In sharp contrast with market fears that the US economy is headed for significantly slower growth, or even a double-dip recession, the pace of activity is expected to quicken somewhat in coming months. To be sure, the threat of contagion from the European sovereign debt crisis remains a potentially significant headwind for global growth.
The advance in first-quarter output was revised down; real consumer spending stalled and core capital goods orders declined in April; and the March-April surge in home sales probably will fade with the expiration of the first-time homebuyer tax credit. However, incoming data portray a robust economy, one accelerating from a 3% pace in Q1 to a 4% annual clip in Q2 even as consumer spending decelerates. A 3% overall growth is expected in the second half of this year.
Three factors account for that strength:
1) still-strong global demand,
2) the 'handoff' to domestic strength through accelerating income, and
3) the lingering impact of fiscal stimulus, especially in infrastructure outlays.
Those incoming data aren't as weak as market participants' fear. First, the downward revision to Q1 GDP owed importantly to a temporary lull in software outlays and to warmer weather that reduced spending on utilities. The former represents a consolidation in the pace of spending, not the start of a slowdown. After all, capex outlays picked up early in this recovery compared with past norms, so a bumpy start should not be a surprise. Ditto for capital goods orders, which have shown a pronounced pattern of weakness in the first month of the quarter, followed by strength in the second and third months. Thus, the April data understate strength in domestic and overseas demand for US-made capital goods.
The May employment statistics are perhaps the best example of data being less weak than meets the eye. While non-farm payrolls ex-Census-worker hires rose by just 20,000 last month, the timing of the payroll survey week in April and unusually favorable weather probably borrowed job gains at the expense of May; the two-month gain of 122,000 more accurately represents the underlying pace. Thanks to steady increases in the workweek, moreover, that hours worked are estimated to rise at a 3% annual clip in Q2 — the strongest pace since Q1 2006.
Fourteen months after passage of the American Recovery and Reinvestment Act, the March-April data for state and local construction outlays show that such Federally-enabled spending has at last overwhelmed ongoing cutbacks by state and local governments in construction of schools and other public works. Real state and local nonresidential construction outlays are estimated to rebound at an 18% annual rate in the current quarter, following two quarters in which such spending plunged at an average 12.9% annual rate. To be sure, the recent surge probably overstates the new upswing, but there remains ample unspent Federal funding, and officials are unlikely to turn off the spigot in an election year when incumbents are threatened.
Contagion from the European sovereign debt crisis remains a potentially significant headwind, manifest in a stronger dollar, sinking equity wealth, higher bank and capital-market funding costs, and the potential for slower European growth to spill over into the global economy. Hints that heavily-indebted sovereigns are inclined to restructure their debt rather than succumb to fiscal austerity are elevating those worries. However, limitations to the downside risks are expected through each of those channels.
Moderate gains in consumer spending and a rising personal saving rate (to 5%+) are expected over the balance of the year, despite hearty income gains. In addition, the lower energy quotes and lower mortgage rates that are partly the result of the sovereign crisis are potentially significant tailwinds for US consumers. Together with a decline in other energy quotes, that decline could add $75 billion (0.7%) annualized to discretionary income in the spring and summer months. The dip in conventional 30-year mortgage rates to about 4.8% has triggered a minor refinancing boom; reduced debt service will further add to discretionary spending power for many mortgage borrowers.
There is also concern that a stronger dollar in concert with the sovereign crisis would promote deflation. In contrast, we think the fundamentals for pricing power are gradually improving. In our view, although slack in the economy remains significant, the change in slack also matters for inflation, and slack continues to narrow as companies cut back capacity and industrial production continues to boom. Inflation will remain tame for now, but the stage is set for an upturn in 2011.
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