I am becoming increasingly concerned about the extent of the slowdown which is now underway in the US economy, a trend which has not yet been fully recognised by the Federal Reserve. Admittedly, some decline in the growth rate was always inevitable at this stage of the cycle, because the large boosts to growth stemming from the upswing in inventories and from fiscal stimulus were certain to lose momentum about now. But the pick up in more sustainable sources of growth, notably consumers’ expenditure and capital investment, has so far been more anaemic than I had hoped, and the improvement in the labour market may be going into reverse. The Fed may soon be forced to confront the choice they most wanted to avoid, which is whether to extend quantitative easing, instead of allowing their programmes of unconventional easing to lapse, as they fervently hoped earlier this year.
As recently as last week, the FOMC suggested that it had reduced its growth projections, but it still expected resource utilisation to rise, implying that GDP growth would be maintained above the 2.5 per cent trend into 2011. This sanguine view of the economy seems increasingly difficult to maintain. On Friday, the publication of revised GDP figures for 2010 Q2 is likely to show the annualised growth rate dropping to around 1.5 per cent, because of downward revisions to inventory and net trade figures. This would be the first quarter of sub trend growth since the recovery started.
More worryingly, the straws in the wind for Q3 are not very encouraging. The first graph shows the results of the New York and Philly Fed Surveys for August, along with the ISM Manufacturing Survey up to July. The Fed surveys suggest that the ISM survey may drop quite sharply when it is published on 1 September, perhaps to somewhere in the low 50s, compared with recent healthy readings of around 55. This indicator is widely watched, and it could trigger a major rethink about the strength of the economy.
So too could the monthly US employment numbers, which are due to be published on 3 September. Initial claims for unemployment benefit have been rising ominously in recent weeks. Although there are some special reasons why this might be a distortion (such as the ending of government jobs to conduct the census), it appears increasingly likely that the underlying trend has stopped falling. In fact, the number of private sector jobs in the economy might have fallen last month.
With the ISM dropping towards the low 50s, initial claims rising, and the number of private sector jobs declining, it seems likely that the Fed will be forced to accept that below trend GDP growth is likely in coming quarters. Previously optimistic private sector forecasters have been downgrading their central case, and the danger of a double dip is coming onto the radar screen. For example, JP Morgan have recently shaved a full percentage point from their US GDP growth forecast for the second half of 2010, taking it down to 1.75 per cent.
No-one yet makes a double dip the most likely course of events in the US. But this is not very surprising, since economic forecasters almost never acknowledge the start of a recession until some months after it has actually taken place. Instead, they talk about “increased risks of recession”. It is interesting to note that both JP Morgan and Goldman Sachs now say that a double dip recession is about 25-30 per cent probable, which is what forecasters generally say when they are becoming really concerned that such an outcome could easily occur.
Why is a double dip not the central case? It is because the factors which generally cause recessions (like inventory declines, job shedding and drops in home and car purchases) have already to a great extent occurred, leaving less room for large falls from here. Furthermore, the corporate business sector is in rude financial health, and the financial sector is not reinforcing recessionary trends, as it did in 2008. In fact, financial conditions look to be exceptionally easy.
Even so, Jan Hatzius at Goldman Sachs reckons that “forecasts which do not look for GDP growth well below trend are quite implausible” and he predicts that a generalised downward revision to consensus growth forecasts is inevitable in the near future. It will be interesting to see whether Ben Bernanke gives any nod in this direction when he makes his big speech at the Fed gathering at Jackson Hole on Friday. With press reports suggesting that the FOMC is split on whether to ease further, his job is certainly not an easy one.
Related reading:
Money Supply FT blog on central banks
Fed wavers as the world gets the sweats FT
America: A new way forward FT
Fed and Bank of England still seem more dovish than hard currency mob at ECB and BoJ Gavyn Davies, FT
ISM survey confirms sharp slowdown in US economy Gavyn Davies, FT
