What Sort Of Rebound In 2H11?
July 4 – July 8, 2011
The recent data have been mixed, consistent with a slower rate of economic growth in the near term. The economy faced a number of headwinds in the first half of the year. Some of those headwinds are likely to be temporary. Others will linger. Growth should pick up in the second half of the year, but the pace seems unlikely to be especially strong.
The markets showed little reaction to the May figures on personal income and spending (which were close to expectations). However, the real meat and potatoes are in the details. Inflation-adjusted consumer spending, 70% of GDP, edged down 0.1% in both April and May. Moreover, unit motor vehicle sales fell further in June. Hence, real consumer spending appears to be on track for an annual rate of growth of 1% or less in 2Q11. We’re still missing key components in 2Q11 GDP, including figures on inventories and net exports, but it appears likely that GDP growth will come in relatively low (perhaps around 1% – the advance estimate is due on July 29).
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One important caveat is that the National Income and Product Account data will undergo annual benchmark revisions with the release of the advance estimate of 2Q11 GDP growth. However, as it stands now, growth has definitely slowed.
Some of the second half headwinds are likely to be temporary. Supply chain disruptions related to Japan’s disaster should reverse, leading to some increase in production and better auto sales in the near term. The increase in the price of gasoline was a major factor restraining consumer spending growth in recent months. Disposable income rose at a 4.2% annual rate from December to May, reflecting gains in wage income and the reduction in payroll taxes. However, adjusting for inflation, disposable income rose just 0.1% over this period. That’s not much fuel for consumer spending growth.
Other headwinds are likely to stay with us for some time. The spring housing season was a major disappointment. Home prices have continued to edge down, leaving many homeowners underwater on their mortgages. Most of these households will continue to make mortgage payments, hoping that home prices will eventually rebound. However, these households will be susceptible to a number of difficulties if conditions change – such as a loss of a job, illness, or divorce. There is a wealth effect on consumer spending, which is not expected to be a positive factor for the foreseeable future.
State and local budget problems have led to further austerity measures. Job cuts and increased taxes and fees will dampen growth in the near term. Tuition increases at state universities will shut off a key path of class mobility and weaken long-term growth prospects. At the federal level, adjustments are clearly needed to the long-run budgetary path. However, spending cuts or tax increases that come too soon will threaten the economic recovery. After some progress, negotiations to raise the debt ceiling have broken down and both sides have moved further away from a possible agreement. However, at some point, both sides will have to accept what they can and raise the debt ceiling. The leadership in Washington understands the consequences of not raising the debt ceiling – and some action is likely over the next couple of weeks. However, the heightened political rhetoric hasn’t helped in the short term.
While growth is expected to improve in the second half, there are downside risks. More importantly, the economy is now performing without a net. Suppose more support for the economy is needed. The Federal Reserve is handcuffed by the short-term inflation outlook (no QE3). Stimulus is now a dirty word in Washington (no fiscal stimulus). And heaven help us if there is another financial crisis, as the public is unlikely to tolerate another bank bailout. Have a nice day.
Copyright © Raymond James
