Now that the market's bipolar yet brief attention span has once again shifted back to Europe, the vacuum tubes have completely forgotten that last week just confirmed that the labor part of the US economy (one part of the Fed's original dual mandate, before the whole market manipulation thing became dominant) has joined housing into sliding back into near outright contraction (and the just released news that Cisco will fire 10,000 people - more on that later - will only make things much, much worse). And so the US, which up until two weeks ago was supposed to be the source of "reverse decoupling" has been quietly swept under the carpet. Yet Goldman's economics team, which in addition to being wrong about NFP forecasts, is unable to conveniently avoid discussing the US economy, has just released its latest macro report, titled, appropriately enough: "Still Disappointing." Needless to say, Hatzius still refuses to acknowledge that his December 1 "economic renaissance" call was abysmal, and so continues to push for a 3% growth in H2, but is finally getting closer to admitting defeat: "The bottom line is that acceleration to a slightly above-trend growth pace in coming months, coupled with unchanged monetary policy through 2012, remains our modal forecast, but the risks to this view are very much tilted to the softer side. In order to hold on to the modal forecast, we will need to see a clear improvement in the indicators as well as a resolution to the debt ceiling debate that imposes fiscal restraint of not much more than the 1% of GDP that we are currently building in for next year. We should have more clarity on both of these issues by early/mid-August." Good luck Jan.
From Jan Hatzius
1. The June employment report was a disappointment all around. There are essentially four separate measures of activity in the employment report—payrolls, the workweek, hourly wages, and household employment—and all of them came in below expectations. Following the employment numbers, we released our preliminary Current Activity Indicator (CAI), which is down to 1.2% annualized in June from 1.6%-1.7% in April and May. All of the net deceleration was due to the weakness in the employment report; other indicators have looked more mixed in June, with better news in the manufacturing ISM and Chicago PMI offset by more weakness in the Philly Fed and consumer confidence figures.
2. We spent a lot of time on Friday answering questions whether the weakness in the jobs report might be due to seasonal adjustment distortions, but we don’t find that story compelling. True, seasonal adjustment subtracted 59,000 more jobs from the monthly payroll gain in 2011 than in 2010. But that can be explained by the fact that the survey interval between the May and June report was 5 weeks in 2011, but only 4 weeks in 2010. And since May/June is a seasonally strong period for employment, a larger subtraction makes sense if the survey interval is longer. More generally, we have found over the years that second-guessing the government’s seasonal factors does not have a high Sharpe ratio unless there is a clear and intuitive rationale for why mechanical adjustment methods might have gone astray, e.g., a structural shift in holiday shopping patterns or a change in annual auto plant retooling schedules.
3. A more straightforward explanation for the weak employment numbers is that real GDP has grown at only about a 2% pace in the first half of 2011. In an economy whose trend productivity growth rate (calculated as whole-economy real GDP per hour worked) is also about 2%, such sluggish growth really shouldn’t produce rapid employment gains. So while Friday’s numbers were an unpleasant surprise relative to the high-frequency labor market indicators that enter our monthly payroll models, such as the ISM employment, ADP, and jobless claims data, they were less puzzling from a bigger-picture GDP perspective.
4. So what happens next? Our baseline forecast remains that growth will pick up over the next few months, to a 3%+ pace, as the auto sector rebounds and the modest decline in commodity prices since April helps real income and consumption. We also still think that the housing market is in the process of stabilization and consumers have made significant progress in adjusting their balance sheets. Finally, financial conditions are still reasonably accommodative. Our weekly piece on Friday takes another look at financial conditions indexes and discusses two experimental alternatives to our long-standing GSFCI (see "Time to Revamp the GSFCI?" US Economics Analyst, 11.27, July 8, 2011). These experimental FCIs include not only traditional variables such as interest rates, equity prices, and the dollar, but also credit availability surveys and quantitative credit aggregates. They remain consistent with an acceleration in growth in coming quarters from the disappointing 2% pace of the first half of 2011.
5. But the risks remain clearly on the downside. The biggest ones over the next month lie on the fiscal side, both in the US and in Europe. The European sovereign crisis—where we should get an announcement from the finance ministers later this evening—matters for the US primarily because it is important for financial conditions. In contrast, the US debt ceiling discussion matters directly because it will affect the stance of fiscal policy in coming years. There are essentially two plausible outcomes. One is that the two sides agree on a deal in coming weeks, with headline cuts of $2+ trillion over a 10-year horizon, probably mostly composed of discretionary spending caps that gradually squeeze projected outlays in a highly back-end loaded fashion. The other outcome – whose probability has unfortunately risen in recent weeks – is that there is no deal by August 2. Even in this case, we continue to believe a default is extremely unlikely, as the Treasury would likely prioritize interest payments, Social Security and Medicare payments, and “essential” defense payments over other types of spending, and should have enough revenues to cover the essentials. But make no mistake: the negative consequences of failing to make other payments would be very severe. In the month of August, projected outflows exceed projected inflows by about $150bn (not annualized), or about 12% of GDP. Even if we allow for a further decline in cash holdings in the Treasury’s account with the Fed, this means that a failure to reach a deal would imply a huge, immediate fiscal retrenchment. The economic consequences of such a retrenchment would likely force a deal within a few days.
6. The risk of higher oil prices has also crept back onto the agenda. Our commodity strategists forecast that Brent crude prices will rise to $140/barrel at the end of 2012. It has indeed been remarkable how quickly the tentative stabilization in the economic activity indicators (prior to the payroll numbers) in the past two weeks has fed through into higher oil prices; that is very consistent with the notion that the tight supply of oil production capacity is imposing a tighter constraint on global GDP growth than in past cycles. Especially in an economy that is as oil-dependent and energy-inefficient as the US, this remains a significant downside risk to the growth outlook.
7. The biggest question in Chairman Bernanke’s semi-annual monetary policy testimony on Wednesday and Thursday is whether he will provide a more extensive discussion of a) what it would take for the Fed to ease monetary policy further; and b) what easing options are on the table. He did provide a list of options in the June 22 press conference, but only in the Q&A part; if this list migrated into the prepared remarks, it would likely be viewed as one additional step on the road to QE3. However, our baseline view is that the chairman will stay reasonably close to the line laid out at the press conference, i.e., that he still sees high hurdles to a resumption of unconventional easing because inflation is significantly higher than it was in the fall of 2010.
8. The bottom line is that acceleration to a slightly above-trend growth pace in coming months, coupled with unchanged monetary policy through 2012, remains our modal forecast, but the risks to this view are very much tilted to the softer side. In order to hold on to the modal forecast, we will need to see a clear improvement in the indicators as well as a resolution to the debt ceiling debate that imposes fiscal restraint of not much more than the 1% of GDP that we are currently building in for next year. We should have more clarity on both of these issues by early/mid-August.