Bouncing Back
The recovery is getting off to a fast start—faster than can be sustained—but welcome news nonetheless. Among the recent upbeat indicators: an ISM manufacturing index breaking above the 50 mark; further improvements in home sales; stabilizing home prices; and rising capital goods shipments. The news from overseas markets has also improved, as have export orders. As a result, we have raised our third-quarter GDP growth forecast to 3.7%, from 2.0% in our August forecast. The recession trough will probably be dated as June, although the NBER will allow plenty of time before it makes a ruling.
Not Just an Inventory Cycle. 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 has accentuated the cycle in the auto sector, but production had fallen far below even the pre-clunkers level of sales. Despite the fast start, we continue to expect that the recovery will prove a subpar one, and that growth will ease back to a 2.0% pace by the first quarter of 2010, after the inventory swing runs its course. But the improvements being signaled in residential investment, business equipment spending, and exports suggest that the growth revival is not just about inventories. The forecast profile shows a mild “W” shape to economic activity, but not a double-dip downturn.
The Consumer Remains the Weak Link in the Recovery. Consumers will spend when the deal is attractive enough, as shown by cash for clunkers. But debt burdens remain high, and wealth depleted, while incomes have taken a beating from the deteriorating labor market. Aggressive business cost-cutting has boosted productivity and profits, but hurt household wage incomes. Spending fell 1.0% in the second quarter, and although we expect it to rise 2.1% in the third, that is mostly due to cash for clunkers. Excluding new vehicles, we expect spending to rise 0.9%. It remains difficult to make a case for a robust consumer recovery.
Single-Family Housing Is Improving. Attractive deals are also helping housing. Much better affordability, and the extra stimulus from the first-time home-buyers’ tax credit have boosted single-family home sales, housing starts, and builder confidence. The single-family upturn means that the third quarter should see the first increase in residential fixed investment since the fourth quarter of 2005. We do expect some payback after the credit expires at the end of November, but the corner has been turned. The picture is much gloomier in the multi-family market, where credit restrictions are biting (and where some renters are becoming first-time buyers).
Business Spending: A Mixed Bag. An improving trend in capital goods orders suggests that the bottom for equipment demand is behind us, and we expect business equipment spending to begin its recovery in the third quarter. But the rise in nonresidential construction spending initially announced for the second quarter has now been revised away, and prospects here remain bleak. The trend for commercial construction such as retail developments, offices, and hotels remains downwards.
Foreign Trade Will Become a Drag. Bounce-backs in Asian economies (spurred by China) and signs of improvement in Europe are helping the outlook for exports, which we expect to rise at a double-digit rate in the third quarter. But we still believe 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 will 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 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
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