SEB report: US economy – more political fallout

7/27/2019 SEB report: US economy more political fallout

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US economy: More political falloutMONDAY

OCTOBER 7, 2013

For the first time in 17 years, the United States is on a partial government shutdown. A shortshutdown would only have small macroeconomic effects. We reckon that a one weekshutdown would shave off 0.1-0.3 percentage points off real fourth quarter GDP growth at an

annualised rate. But uncertainty is high and the costs will accelerate with the length of theshutdown amid declining consumer and business confidence. The upshot is that the currentpartisan battle may resolve issues that otherwise would hang over the debt limit a fewweeks from now.

Our forecast assumes no failure to extend the debt ceiling. Not increasing the debtceiling could be disastrous indeed; it would immediately require the government to balance

the budget. Spending would have to be cut by 20 per cent or 4 per cent of GDP and arecession would surely follow. Moreover the credit market could freeze, the dollar could

plummet and interest rates could skyrocket.

A protracted stalemate to pass a new budget would likely delay the Federal Reserves taperingdecision into 2014. As things now stand, however, our forecast still is for the Fed to starttapering its bond purchases in December.

We expect no long-lasting market and economic impacts, and our 2014 real GDPgrowth forecast is unchanged at 3.3 per cent. Bellwether macro indicators are compatiblewith 3 per cent real GDP growth year-on-year. Amid the fiscal wrangling, such growth ratesare unlikely in the short term but will materialise in 2014, according to our forecast.

Mattias Brur

SEB Economic

Research

+46 8 763 85 06

Key dataPercentage change

2012 2013 2014 2015

GDP 2.8 1.6 3.3 3.7

Unemployment 8.1 7.5 7.0 6.2

Inflation 2.1 1.6 1.6 2.2

Core inflation 2.1 1.8 1.8 2.1

Source: SEB


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Economic Insights

THE INDICATORS ARE ENCOURAGING

The trend in consumer indicators such as the Conference Board and University of Michigan indices is pointingupward, but both measures are still relatively weak by historical standards. The brinkmanship in Washington D.C.will probably affect sentiment negatively in the near term.

Since we published Nordic Outlookin August, economic data have generally surprised on the upside (CitiSurprise Index). Meanwhile the NFIB (small business) index is sitting close to its cyclical high, while the NAHB

(housing market) index is at its highest level since January 2006 when housing starts were 60 per cent higher thantoday.

Our composite ISM index (a weighted average of the ISM manufacturing and the ISM non-manufacturing indices)is consistent with 3 per cent real GDP growth year-on-year. However, such growth rates are not expected untilthe second quarter of 2014, according to our forecast.

Initial claims are currently at six-year lows. A reduction in dismissals rather than stronger hiring is still driving thelabour market. If the hiring pace would normalise by half, monthly payroll growth would easily exceed 300k.Furthermore, the current level of initial claims has historically been consistent with 3.5 per cent real GDP growth.


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Economic Insights

FROM DELEVERAGING TO RELEVERAGING

Consumer credit has risen for more than 20 months in a row and outstanding consumer credit has reached anew all-time high. Student debt is no longer the driving force; consumer credit excluding this segment is growingtoo. The current growth rate also reflects how different conditions are today compared to the massive credit growththat defined the last cycle.

The pace of household deleveraging is clearly slowing and deleveraging is now confined to the mortgagemarket. As a percentage of disposable income, household debt is flattening out. History suggests that a typicaldeleveraging phase lasts between five and seven years. Since this one began in 2008 it seems reasonable we are in

a mature stage. Household wealth relative to disposable income has recovered and is now well above its 20-yearaverage. The improvement has led to easing credit standards, which in turn should support consumer spending.Moreover, owners equity as a share of real estate assets has risen for six quarters in a row and its current levelof 49.8 per cent is well above the recession low.


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Economic Insights

SEVERAL FACTORS UNDERPINNING A REVIVAL IN CONSUMER SPENDING

It is fair to say that consumer spending is still relatively subdued, at least outside consumer durables. Consumerdurables are the most interest rate sensitive category and it is interesting in its own right that durables consumptionhas held up well, given the upturn in bond yields.

Real disposable income growth is running below spending but is trending upward.The savings ratio hasrisen from 3.6 per cent in January to 4.6 per cent today.

We see several developments underpinning a revival in consumer spending. The job market is improving,especially for those with skills and education. Average hourly and weekly earnings are trending upward. Home pricegains may have slowed, but the growth rates are still in double-digit terrain. According to CoreLogic, home price

appreciation in the second quarter alone pushed 2.5 million homeowners out of negative equity which, in turn, isimproving credit quality.

According to our forecast, real consumer spending will grow 2.7 per cent in 2014 and 3.1 per cent in 2015. In2013 we see spending growth ending up slightly below 2 per cent.


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Economic Insights

BUSINESS INVESTMENT WEAK NOW BUT STRONGER LATER

The fundamentals for business investment are good. Profit margins are high while credit availability isimproving. As a percentage of GDP business investment is still low which is suggesting a considerable upside. As faras the third quarter real GDP is concerned, it looks likely that business capital spending will post another weakfigure. Core capex goods shipments which go directly into GDP calculations are tracking business spendinggrowth of -3 per cent year-on-year with one month to go. Looking ahead, however, we are optimistic on business

spending. One leading indicator for business spending, the three-month trend of core capital goods orders, is 8.4per cent higher than a year ago. Meanwhile the ISM new orders index is even loftier.

Lower US energy costs relative to the rest of the world are a comparable advantage for the US manufacturingsector. Moreover, over time it should spur more energy-related investment activity.

After weak growth in 2013 (3.6 per cent according to our forecast) we see business investment growthaccelerating to 10-11 per cent in 2014 and 2015.


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Economic Insights

HOUSING WILL CONTINUE TO SUPPORT THE ECONOMY

Housing starts and new home sales are well below recent peaks. While housing always peaks early in the businesscycle, it is unlikely that the peak in housing is behind us since the current rate of housing starts is well belowunderlying demographic trends. Our forecast is for housing starts to rise to 1.6 million in 2015. Against thatbackdrop, we forecast real residential investment growth of 14-15 per cent annually in 2013-1015.

Higher mortgage rates have affected sales activity to a certain degree but affordability while off its extremelevels is still high. Mortgage refinancing activity has plunged, but that may not be too surprising since peoplehave had plenty of time to refinance over the last couple of years. In any event, higher mortgage rates should be

viewed in the context of the better labour market and in our view the housing recovery will ultimately proveresilient to higher mortgage rates. Excess supply of housing has been largely worked off and home prices gainsare still in double-digit terrain. Admittedly, house price gains are slowing somewhat as lower affordability impactsdemand.

We expect home price gains of 8 per cent next year and 6 per cent in 2015. Rising home prices are helpingpush people out of negative equity, which in turn is improving credit quality and possibly labour mobility.


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Economic Insights

THE LABOUR MARKET IS STEADILY IMPROVING

The unemployment rate has come down to 7.3 per cent. While it is true that the drop in labour force participationhas pulled the unemployment rate lower, whether it is appropriate to say that the unemployment rate is decliningfor the wrong reason is debatable. According to research from the San Francisco and Boston Fed, the drop inparticipation is structural for the most part; 60-66 per cent of the drop in participation over the past five years isstructural, according to these researchers. What this is suggesting is that the US economy may be closer to full

employment than commonly acknowledged. That said, the labour market is improving, as the 2.2 million netnew jobs created in the past 12 months attest. Historically, the current level of initial jobless claims is consistentwith around 3.5 per cent real GDP growth.

Indeed, the downtrend in hourly earnings has reversed. Compared to a year earlier, hourly earnings rose 2.2 percent in August significantly above the all-time-low of 1.3 per cent last October. With wage growth picking up, the

key question is whether the output gap really is as large as the Federal Open Market Committee thinks.

A mere 1.5 per cent real GDP growth rate has managed to drag the unemployment rate down eight-tenths of apercentage point in the past year. What this is again suggesting is that the potential non-inflationary speed limitmay be much lower than most people assume, at least on a temporary basis. The late 1990s is the mirror image.


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Economic Insights

INFLATION STILL WELL-BEHAVED

Inflation was 0.1 per cent month-on-month in August (below expectations) and was 1.5 per cent higher than a yearearlier. Core inflation was 0.1 per cent as well and was 1.8 per cent higher than a year earlier. Our forecast is for 1.6 percent inflation this year and the next. In 2015 we expect 2.2 per cent inflation. The consensus expects prices toincrease 1.90 per cent in 2014 and 2.20 per cent in 2015, respectively.

There is a dearth of qualified applicants for available jobs which, together with a very weak pace of capital formation, hasled to stagnating productivity growth. This means that even low wage growth may trigger an acceleration in unit laborcosts. In turn, unit labor costs command a high correlation with inflation, so this poses an upside risk to the inflation

process.

The dollar has weakened since the September FOMC meeting. The recent political deadlock has not been dollar-supportive either. Meanwhile inflation expectations (5Y forward BE inflation) has moved up since end-August but itscurrent level is hardly alarming.


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Economic Insights

A RELATIVELY SHORT GOVERNMENT SHUTDOWN WILL HAVE LIMITED EFFECTS

For the first time in 17 years, the U.S. is experiencing a partial government shutdown, affecting some 800,000federal workers. We reckon that a one week shutdown would shave off 0.1-0.3 percentage points off fourth quarterreal GDP growth at an annualized rate.

In our view the government shutdown may well imply less risk of a debt limit showdown a much moredangerous event. Having made their point, Republicans in the House will hopefully go ahead and vote to raise thedebt ceiling without any drama. The key is for the shutdown to be over before the October 17 deadline whenthe Treasury runs out of funds. Otherwise the deadlock will bleed over into the crucial vote to raise the debt ceiling.

As we understand it, big payments for Social Security, Medicare and the like are not due until the end of October, sothere may be a little more time than the above deadline suggests. Moreover the CBO estimates that October 22 isthe first date the government may begin missing payments.

Failure to raise the debt ceiling would immediately require the government to balance the budget. Spending must becut by 20 per cent or 4 per cent of GDP. If such a scenario becomes reality, at best the US economy will be pushed

into recession. In such a scenario, the hope is that the Treasury will be able prioritise and manage cash flows in sucha way that a default need not occur.

According to polls and media coverage, the Republicans are taking most of the blame for the partisan battle. So ifthey do not want to throw away the chance to capture a Senate majority in the mid-term election next year, they had

better relax their hard line-stance. In any event it is hard to imagine that President Obama will sign into law anybill that defunds his signature achievement,especially since he is not running for re-election.


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Economic Insights

THE FOMC IS EXPECTED TO TAPER IN DECEMBER

After convincing the market that a soft tapering was coming at its September meeting, the Fed surprisingly left thecurrent policy unchanged. Our forecast now is for a USD 10 billion reduction in the pace of Treasurypurchases at the December meeting. As for MBS, we expect no change. Our new forecast is that the program willend in September 2014.

Clearly a protracted government shutdown could easily push the tapering decision to early-2014. Twenty-four out of 41 economists foresee a Fed tapering decision at the December meeting, but the longer the partialgovernment shutdown lasts, the bigger the chance that the decision will come early in 2014 instead.

The FOMC was criticised for its no-tapering decision last month; it was a huge surprise at the time and a blow to theclaim that the central bank has improved its communication. But if we fast forward to today, Fed Chairman Ben

Bernanke is being seen as something of a visionary against the backdrop of the partial government shutdown andthe possibility that brinkmanship could bleed over to the debt ceiling issue.

In any event the decision at the September meeting was likely a close call. The primary reason not to taper wastighter financial conditions (especially higher mortgages, we assume). That is a bit ironic since the main reason forthe tightening was that the FOMC had allowed tapering to be priced into the market.

Evidently, the FOMC is starting to feel unhappy about the (informal) 7 per cent number on the unemployment ratefor stopping its current third round of quantitative easing (QE3). At the post-meeting press conference, Bernankestated that there is not any magic number. Instead, what one should start focusing on more going forward isthe employment rate (employment to population ratio), in our view.

SEB report: US economy – more political fallout

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