A Better Second Half
Recent data revisions have shown us that the recession was deeper than first thought, in GDP terms, with a 3.9% decline in real GDP from the second quarter of 2008 to the second quarter of 2009. But even though we still expect the recovery to be a slow one, the incoming evidence suggests that the pick-up in growth in the second half of the year will be more rapid than anticipated. We have raised our growth forecast for the second half to an average 2.2% pace, from 0.9% in our July forecast.
Growth Resumes in the Third Quarter. The main driver of growth in the second half of the year remains the turn in the inventory cycle. Firms will at first cut their inventories less rapidly, and then by the fourth quarter begin to add to them. The success of the “Cash for Clunkers” program is accentuating the cycle in the autos sector, as the surge in demand is depleting supplies of popular vehicles and manufacturers are raising their production plans in response. There is some growth payback in the first half of 2010, since we think that some of the Cash for Clunkers demand is pulling sales forward. In addition, compared with our July forecast, the turn in residential investment, business equipment spending, and exports begins earlier, helping the third and fourth quarters. But the forecast profile remains a U-shaped one, since it takes a long time (not until 2011 and 2012) to move into higher gear.
Consumer Remains the Weak Link in the Recovery. Consumers will spend when the deal is attractive enough, as shown by the success of Cash for Clunkers. But incomes have taken a beating from declining employment, low wage increases or wage cuts, and short working hours, while debt burdens remain high, and wealth losses remain heavy despite the recent improvement in the stock market. Spending fell 1.2% in the second quarter, and although we expect it to rise 2.5% in the third, that is almost all due to Cash for Clunkers. Excluding new vehicles, we expect spending to edge up just 0.6%. It remains difficult to make a case for a robust consumer recovery.
Single-Family Housing Is Improving. Much better affordability, and the extra stimulus from the first-time home-buyers’ tax credit, have led to improvements in single-family home sales, housing starts, and builder confidence. The picture is much gloomier in the multi-family market, where credit restrictions are biting (and where some renters are becoming first-time buyers). But the single-family upturn will dominate, and overall residential construction should be rising at double-digit rates by the fourth quarter.
Business Spending: A Mixed Bag. The signals from capital goods orders suggest that the bottom for equipment demand is behind us, and we expect business equipment demand spending to begin its recovery in the third quarter.
Nonresidential construction spending, in contrast to equipment spending, saw an increase in the second quarter, but the gain looks unsustainable. The trend for commercial construction such as retail developments, offices, and hotels remains downwards. Business construction spending has much further to fall.
Foreign Trade Will Become a Drag. The export outlook has improved a little given bounce-backs in several Asian economies (spurred by China) and the surprising positive second-quarter growth in some European economies. But we expect that trade will be a drag on growth in the second half of the year, as the turn in the inventory cycle will pull imports sharply higher. But both exports and imports should be growing—that’s good news.
Inflation Threat Not Immediate. Recent inflation indications show core inflation very quiet, despite increases in commodity prices. That is to be expected, given the excess capacity in product markets and, especially, in the labor market. Wage inflation in the private sector has almost disappeared. Inflation is a real long-term threat, but the Fed has sufficient time to make a gradual retreat from its extreme stimulus. We do not expect the Federal Reserve to begin to raise interest rates until the third quarter of 2010