U.S.

economy on a firmer footing

A slowdown in real GDP growth seems increasingly likely in Q1 and we estimate that real GDP grew at a 2 percent annualized rate in the first quarter, compared to 3.0 percent in Q4. But the weaker first-quarter growth wouldnt rule out stronger performance in subsequent quarters, and since many soft indicators of final demand is strengthening our 2012 and 2013 GDP forecasts remain unchanged at 2.5 percent. The unemployment rate is sliding gradually to 7.4 percent at the end of 2013. Although we believe that the recovery is on a firmer footing it is not going to be a straight line up by any means. Unseasonably warm weather may have boosted activity while high oil and gasoline prices are beginning to cut into consumers purchasing power and growth prospects in general. Fortunately there are offsets: the looming credit squeeze was averted and the tail risk of a severe recession in Europe is decidedly lower. Financial conditions are much easier compared to a few months ago. Employment growth has been stronger than expected as well, but wage growth remains subdued. Arguably too much fiscal tightening too fast is the biggest risk in 2013. Under current law the fiscal tightening is around 4.5 percent of GDP easily enough to break any recovery. Even if only 2 percentage points of tightening actually occurs, its still the second largest in modern history. Dont look for any clarity until after the November election when action is needed on a smorgasbord of contentious economic issues, among others the expiring Bush era tax cuts and the sequester which automatically slash federal outlays. This is why Fed chairman Bernanke is talking about a fiscal cliff at years end. Our assumption is that the fiscal headwind will be little more than 1 percent in 2013 which is not enough to break the recovery. But expect a messy process with possible macroeconomic as well as debt rating related concerns along the way. Our inflation forecasts are revised higher this year on oil. But the upturn is judged to be temporary and in 2013 both headline and core inflation will be running well below the target. Consequently, we stick with our forecast of additional QE although it is a close call.

TUESDAY 20 MARCH 2012

Mattias Brur
SEB Economic Research +46 8 763 85 06

Key data Percentage change

2010 2011 2012 2013 GDP Unemployment* Inflation Core inflation

Source: SEB

3.0 9.6 1.6 1.0

1.7 9.0 3.1 1.7

2.5 8.2 2.2 1.9

2.5 7.6 1.3 1.3

* Per cent of labour force, yearly averages

Economic Insight

THE BIG PICTURE

Currently there is a huge split between the demand side and supply side in the U.S. economy. The supply side is all good: employment growth is around 250k a month and aggregate hours worked is 3.5 percent above the Q4 average. So what the supply side is suggesting is that growth is running above 4 percent at an annualized rate. The demand side is a different story: real consumer spending has practically no momentum and both capital spending and net exports are tracking negative GDP contributions. According to the demand side data alone real GDP growth could be closer to zero right now. But the housing market is in better shape which is one reason why the recovery may end up being more sustainable than last year. The glass half full group would point out that housing only is 2 percent of the U.S. economy, however. Soaring oil and gasoline prices are advancing on the worry list. It is not the level but the change in prices that influences growth, and the rule of thumb we use is that a persistent USD 10 dollar increase in the oil price lowers real GDP growth by 0.2 percent year one as well as year two. So compared to the October lows we may be looking at a 0.8 percent drag on real GDP growth in 2011 if oil prices stay where they are for a year all else being equal (somewhat smaller effects when using yearly averages). Fortunately there are offsets since financial conditions are much easier today compared to a few months ago and should no longer hurt growth. Higher oil prices will push up inflation temporary but further out inflation is expected to run below the level the Fed is shooting for. As long as inflation expectations are behaving well the Fed will probably look through any oil-related bounce in inflation. Remember that in January the Fed said that the funds rate is going to be held to the floor at least through late 2014 and six of the 17 Fed officials dont believe they will raise rates until 2015-16. So we remain of the view that the available policy options are 1) an unchanged accommodative monetary policy stance or 2) additional easing. Higher inflation is making more asset purchases a harder sell but more easing may come, especially if the economy starts fraying at the edges. Since Q1 real GDP growth is poised to disappoint we are reluctant to change our forecast of additional policy easing. What has been floating around recently is sterilized QE which could have the potential to stimulate the economy while at the same time subdue worries about future inflation. As an aside, Bernanke again described U.S. growth as frustratingly slow last week. Meanwhile markets may be in the process of pricing out QE and pricing in an early tightening cycle.

Economic Insight

CONSUMER SPENDING / CAPITAL EXPENDITURES

The trend in real consumer spending is running at a low level and our models do not suggest much improvement over the near term. Despite faster employment growth and the long and generous arm of Uncle Sam, who contributes 20 percent of the income pie, weak income growth is holding down consumer spending. Whilst growth in real disposable income has trended below real consumption growth since the beginning of 2011, the drop in the savings rate and the fading fuel shock supported consumption last year. But these tailwinds may be turning: driven in part by the ratio of household net worth to personal income falling from 650 percent at the bubble heights to 500 today, our savings model suggests that an uptrend in the savings rate is fundamentally motivated. When this ratio was at current levels in the past, the savings rate was within the 7-10 percent band with near consistency. The labor market is the key; stronger employment growth should ultimately fuel income and spending. A signpost of the current hardship: the number of Americans receiving food stamps is above 46 million. Usually the unseasonably warm weather is an argument that the bears are pushing, arguing that the economy has been artificially strong as a result. But the flip side is that excluding energy, real consumption growth is above 2 percent. In our view what is driving consumption right now is almost exclusively auto related where fleet sales represent most of the buying. Meanwhile 89 percent of the consumption pie is shrinking and we would like to see a more broad-based expansion in any event.

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Economic Insight

THE LABOR MARKET

The unemployment rate has fallen by 0.8 percentage points since August, to 8.3 percent. More private jobs have been created since November than in any three-month period since 2006. Aggregate hours worked are up 3.6 percent at an annual rate over the last three months. As a standalone number this is suggesting real GDP growth at around 4.5 percent in Q1. But real GDP growth is tracking around 2 percent in Q1 so productivity must be contracting in the current quarter just as it did a year ago. Whenever this happens, companies move to protect their squeezed profit margins and respond the following quarter by slowing hiring. Looking back over the past decade this happened every time, and monthly payrolls, on average, come in 70k lower the following quarter. This is why we caution against extrapolating current employment trends into the future. The progress on the unemployment front has been much faster than justified by the classic Okuns law, but that is implicitly assuming that trend GDP growth rate has not changed much. But remember that trend GDP growth is the sum of labor force growth and productivity growth. While the growth in the labor force has recently picked up, the productivity trend is running slightly above zero right now. Putting these numbers together they are suggesting that trend GDP growth has been running below 1 percent for a year now. That can explain the better labor market outcomes even with frustratingly slow growth. Going forward, however, what the pick up in labor force growth is suggesting is that the lower speed limit is only temporary. Thus, going forward we expect much slower progress against unemployment even if real GDP growth will be better than last years 1.7 percent.

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