Quarterly Economic Forecast

Size: px

Start display at page:

Download "Quarterly Economic Forecast"

Joshua Clark
6 years ago
Views:

1 HIGHLIGHTS The U.S. economy is forecasted to grow by 3.0% in 2011 and 2012, roughly unchanged from our previous view in December. Supported by tax stimulus, low interest rates and pent up demand, consumer and business spending will be key pillars of growth over the next year. In 2012, improvement in the housing market will help support growth, but the unwinding of fiscal stimulus and the normalization of monetary policy will mute the acceleration. Risks remain a key theme of the forecast. In addition to housing market and sovereign debt risks, rising oil prices the result of political instability in the Middle East and North Africa and the ongoing tragedy in Japan pose new risks to the economic outlook. Downside risks are balanced against the potential upside of stronger than expected spending growth and increasing signs of accelerating job growth. Beata Caranci, AVP and Deputy Chief Economist, United States and International mailto:beata.caranci@td.com James Marple Senior Economist United States mailto:james.marple@td.com U.S. ECONOMIC RECOVERY GAINING TRACTION, BUT RISKS STILL ELEVATED After a turbulent year, the U.S. economic recovery has hit its stride. Our forecast in December emphasized the positive impact of fiscal and monetary policy on the economic outlook over the next two years. Looking at the world three months later, this view remains broadly in place. Economic data since the end of last year are telling the story of a recovery continuing to gain traction as it moves further away from the financial crisis and recession. With household incomes supported by tax cuts and businesses incented to invest, real GDP looks set to grow by 3.0% in We expect a similar pace of growth in 2012, as the possibility for a further acceleration is muted by the temporary impact of fiscal stimulus wearing off and the Fed s long process of normalizing interest rates and shrinking its balance sheet. Both of these projections are roughly unchanged from our December forecasts of 3.1% in 2011 and 2.9% in Now for the fine print: While our basecase forecast is relatively unchanged, the risks around the forecast are anything but. In December, we listed the usual suspects related to the unrelenting woes in the housing market, the uncertain course of U.S. fiscal policy and the equally uncertain course of the European sovereign debt crisis. However, new risks have come to the forefront political instability in the Middle East and North Africa that poses upside risks to crude oil prices, and the devestation caused by the earthquake and tsunami in Japan that has hobbled, at least temporarily, the world s third largest economy. We have long stated that this would be a risk-filled recovery and recent events have done little to dissuade us from this view. U.S. consumers still kicking REAL GROSS DOMESTIC PRODUCT Percent change (annualized) Y/Y % Chg. (Q4/Q4 % growth) 2011F 3.0% (3.2%) 2012F 3.0% (2.9%) Q1-08 Q3-08 Q1-09 Q3-09 Q1-10 Q3-10 Q1-11 Q3-11 Q1-12 Q3-12 by, March Source: Bureau of Economic Analysis Like most U.S. economic forecasts, this one begins with the most important variable the state of consumers. Consumer spending roared to life in the fourth quarter of 2010, rising by 4.1% annualized its fastest pace since Growth was broad based, but driven mainly by rising durable goods purchases, which grew by an outsized 21% in the quarter. Pent-up demand is a powerful force, especially in an environment of record low real interest rates. Nowhere is this more evident than in motor vehicle sales, which fell to a record low of 9.3 million (SAAR) in

2 2 early 2009 well below replacement levels. The rise in auto sales in February brought light vehicles sales to 13.4 million (SAAR). Even with this increase, the level of U.S. car sales per adult is still 27% below its long-run average and there is considerable room for durable goods purchases to continue this outperformance over the next two years. While consumer spending has surprised many over the past several months, U.S. households are operating in a different environment from the one that prevailed prior to the economic crisis. Spending will continue to be restrained by diminished household wealth and a high unemployment rate. However, this is not the whole story. What is often underappreciated in the consumer deleveraging saga is how much of the correction in household behavior has already taken place. From its trough of 1.2% in 2005, the personal saving rate has risen to 5.8% as of January. The biggest economic drag from household deleveraging occurs from the swift change in the savings rate, rather than the level itself. Thus, the worst of the consumer deleveraging cycle has already occurred. The rise in the saving rate is consistent with the 25.8% decline in wealth that occurred over the recession. Fortunately, household net worth has begun to improve. Households experienced a $2.1 trillion increase in net worth in the fourth quarter of 2010, and from its trough in the first quarter of 2009 household wealth has rebounded by 28%. While home prices are expected to decline over the remainder of this year, the magnitude of the drop will be much smaller than what occurred over the past several years. In all likelihood, gains in equity wealth will more than offset the decline in home prices. As a result, household wealth should continue PERSONAL SAVING RATE & HOUSEHOLD NET WORTH Saving rate, percent of DPI* Net worth (lhs) Personal saving rate (rhs) *Disposable personal income Source: Federal Reserve, Bureau of Economic Analysis Net worth, percent of DPI* U.S. LIGHT WEIGHT VEHICLE SALES Per 1,000 persons 16 years of age or older Source: BEA, BLS, 27% below average to repair the damage that occurred over the recession. As the negative impact of the wealth shock wanes, spending growth will be driven primarily by gains in real income. One of the most encouraging developments to take place over the last few months are signs that the labor market is finally beginning to join in the economic recovery. Private payrolls topped 200,000 in February and recent revisions have added more jobs in past months. Combined with fiscal and monetary stimulus, the stars appear aligned for consumers to play an important role in supporting economic growth over the forecast horizon. High gas prices take a bite out of spending power If there is one major risk to this view it is that just as consumer spending appears to be regaining its sea legs, households are being hit with higher prices at the pump. Gas prices have been rising steadily since the recovery began; but up until recently, the rise has been well within the range associated with a rebounding global economy. That changed over the last several weeks as the conflict in Libya and protests elsewhere in the Middle East and North Africa intensified. After remaining relatively steady at around $89 a barrel, oil prices shot up above $105 dollars in early March. While oil prices have retreated as a result of the disaster in Japan, they continue to hover around $102. The rise in oil prices or more importantly the rise in gas prices that they generate will have an impact on the economic recovery. For every 20% increase in the price of oil, U.S. economic growth is slowed by roughly 0.4 percentage points. Should the 15% run up in oil prices that we ve seen so far be sustained, this could cut 0.3 percentage points from U.S.

3 Indexed; January 2010=100 GASOLINE & OIL PRICES WTI Regular gasoline Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Source: Wall Street Journal / Haver Analytics economic growth over the next year. As long as the events in the Middle East and North Africa settle down, oil prices should stabilize around the $90-$95 dollar range. Still, given the increase so far, consumer spending is likely to be around 0.2 percentage points lower than it would be but for the recent increase in oil prices. Policy still supportive, but won t last forever While political events abroad remain the main source of downside risk to the U.S. outlook, the threat of a homegrown policy crisis has also grown in recent weeks. The source of the crisis is disagreement in Congress about how to trim the U.S. budget. In February, the Republican led House of Representatives passed a spending bill that would reduce Federal government budget authority by $61 billion and, according to Congressional Budget Office estimates, would reduce outlays by $19 billion in fiscal year 2011 (through to September). The legislation has so far failed to pass the Senate and the normal operation of government has depended on continuing resolutions. It appears likely that a compromise will be reached, which will include some budget cuts. If it is not, non-essential government services could be shut down. Such an event did occur in when Bill Clinton was President. A relatively short lived shutdown would likely have a negligible impact on economic growth, and since it would likely prove temporary, some of this would be made up in the following quarters. Still, better to hope that it can be avoided altogether. Perhaps more than anything else, the current debate speaks to the increasing concern in Washington over the longer-run fiscal challenges of the country. Fiscal austerity has become the default policy for a number of countries around the world. And while it is also the paradigm at the state and local level in the U.S., it has yet to take hold at the federal level. The privilege of hosting the world s reserve currency and flight to safety asset of choice (U.S. Treasuries) has enabled the U.S. government to continue to run large deficits to fund the payroll tax cut and the continued extension of the Bush-era tax cuts; but, there are limits to the tolerance of financial markets to perpetual deficits. While major action on the U.S. deficit is likely still years away, recent budget proposals confirm that at least some restraint is likely to become a reality now. Our forecast assumes that total government spending declines by 1.0% in 2011, subtracting 0.2 percentage points from real GDP growth in the year. This seems reasonable given the dual impact of continued cutbacks by state and local governments and the size of cuts likely to be put forth by the federal government. As the U.S. economic recovery advances, the need to move spending into closer alignment with revenues is likely to become the central policy concern. In addition to fiscal policy, the Federal Reserve is also engaging in policy support of its own and we are fast approaching the twilight of monetary stimulus. As of now, the Federal Reserve is roughly half way through its $600 billion of large scale asset purchases. Our outlook assumes the Federal Reserve completes its purchase program in June. Once the program ends, the Fed is likely to continue to leave the target for the Fed Funds rate close to its zero lower bound for the remainder of 2011 and through the first quarter of 2012 (see page 6 for financial market forecasts). The Fed s success in pushing up inflation expectations has all but eliminated the deflationary threat from dragging Percent of GDP U.S. FEDERAL GOVERNMENT SPENDING & REVENUES Revenues Expenditures Fcst.* *President's Budget, Fiscal year Source: Office of Management and Budget

4 4 down the economic recovery. The Fed s challenge over the next several years will be how it manages the exit strategy. With a $2.5 trillion balance sheet, this will be no easy task. In the current environment of excess supply, inflationary risks are likely to be contained; but, as we move deeper into the economic recovery, these risks will point increasingly to the upside. Bottom Line U.S. economic growth is expected to remain close in line with our views expressed in December. With real GDP growth of 3.0% over the next two years, the unemployment rate will move gradually lower and the need to withdraw the hefty doses of fiscal and monetary stimulus will become more acute. From its current level of 8.9%, we expect the unemployment rate to reach 8.6% by the end of this year and 8.1% by the end of This is still significantly above its pre-recession levels and speaks to the ongoing challenges facing the post-recession U.S. economy. Risks continue to be a key theme of the forecast. Old risks from the fiscal situation in Europe which has shown few signs of a resolution and from the U.S. housing market which has shown early signs of burgeoning demand, but continues to be plagued by inventory overhang will continue to shade the forecast. Add to these risks higher oil prices, heightened geopolitical uncertainty and political U.S. UNEMPLOYMENT RATE AROUND RECESSIONS Cumulative change in unemployment rate, % Recession Post-WWII Recession Average Months Since Recession Onset by as at March 2011 Source: Bureau of Labor Statistics, discord in Washington, and it is easy to see why volatility continues to be the name of the game. Nonetheless, it is also important to note that not all of the risks are to the downside. The recent strength in consumer spending, in combination with increasing signs of accelerating job growth, offer upside potential to the economic forecast. While the range of possible scenarios is considerable, the most likely path is for gradual repair and improvement.

5 5 U.S. ECONOMIC OUTLOOK Period-Over-Period Annualized Per Cent Change Unless Otherwise Indicated Q1 Q2 Q3 Q4 Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F 10 11F 12F 10 11F 12F Real GDP Consumer Expenditure Durable Goods Business Investment Non-Res. Structures Equipment & Software Residential Construction Govt. Consumption & Gross Investment Final Domestic Demand Exports Imports Change in Non-Farm Inventories Final Sales International Current Account Balance ($Bn) % of GDP Pre-tax Corporate Profits including IVA&CCA % of GDP GDP Deflator (Y/Y) Nominal GDP Labor Force Employment Change in Empl. ('000s) ,674 2, ,383 2,799 Unemployment Rate (%) Personal Disp. Income Pers. Savings Rate (%) Cons. Price Index (Y/Y) Core CPI (Y/Y) Housing Starts (mns) Productivity: Real Output per hour (Y/Y) F: by as at March 2011 Source: U.S. Bureau of Labor Statistics, U.S. Bureau of Economic Analysis, Annual Average 4th Qtr/4th Qtr

6 6 INTEREST RATE OUTLOOK Spot Rate /15/2011 Q1 Q2 Q3 Q4 Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F Fed Funds Target Rate (%) mth T-Bill Rate (%) yr Govt. Bond Yield (%) yr Govt. Bond Yield (%) yr Govt. Bond Yield (%) yr Govt. Bond Yield (%) yr-2-yr Govt. Spread (%) f: by as at March 2011; All forecasts are for end of period. Source: Bloomberg, Currency Exchange Rate FOREIGN EXCHANGE OUTLOOK Spot Price /15/2011 Q1 Q2 Q3 Q4 Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F Trade-wtd. USD Jan-1997= Canadian dollar USD per CAD Japanese yen JPY per USD Euro USD per EUR U.K. pound USD per GBP Swiss franc CHF per USD Australian dollar USD per AUD NZ dollar USD per NZD f: by as at March 2011; All forecasts are for end of period; Source: Federal Reserve, Bloomberg,

7 7 GLOBAL ECONOMIC OUTLOOK Annual per cent change unless otherwise indicated 2007 Share* Real GDP (%) World North America United States Canada Mexico European Union (EU-27) Euro-zone (EU-16) Germany France Italy United Kingdom EU accession members Asia Japan Asian NIC's Hong Kong Korea Singapore Taiwan Russia Australia & New Zealand Developing Asia ASEAN China India Central/South America Argentina Brazil Other Developing *Regional wts. do not sum to 100% because some countries omitted as at March 2011 Source: International Monetary Fund, national statistics agencies ECONOMIC INDICATORS FOR THE G-7 AND EUROPE Real GDP (Annual per cent change) G-7 (41.17%)* U.S Japan EU Germany France Italy United Kingdom Canada Consumer Price Index (Annual per cent change) G U.S Japan EU Germany France Italy United Kingdom Canada Unemployment Rate (Per cent annual averages) U.S Japan EU Germany France Italy United Kingdom Canada *Share of 2007 world gross domestic product (GDP) as at March 2011 Source: National statistics agencies, This report is provided by for customers of TD Bank Group. It is for information purposes only and may not be appropriate for other purposes. The report does not provide material information about the business and affairs of TD Bank Group and the members of are not spokespersons for TD Bank Group with respect to its business and affairs. The information contained in this report has been drawn from sources believed to be reliable, but is not guaranteed to be accurate or complete. The report contains economic analysis and views, including about future economic and financial markets performance. These are based on certain assumptions and other factors, and are subject to inherent risks and uncertainties. The actual outcome may be materially different. The Toronto-Dominion Bank and its affiliates and related entities that comprise TD Bank Group are not liable for any errors or omissions in the information, analysis or views contained in this report, or for any loss or damage suffered.

TD Economics QUARTERLY ECONOMIC FORECAST U.S. ECONOMIC OUTLOOK: GLOBAL HEADWINDS WILL NOT BLOW GROWTH OFF COURSE

TD Economics QUARTERLY ECONOMIC FORECAST U.S. ECONOMIC OUTLOOK: GLOBAL HEADWINDS WILL NOT BLOW GROWTH OFF COURSE QUARTERLY ECONOMIC FORECAST TD Economics U.S. ECONOMIC OUTLOOK: GLOBAL HEADWINDS WILL NOT BLOW GROWTH OFF COURSE Highlights Global headwinds have increased speed since our last Quarterly Economic Forecast