u.s economic update

8/8/2019 U.S Economic Update

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Economic Update

Richard B. Hoey

Chief Economist, BNY Mellon

September 13, 2010 bnymellon.co

We continue to believe that both the global economy

and the U.S. economy are in sustained economic

expansions. We do not expect a double-dip

recession.

The U.S. economy has been in a slowdown within

what we expect to be a sustained subpar economic

expansion. We believe that the most pronounced

weakness in the U.S. economy should be in the

second and third quarters of 2010, with this phase of

below-trend growth likely to be followed by trend or

slightly above-trend growth in the U.S. Even after the

period of significantly below-trend growth ends,

however, economic expansion is likely to be subpar,

accompanied by an elevated unemployment rate.

Why has the U.S. slowdown occurred? We believethat the main causes were (1) the shift from positive

to neutral in the inventory swing contribution to both

the global and U.S. economies, (2) a temporary shock

to U.S. financial conditions from the European

financial crisis this spring, (3) a large flood of imports

into the U.S. concentrated into the second quarter,

(4) tax and regulatory concerns, especially in t

small company sector, (5) the expiration of t

temporary homebuyers tax credit which shift

housing demand into prior months out of the last fe

months and (6) a continuing long hangover fro

the bursting of the credit bubble.

One key cause of the slowdown was th

normalization of the inventory cycle. The glob

pattern of extreme inventory liquidation followed

aggressive macroeconomic stimulation and th

positive inventory growth generated a phase of rap

global growth in industrial production. Consiste

with past cyclical patterns, a deceleration in t

growth rate of industrial production occurred on

most of the inventory swing was completed.

renewed phase of significant inventory liquidationunlikely. However, from now on there should be litt

incremental contribution to economic growth fro

the normal moderate expansion of inventories in li

with final sales growth. In the U.S., there was a swi

in real inventory accumulation from minus $161

billion in the second quarter of 2009 to pl


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ECONOMIC UPDATE September 13, 2010

$63.2 billion in the second quarter of 2010. This

$225 billion swing accounted for more than half of

the total four-quarter rise in real GDP of $381.5

billion.

We believe that a temporary period of stressed U.S.

financial conditions during the worst of the financial

European crisis this spring contributed to the U.S.

slowdown. Year-to-date, the U.S. stock market

topped in late April 2010 as the European financial

crisis intensified and it bottomed in early July as the

crisis eased. Many credit risk spreads in the U.S. and

elsewhere followed a similar pattern. There was a

brief period of substantially more restrictive financial

conditions when fears of a European crisis were at

their most extreme. When the European authorities

finally stabilized European financial conditions, U.S.

financial conditions quickly eased. While this episode

of feared financial meltdown was brief, we believe it

was a major factor in the U.S. slowdown. We believe

that its effect will prove to be temporary. Most large

financial and non-financial corporations in the U.S.

are now in a strong financial position. Financial

conditions in the U.S. have eased substantially and

are now more supportive of economic growth.

The structure of the U.S. economy limited the benefit

of consumption-oriented fiscal stimulus, since the

effect of rising consumption in the U.S. economy was

diluted by increases in imports, especially of energy

and consumer goods. Abstracting from the rise in

real exports, the surge of real imports reduced U.S.

economic growth in the second quarter of 2010 by

445 basis points from about 6% to 1.6%. However, a

well-anticipated expiration of a Chinese export tax

rebate on July 15, 2010 probably contributed to some

temporary loading of imports into the second quarter.

The swing in overall real net exports (real exports

minus real imports) lowered real GDP growth in t

second quarter by 337 basis points from about 5.0

to 1.6%, the worst negative contribution of real n

exports to quarterly real GDP growth in over 6

years. The rise in real imports in the second quart

of 2010 made a negative contribution to real GD

growth of 445 basis points while the positi

contribution from the rise in real exports was 10

basis points for a net negative contribution of 33

basis points. This source of weakness has probab

run its course. With positive but slow growth like

in U.S. consumer spending, this flood of increas

imports is unlikely to be repeated. With t

emerging market countries growing faster than t

U.S. and U.S. consumer spending growing on

slowly, real net exports are likely to be a rough

neutral factor over the next year rather than

continuing drag on domestic growth. The drag fro

net exports should ease just when strength from th

positive inventory swing is fading.

There have been multiple concerns in the sm

company sector in the U.S. Hiring in the sm

company sector has been quite weak, despite

tentative uptrend in loans by small banks. The hiri

rate among small businesses in the Lab

Departments JOLTS survey for July was at

absolute cyclical low. Portions of the small busine

sector have had concerns about the strength

demand and about tax and regulatory uncertaintie

While regulatory uncertainty may remain high, t

uncertainty should drop sometime in the next sever

months when a tax bill is finally passed.

The underlying trend in the housing sector has bee

weak for many quarters. The homebuyers tax cre

has generated great volatility in housing indicato

from month to month and from quarter to quarte


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While national house prices may now weaken

modestly as the artificial stimulus from the tax credit

is unwound, our basic view is that the housing sector

is finally at the bottom of an L-shaped pattern. We

believe that the current level of residential

construction is near a bottom and that the potential

for substantial further job losses in construction is

limited. We expect modest expansion in residential

construction over the course of 2011.

With respect to the long hangover from the credit

bubble and bust, the paper After the Fall by Carmen

M. Reinhart and Vincent R. Reinhart about the

aftermath of major economic shocks, which was

presented at the Jackson Hole conference of the

Federal Reserve Bank of Kansas, concludes that

the decade of relative prosperity prior to the fall

was importantly fueled by an expansion in credit and

rising leverage that spans about 10 years; it is

followed by a lengthy period of retrenchment that

most often only begins after the crisis and lasts

almost as long as the credit surge.

In our view, the long hangover from the credit boom

and bust explains why the economic expansion is

likely to be subpar, but does not imply a double-dip

recession. With a high level of consumer debt and a

reduced proportion of credit-worthy consumers,

credit-financed expansion of consumer spending is

likely to be limited during this economic expansion.

With growth in consumer spending largely

dependent on growth in consumer incomes, the pace

of consumer spending growth is likely to be positive

but slow. The personal savings rate has already

shifted higher and we do not expect a further rise

soon given the low yields available to savers.

The long hangover from the credit boom and bu

is less of an issue in the corporate sector, where th

rebound in profits and strengthened balance shee

provide adequate financial resources. Instead, a k

issue in the corporate sector is the competitivene

of domestic economic activity relative to foreig

alternatives.

Given the slowdown dynamics, will there be

double-dip recession? We dont believe so. Mo

cyclical sectors of the economy continue to be

below-normal levels due to the recession an

therefore the potential for further weakness

limited. For a number of years, auto sales tended

fluctuate around 16.5 million units. They bottom

slightly above 9 million units in February 2009 an

have trended higher to about 11.5 million uni

recently. U.S. auto sales are dramatically belo

historic norms but have entered a gradual uptren

which is likely to persist. The level is depressed b

the growth rate is positive.

There is a similar pattern with respect to the capit

stock and capital spending. The dramatic decli

during the recession caused capital stock ratios

fall sharply below normal levels. Since then capit

spending has been recovering from deeply depress

levels. Major companies now have strong balan

sheets, high cash flow and high profi

Modernization spending is necessary to avo

obsolescence and that has contributed to a sha

rebound in equipment spending in recent quarte

We expect the rate of growth of capital spending

decelerate to a more moderate growth rate in t

coming quarters, but remain a positive contributor

economic growth.


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The trends in the construction sector have been

extremely negative for many quarters. The drop in

both residential and non-residential construction has

been so severe that the odds of substantial further

weakness in construction activity in 2011 are limited,

in our opinion. Again, it is important to distinguish

between levels and growth rates. The prospects for

the levels of residential and non-residential

construction are very poor. On the other hand, we

believe that the downtrend in both residential and

non-residential construction is likely to burn out soon

at extremely depressed levels, eliminating a source of

incremental weakness in the economy. In the GDP

accounts, the drop in residential construction

expected for the third quarter of 2010 may mark the

end of the residential construction drag on real GDP

growth.

What about the U.S. labor market? There is good

news and there is bad news. The good news is that

private sector payroll employment has been rising

even during the slowdown with monthly gains of

61,000, 107,000, and 67,000 in the last three

months. With year-over-year wage inflation slightly

below 2% and some private employment growth,

private wage and salary incomes are growing,

supporting moderate but positive growth in

consumption. The bad news is that such a modest

growth rate in private sector employment is

insufficient to reduce the unemployment rate, so a

high unemployment rate should persist for some

months.

We believe that resolving the tax uncertainties is one

key to improving confidence in the U.S. economy.

The longer the stalemate over U.S. tax policy persists,

the greater the risk to the fragile U.S. economy, as

there is a natural tendency to delay economic

decisions until the tax regime is clarified. When a t

bill is finally passed, the resulting reduction

uncertainty might contribute to improv

confidence.

With respect to monetary policy, our most likely ca

is that the near-term economic evidence is likely

be mixed enough that the Fed may conclude that it

not necessary to adopt another round of quantitati

easing (commonly known as QE2). In our view, Q

would represent powerful financial medicine wi

severe side effects. Since there is no limit to t

Feds buying power, we do not doubt that it ca

temporarily succeed in driving down long-ter

Treasury bond yields. However, the fundamen

problem of the U.S. economy is not that intere

rates are too high. We believe that the risks of futu

unintended consequences from QE2 are quite hig

For example, driving down bond yields cou

potentially force increased pension contributio

from corporations and state and local governmen

over the next several years. Such an effect wou

tend to reduce the net stimulative effect of QE2.

In addition, central bank credibility could be erode

to the degree that the Fed is regarded as monetizin

unsustainable fiscal deficits. The Fed

independence in monetary policy from supporti

the Treasury bond market was won roughly s

decades ago, as described in Treasury-Fed Accor

A New Narrative Account, available from t

Federal Reserve Bank of Richmond. There is som

risk that the Feds relative independence in moneta

policy could be eroded in the course of financi

persistently high budget deficits. Nonetheless, if t

U.S. economy proves to be substantially worse tha

we expect, we believe that the Bernanke Fed wou

move to QE2.


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Given the cyclical realities, we believe that the Feds

first tightening is likely to be more than a year in the

future. We expect a very low rate of inflation over

the next two years, but do not expect any sustained

consumer price deflation. Overall, we believe that

the U.S. economy is in a recuperative mode and th

the persistence of low interest rates over

extended period of time should contribute

sustained but subpar economic expansion.


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BNY Mellon Asset Management is the umbrella organization for BNY Mellons affiliated investment management firms and global distributioncompanies. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation. The statements and opinions expressed in this articleare those of the author as of the date of the article, and do not necessarily represent the views of BNY Mellon, BNY Mellon Asset ManagementInternational or any of their respective affiliates. This article does not constitute investment advice, and should not be construed as an offer to sell or asolicitation to buy any security or make an offer where otherwise unlawful. BNY Mellon Asset Management International Limited and its affiliates arenot responsible for any subsequent investment advice given based on the information supplied. Past performance is not a guide to futureperformance. The value of investments and the income from them is not guaranteed and can fall as well as rise due to stock market and currencymovements. When you sell your investment you may get back less than you originally invested. Portfolio holdings are subject to change at any timewithout notice, are for information purposes only and should not be construed as investment recommendations. While the information in thisdocument is not intended to be investment advice, it may be deemed a financial promotion in non-U.S. jurisdictions. Accordingly, where this documentis used or distributed in any non-U.S. jurisdiction, the information provided is for use by professional investors only and not for onward distribution to,or to be relied upon by, retail investors. This material is not intended, and should not be construed, as an offer or solicitation of services or products oran endorsement thereof in any jurisdiction or in any circumstance that is otherwise unlawful or unauthorized. Any investment products or servicesmentioned here are not insured by the FDIC (or any other state or federal agency), are not deposits of or guaranteed by any bank, and may lose value. This document should not be published in hard copy, electronic form, via the web or in any other medium accessible to the public, unless authorized by

BNY Mellon Asset Management International Limited.

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