macro update: fiscal cliff in focus for us economy

7/31/2019 Macro Update: Fiscal cliff in focus for US economy

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US economy: Fiscal cliff in focusTHURSDAY

11 OCTOBER 2012

US real GDP growth in Q2 was revised to an annualized rate of only 1.3% from 1.7%previously. While still sluggish, economic activity appears to have accelerated in

September with ISM manufacturing and ISM non-manufacturing both improving andemployment better than expected. Q3 real GDP is currently tracking 2% growth,largely in line with our previous forecast in Nordic Outlookpublished inAugust.

Regarding Q4 and early 2013 we believe downside risks have increased in recent months.There is an appreciable risk of temporarily falling off the fiscal cliff. At the same

time,core capital goods orders are decreasing, suggesting potentially slower capex.Moreover exports are stagnating while the inventory cycle is probably also turningnegative.

On the one hand, the Fed has initiated open-ended QE3 which, assuming the fiscal cliff isavoided, should help the economy expand by 2.0-2.5% in 2013 before accelerating in

2014. On the other, even if most Bush administration tax cuts are extended and mostspending cuts under the sequester postponed, we should still expect fiscal drag ofapproximately 1.5 percentage points in early 2013, with, for example, the USD 126bnpayroll tax cut probably expiring around the turn of the year.

Mattias Brur

SEB Economic Research

+46 8 763 85 06

Key data

Percentage change 2011 2012 2013 2014

GDP 1.8 2.2 2.1 2.6

Unemployment 9.0 8.1 7.7 7.0

Inflation 3.1 2.2 1.9 1.4

Core inflation 1.7 2.1 1.8 1.3

Source: SEB


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Economic Insights

REAL GDP GROWTH STEADY AT AROUND 2% BUT RISKS SKEWED TO THE DOWNSIDE

Our H2 real GDP forecast of around 2% is apparently tracking well. Traditional bell weathermacroeconomic indicators including ISMs suggest growth remains reasonably resilient. Meanwhile the Citi

surprise index, previously near zero, has recovered following positive payroll data.

Several indicators, however, suggest downside risks are increasing. We particularly favour the Chicago FedNational Activity index (CFNAI) as it includes no fewer than 85 economic variables. It substantially disappointed

in August, falling to -0.87, its lowest level since June 2009 and a warning sign, implying a three-month movingaverage of -0.47 (anything below -0.70 signals recession).

Durable goods orders dropped 13.2% in August, one of the largest decreases since the series began, mainly dueto the aircraft sector, although most others fell back. Still, we usually focus on core durable goods orders, which

are currently down by 4.1% y/y. Order data suggest a capex slowdown is possible.


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Economic Insights

US CONSUMPTION MARKING TIME

US auto sales have trended up with 14.9 million annualized in September, a post-March 2009 high, largely dueto easier financial conditions and pent-up demand following two unprecedented years in which autos were

taken off the roads and driveways of the US. Moreover, consumer plans to increase auto purchases suggest

sales will continue to trend upwards.

Currently, the Fed hopes the ongoing wealth effect will kick-start US consumer spending. Household net worthhas increased to 527% of disposable income after bottoming at 477%. Still, before the last recession in 2008-09 the corresponding figure was around 650%. However, we do not regard a consumer spending boom as

imminent. Core retail sales are decreasing while the savings ratio currently stands below 4%, hardly

implying much pent-up demand. The corresponding figure was 6% when QE1 was announced in 2009 andjust over 5% when QE2 was launched in 2010.

Currently, disposable personal income is increasing by around 2% annually. Going forward we expect it to trendslowly higher with real consumer spending projected to expand by approximately 2%.


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Economic Insights

HOUSING IS PERFORMING WELL

Arguably the US housing market was the root cause of the domestic and global recession and the main reasonwhy this has been the most tepid recovery on record. However, the market is improving which is important for

consumer behaviour: almost 65% of households own a home compared to 50% who owned stocks in2010. Further, themedian value of homes is around seven times greater than the median value of

stockholdings.

Due to tighter supply, home prices have risen according to all metrics we follow. Home price appreciationshave lifted 1-1.5 million Americans out of negative-equity positions thus opening up the possibility for more

people to refinance and take advantage of historically low interest rates. Mortgage applications for refinancing

have increased to its highest level since 2008. Among those with a mortgage between 20% and 30% still suffer

from negative equity. When you look at the supply of houses on the market it should continue to exert an

inflationary impact on home prices. But the shadow inventory of homes held by banks will come on the market

eventually, increasing both foreclosures and official housing inventory and capping potential house price gains.


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Economic Insights

THE INVENTORY CYCLE AND THE TRADE SECTOR SOON NEGATIVE FOR GDP GROWTH

Business inventories have increased, driving the inventory/sales ratio to its highest level since 2009, suggestingcompanies are in the process of de-stocking . The Philadelphia Feds inventory index plunged to -22.7 inSeptember which also suggests companies will sell out excess inventory for a while. The Midwest drought willadversely affect H2 growth through its direct effects on agricultural output and indirect effects on higher food

prices and lower disposable incomes.

The Euro-zone recession and slowdown elsewhere are hurting US exports. The ISM new export orders indexsuggests export growth may fall below zero on a year-on-year basis. Meanwhile, import growth is already negative

which explains why the trade sector is currently not acting as a drag on GDP growth.

The US is experiencing an unprecedented boom in oil production; in only four years oil output has increased by25%. The mining and logging sectors have outperformed all others in terms of employment growth. In 2005 the US

imported 60% of crude oil compared to around 40% today.


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Economic Insights

THE LABOUR MARKET: IMPROVING BUT STILL ONE SICK PUPPY

September employment data exceeded expectations, with the unemployment rate falling to 7.8% from 8.1%, itslowest level since President Obama took office in January 2009. All consumer confidence indicators we followgained ground in September, suggesting a real improvement. However, surprisingly, the broadest measure of labour

underutilization, the U6, held steady at 14.7% as the number of involuntary part-timers rose sharply. The current

divergence between the regular unemployment rate (U3) and U6 is unprecedented.

Broadly, the labour market is climbing out of a very deep hole; with private employment 4.2 million less than inJanuary 2008, employment will not recover to its previous peak for another three years given its current rate of

recovery. A total of 12 million Americans are out of work or almost 23 million if those who have stopped looking are

included. At 63.6% the labour force participation rate is at the same level it was 30 years ago. The number of

citizens of working age outside the labour force is approaching 90 million.

Still, the labour market is gradually improving as suggested by the preliminary 2012 benchmark upward revision of386,000.


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Economic Insights

INFLATION IS WELL-BEHAVED

The Fed is doing open-ended QE but given a near-6% output gap our forecast is for inflation to continue to behavewell.

However, TIPS market-based inflation expectations are above 2.80% and rising, compared to previous QE rounds wheninflation expectations were below 2% and falling. From this perspective, the Feds latest move was fairly radical, not

being a response to a downturn in the economy but instead more an act of impatience with the economy. This stands in

stark contrast to the period when the Fed spoke at length about how important it was to prevent inflation expectationsfrom becoming unhinged. Now it obviously wants asset prices to increase, especially houses and shares, thus in a way

using inflation to relieve the economy of its debt burden.

While the market is currently relatively disinterested in gasoline prices, they are very high both in absolute and seasonalterms.


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Economic Insights

THE FISCAL CLIFF, ELECTIONS AND MONETARY POLICY - INSIGHTS

According to Intrade, President Obama remains the favourite to win the upcoming US presidential election.Certainly, going into his series of debates with Governor Romney most political experts expected the president to bere-elected. However, with Romney outclassing the president in the first of three debates, the polls show theRomney campaign has momentum. At the time of writing the average of the seven most recent polls givesPresident Obama only a 0.5 percentage point lead. If he is re-elected he will certainly have a mandate to impose tax

increases on the wealthiest Americans and cut defense spending. However, the Senate race is open while the Houseis likely to remain in Republican hands implying a very real risk of continued policy gridlock. Indeed, there is a strong

likelihood (more than is popularly supposed) that House Republicans will let Obama bear the responsibility forthe inescapable recession likely to result from falling over the upcoming fiscal cliff, one which becomeseven greater if Republicans take control of both chambers. If President Obama wins the election but theCongressional balance of power remains unchanged we regard an agreement before the year-end as 60% likely,

increasing to 80% by the end of the first quarter of next year. Alternatively, if Obama wins the presidential electionbut Republicans take control of both chambers, these percentages fall to 35% and 65%, respectively.

Conversely, if Mitt Romney wins we believe his party will be well placed to demand that most of the Bushadministrations tax cuts be extended, at least on a temporary basis, especially since customarily Congress raises no

budgetary objections during the earliest stages of a new presidency. If Romney wins and the Congressional balanceof power remains unchanged we regard an agreement before year-end as 80% likely. If the Republicans take controlof both chambers that percentage falls to 70%; the GOP then has an incentive to delay until the new Congress is

installed. If Romney wins the battle for the White House and the Congressional balance of power stays the same, weregard an agreement before year-end as 80% likely, increasing to 90% by the end of Q1 2013. Alternatively, if

Romney wins but the Republicans take control of both chambers these percentages become 70% and 90%,respectively.

At its September meeting the Fed announced that it will leave the Fed funds rate at near-zero at least until mid-2015 and pump USD 40bn into the economy each month for the foreseeable future. Indeed the FOMC is veryaggressive as these excerpts show:

If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agencymortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriateuntil such improvement is achieved in a context of price stability.

The Committee expects that a highly accommodative stance of monetary policy will remain appropriate for aconsiderable time after the economic recovery strengthens.

In September, the unemployment rate fell below 8% for the first time in 44 months, although in our view that doesnot represent the substantial improvement the Fed seeks. The FOMC will be considering a broad range of labour

market indicators and we know Bernanke pays close attention to the employment rate which presentlysuggests QE3 will continue for a very long time. Moreover, when Operation Twist ends in December the FOMC islikely to announce a new program, possibly of the same size (USD 45bn per month).

macro update: fiscal cliff in focus for us economy

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