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President Barack Obama speaks about the economy following a tour of Thompson Creek Manufacturing, which makes custom replacement windows in Landover, Maryland, Jan. 07, 2011. On stage with the President are the newest members of his economic team, from left: Jason Furman, Principal Deputy Director of the National Economic Council; Katharine Abraham, nominee for member, Council of Economic Advisers; Gene Sperling, National Economic Council Director; and Heather Higginbottom, nominee for Deputy Director, Office of Management and Budget.
Three themes for 2011. Three themes will dominate
the debate around the US economic outlook: 1) inflation will bottom and
gradually turn up; 2) the two-tier economy will persist, as strong exports and capex
(capital expenditure) will lead while weak housing and state and local government outlays will
drag; and 3) the shift to fiscal from monetary stimulus will push both real and
nominal rates higher, according to Richard Berner and David Greenlaw of Morgan
Stanley, the investment bank, in a commentary published on Tuesday.
The US economy will expand by 3.2% this year and add 2.4m jobs, Chamber of
Commerce President Thomas Donohue said as the nation’s biggest lobbying group
offered an optimistic forecast for 2011.
“We are cautiously optimistic that the recovery will continue and pick up
steam as the year progresses,” Donohue said in
a speech at the Chamber’s Washington headquarters. “It’s a very fragile
kind of economic growth, depending on what happens in the interim.”
New normal: RIP? The Morgan Stanley economists say they
don't want to short-change the growth debate; it remains central, as the tepid
employment report underscores. Non-farm payrolls rose just 103,000 in December;
inclement weather likely depressed the job tally somewhat. It's far from a boom
or even a truly vigorous recovery. Nonetheless, average monthly private payroll
growth in 4Q10 was the strongest in nearly four years. Thus, despite well-worn
and obvious, lingering headwinds, the economists say that the debate about growth is
largely over. And several factors at the least assure moderate growth and raise
the odds of a more bullish outcome this year and next: the combination of
generally better-than-expected incoming data, faster-than-expected deleveraging,
the one-two punch from new fiscal stimulus and a Fed committed to achieve its
dual mandate, and a dramatic reduction in political uncertainty. Consequently,
they continue to expect 4% real growth over the four quarters of 2011.
a blog post in The New York Times, the economics editor, Catherine Rampell,
writes today that: "Everything old is new again, including normality."
She added: "This obsession with a 'new normal' lends some momentum for the
current catastrophe or craze, but nonetheless subsides as things eventually
return to their long-run trend."
Berner and Greenlaw say that: "The inflation debate, however, is even more important:
The economists say it has only just
begun, inflation is not in the price, and thus even a genuine bottoming in
inflation, let alone an increase, would have significant market and policy
consequences. They don't think inflation will rise back to the Fed's
‘mandate-consistent' rate of 2% or just below until 2012. But a rise in core
inflation back above 1% in the next several months is highly likely, in their
view, and that inflection point will kick off the inflation debate in earnest.
Inflation inflection point. The economists believe that
inflation is bottoming and will gradually move higher. A tug of war is under
way: Significant slack in markets for goods and services, housing and labour will
depress inflation. But stable-to-higher inflation expectations will push it
higher. While operating rates are low and the jobless rate is high, changes
in those gaps - - so-called ‘speed effects' - - are promoting an inflation
inflection point. That is especially the case for rents, which are a major
inflation component and which are already moving higher.
In addition, several global factors seem likely to contribute to US
inflation over the next few months. Among them: Strong global demand
and limits on supply are boosting energy and food quotes. Energy quotes jumped
by 17% (not annualized) in the three months ended in December. While the pace
should slow from here, The MS commodity team believes that the direction is
higher. Measured in the CPI, meanwhile, US retail food prices have also
accelerated - - admittedly to a modest 2.4% annual rate in the September-December
span. But the strength of global demand is pushing food prices higher, and
there are upside risks to the November view that food inflation would be limited
to 2-3%. Finally, many prices for imported goods are beginning to turn up
again, despite the recent stability in the dollar. Berner and Greenlaw
say that sellers
typically pass some of these price hikes through to core prices with roughly a
2-4-month lag, and these price hikes may also contribute to US inflation by
reviving inflation expectations.
Two-tier economy to persist. The impressive improvement in
most incoming data and the onset of new federal fiscal stimulus hint that 4%
growth is likely, perhaps even conservative. But neither of those developments
changes the ongoing dichotomy in overall economic performance: Strong leadership
from exports and capital spending will continue to outweigh the drag from weak
housing activity/home prices and from ongoing state and local government budget
cuts, but those two headwinds may take one percentage point or more from growth
The upper tier is strong... Reflecting the strength of
global growth, exports have been a boost to US growth, but until recently a
surge in imports has been an even bigger drag. Now, net exports seem likely to
provide a major boost as the import surge reverses and import growth seems
likely to be subdued. In addition, pent-up demand for capital spending is
healthy; in the recession, capex slipped well below depreciation expense.
Together with the acceleration expected in economic activity and the business
expensing provisions of the new tax deal, that pent-up demand should spur hearty
gains in capex in the coming year. And improving fundamentals will
boost capex outlays in 2012 despite the inevitable ‘payback' in outlays after
the tax expensing provision expires.
Jamie Dimon, CEO of JPMorgan Chase, goes on the record with CNBC's Maria Bartiromo, to discuss the medical conference, the economy, and Bill Daley:
...while the lower tier is still fraught.
housing imbalances remain the most significant single downside risk; Berner and Greenlaw expect a
6-11% decline in home prices this year, which will limit the supply of mortgage
credit, restrain consumer net worth, and thus cap growth in consumer spending.
Mortgage credit is still tight; indeed, in 4Q banks signaled tighter standards
for mortgage lending. The ongoing issues around mortgage ‘putbacks' continue to
keep origination criteria from loosening, although recent developments have
greatly reduced the uncertainty associated with putbacks. Second, state and
local government finances remain weak; faced with additional shortfalls,
officials are likely to cut spending and employment somewhat further, especially
as federal grants fade. In particular, some $26bn in assistance for
Medicaid will disappear in July. The good news is that revenues are starting to
improve, which should somewhat mitigate that risk.
Shift in policy mix implies higher real rates.
Berner and Greenlaw say QE2, the Fed's
program of buying government bonds, was aimed
at reducing real yields to boost credit-sensitive demand; its impact was always
likely to be small, given its limited scope. But anticipation of QE2 did reduce
real yields and promote refinancing, and perhaps more importantly, it helped to
break the policy logjam and uncertainty that plagued businesses and consumers
during the spring and summer. In contrast, the shift to fiscal stimulus - and
the expectation of its success - implies that real and nominal yields will
continue to move somewhat higher. Partly for that reason, The economists expect that
10-year Treasury yields will move 50-75bp higher, to 4%, over the course of
Fed on hold through 2011 - but markets likely will anticipate a move
in 2012. In addition, expectations of a change in monetary policy may
contribute to an increase in yields across the maturity spectrum. The Fed call
is unchanged: An inflection point in inflation and hearty growth will not be
enough to trigger any change in monetary policy in 2011. Inflation will still
be below the Fed's ‘mandate-consistent' rate of 2% or slightly below, and the
unemployment rate will still be far above an acceptable level. But by mid-year,
Berner and Greenlaw say investors' outlook for inflation will begin to change as the forces
pushing inflation higher start to gain the upper hand and the infection point is
clearly in sight. At that point, anticipation of the first step away from zero
policy rates that is expected in 2012 will begin to affect the front end of
the yield curve.
Six risks to the outlook: A matter of degree rather than of kind.
Notwithstanding the more upbeat view for 2011, Berner and Greenlaw
say they are acutely aware of
the risks that still lurk. In varying degrees, they have tried to capture six in
their baseline outlook. So, the six risks that they see all represent an
intensification of factors that have been flagged as challenges
for economic or market performance.
Two of these risks are domestic: Housing prices could decline by more than
the 6-11% expected. With seven new GOP governors
coming into office, and both budget and funding pressures persisting, state and
local government spending cuts could be more intense than anticipated. Four
of the risks represent intensification of global challenges that are already in
the baseline global view: more spillover from Europe's sovereign crisis; more
Chinese monetary tightening; a surge in crude quotes to $120 or more; and
politics interfering with appropriate policy responses. On the last risk, the
looming battle over budget priorities seems likely to crystallize in a showdown
over increasing the federal debt ceiling, which could prove disruptive to
Discussing when the economic recovery will kickstart a jobs recovery, with Thomas Donahue, US Chamber of Commerce president & CEO: