclical forces still outweigh the threats from the contagion of the European sovereign credit crisis; the threat of fiscal drag, including likely tax hikes as soon as next year; and uncertainty about economic policies. 

Overwrought about the slowdown:  Berner and Greenlaw say there's no mistaking the recent string of weaker data, capped by the disappointing 83,000 June gain in private nonfarm payrolls and dip in the workweek.  But the data certainly don't validate market fears of a 1-2% second half, much less a double-dip recession, in their view.  Instead, they signal a step down from annualised 3.8% growth in 2Q to about 3¼% in the second half.  Most important, despite the June downdraft in wage income implied by the data, the economists believe real income gains are sufficient both to sustain 2-2½% consumer spending growth and rebuild saving. The data may well understate actual gains, given the stronger pace of withheld income and payroll taxes through June; they estimate that the three-month average of such receipts rose by 4.5% from a year ago.  Even ignoring the tax data to be conservative, the economists estimate that real disposable income rose at a 5% annual clip in 2Q and will slow only slightly to 4% in 3Q, leaving scope for upside in spending if consumers have reason to turn less cautious. 

The US economy is slowing down and the earnings season will reflect limited visibility for companies in the second half, says Peter Boockvar, equities strategist at Miller Tabak & Co. He talks to CNBC's Martin Soong, Karen Tso and Sri Jegarajah:

Forecast myths:  Berner and Greenlaw say three myths pervade current negative thinking about the outlook. One is that the ‘sugar high' from fiscal stimulus is over; now it's payback time.  In their view, fiscal thrust - - measured by the change in the standardized deficit/GDP - - is peaking and probably will decline in the second half.  But the impact of fiscal policy lags behind and is still supportive of growth, especially through stepped-up infrastructure outlays.  Such outlays through May aren't close to reversing all of the decline since last summer, but the 20.1% annualized increase over the last three months is a favourable portent.  Moreover, only about one-third of the infrastructure monies budgeted has been spent.  And with state and local government revenue now improving, noticeable cutbacks in their spending seem less likely as they head into a new fiscal year. 

Inventories leaner by the day: A second myth is that the inventory ‘cycle' has run its course.  In fact, the MS economists see inventories getting leaner in relation to sales by the day.  Excluding motor vehicles, the real manufacturing and trade I/S ratio in April declined to 1.28 months, not far from all-time lows.  Accumulation has just begun, and the pace of production in 2H10 and through 2011 will likely run a few tenths of a percent ahead of demand simply to keep I/S ratios from falling too low.  For example, new production schedules from the car manufacturers show significantly higher-than-expected production levels over the next few months.  One OEM (original equipment manufacturer) has decided to break tradition and keep production lines running in the first two weeks of July because dealers lack vehicles in showrooms needed to bring in traffic.

“It’s all about deflation in the near term,” Kirby Daley, senior strategist from Newedge Group, told CNBC. “The signs are that the sort of pick-up in growth we saw earlier in the year is fading,” added Sarah Hewin, from Standard Chartered Bank, added to the discussion on the US economy Tuesday.

Sustainable support from net exports:  A third myth: The fast-growing EM (emerging markets) economies are too small and fragile to provide a material boost to US exports, and rising US imports will swamp any gains. In contrast, Berner and Greenlaw say strong growth in domestic demand in the larger EM economies in Asia and Latin America will promote strong gains in exports.  Moreover, slower growth in US final demand seems likely to restrain imports.  Imports have recently jumped, but the economists believe that much of the rise has reflected a significant swing in inventories as companies liquidated them more slowly.  Between August 2009 and April 2010, real imports jumped by $16bn (13.5%), while the swing in real manufacturing and trade inventories (the change in the change in the stocks) was more than five times that magnitude ($84bn) over the same period.  The magnitude of such changes likely will slow, as will the rise in imports.

Slower rise in inflation: Berner and Greenlaw say inflation is bottoming and is poised to rise gradually.  At work: narrowing slack in the economy and the Fed's ultra-accommodative policy stance, which will sustain inflation expectations.  Both are lifting pricing power.   Although slack in the economy remains significant, the change in slack also matters for inflation, and slack continues to narrow as companies cut back capacity and industrial production continues to boom.  While factory operating rates probably slipped in June, they are up 660bp (basis points - - 6.6%) from the trough last June and at the highest level since October 2008.  Surveys of consumers evince stable inflation expectations; in the June University of Michigan poll, 5-10 year inflation expectations hovered at 2.8%.

Climbing rents, accelerating prices at the early stages of the processing pipeline, and rising import prices all are starting to signal that inflation is bottoming.  Apartment rents, which enter popular price gauges on a six-month moving average basis, have turned higher, and surveys suggest they are rising 3-5% from a year ago.  Despite the dollar's recent strength, consumer import prices rose 0.4% in the year ended in May.  Nonetheless, the ongoing slide in market-based inflation expectations implies a slower rise into 2011.  By one measure, 5-year forward breakevens have tumbled 70bp since April to 2.1%, and by the Fed's own measure they have declined by 50bp to 2.6%.  Such declines likely will keep inflation tame for longer, and slow the pace at which inflation increases over the next year as businesses and consumers have turned more cautious.

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