Goldman's Hatzius Launches Pre-Emptive Mea Culpa
One of our key predictions from early this year has been that Goldman Sachs' formerly crack economic team (and now considered by some to be nothing but a propaganda team on crack) will in the coming weeks and months materially downward revise its dramatic economic upgrade from early December (just coincidentally coinciding with the minute the Fed released previously secret bank bailout records), which ended the firm's skeptical stance on the US economy, and launched it into all out Kool-Aid mode on nothing but one-time adjustments courtesy of a last gasp attempt at fiscal stimulus. While we are still scratching our heads why Hatzius would totally discredit himself by doing nothing more than what momentum traders do at an inflection point, and calling for a paradigm shift in his outlook when the most recent bout of gains is not driven by any recurring fundamental improvements, frankly we don't care. What we do know is when Goldman turns outright bearish again, some time in late March, early April, it will be time to buy QE3 with both hands, following a dinner or two between Hatzius and Bill Dudley at the Pound and Pence. Tonight, Hatzius issued his first and very vague intro to the coming mea culpa: "The increase in oil prices is emerging as a more meaningful downside risk to growth later in the year. At this point, we emphasize that this is just a risk, not a change in the forecast, as our commodity strategists expect part of the near-term price increase to reverse if the situation in the Middle East stabilizes. But we are now clearly moving into riskier territory" and "eventually, fiscal policy will need to tighten anyway because the current structural deficit is much too large to be sustained over the longer term. But if this tightening occurs more quickly than expected, that would likely weigh on near-term growth and, in turn, reduce the likelihood of tighter monetary policy." We are certain that today's note is the first whisper to those who read between the lines on what is coming from Goldman as soon as a few weeks from today, perfectly in line with Zero Hedge expectations. To be certain, it wouldn't be a Goldman report without the now traditional comic interlude: "Going forward, we expect employment to continue growing at a healthy clip, but participation is likely to flatten out and may rebound a bit, as word about the improvement in labor demand gets around more widely." Come again? Goldman is blaming the lack of propaganda media penetration for what will be a rise in unemployment? Frontal lobe hemorrhage to commence in T minus 5...4...3...
Full note from Jan Hatzius. Paragraphs 5 and 6 are key for those who keep an eye out on nuances, instead of BTFD first and asking questions later.
1. The recent numbers show a US economy with a lot of momentum. Yes, there are some downside risks to our Q1 GDP estimate of 3½%, with weak personal consumption and capital goods orders in January, as well as fairly sluggish growth in hours worked in Q1 so far. But those are likely to reflect distortions from poor weather (on consumption and payrolls/hours), faulty seasonal adjustment (on durable goods), and tax refunds that were delayed by the December fiscal compromise in Congress. Indicators that are timelier and/or less susceptible to these distortions—such as the household survey of employment, jobless claims, and the ISM surveys—are looking much sturdier. So the risk to our Q2 GDP estimate of 4% is if anything on the upside as some of the Q1 distortions unwind.
2. All this is basically what we have been expecting since the sharp upgrade to our growth forecast in December. And by itself, it is not a reason for the Fed to tighten monetary policy. After all, there is still a ton of slack in the economy and inflation is well below target. But the decline in the unemployment from 9.8% in November to 8.9% in February, together with the slightly stickier inflation numbers, has increased the risk to our call that Fed officials will wait until early 2013 before lifting the funds rate.
3. However, there are several reasons why we are not yet ready to change this call. For one thing, it would be a mistake to extrapolate the speed of the recent drop in the unemployment rate into the future. About half of it was due to a pickup in the employment/population ratio, but the other half was due to a drop in labor force participation. Going forward, we expect employment to continue growing at a healthy clip, but participation is likely to flatten out and may rebound a bit, as word about the improvement in labor demand gets around more widely. That hasn’t happened yet, with the proportion of households saying that jobs are “plentiful” still stuck below 5% as of February, but we expect it to happen soon.
4. Moreover, Fed officials themselves continue to sound quite dovish, and we see no signs that they will follow the apparent move toward tighter policy in Europe, where we now expect a rate hike at the April ECB meeting. To be sure, Fed officials issue the requisite warnings that second-round effects from higher commodity prices on wages and core inflation will not be tolerated, but we don’t expect significant second-round effects and there is no sign that they are planning to respond to the first-round effects. We were also struck by Chairman Bernanke’s response to Sen. Toomey’s question about the Taylor rule in the Q&A part of Tuesday’s monetary policy testimony. He said very clearly that “we should in some sense be way below zero in our interest rate...” which certainly doesn’t sound like someone who is itching to raise rates soon.
5. The increase in oil prices is emerging as a more meaningful downside risk to growth later in the year. Brent crude is now up about 30% from the 2010Q4 average. (The increase in West Texas Intermediate crude has been somewhat smaller, but this is distorted by local pipeline issues.) To be sure, our economic forecast has long assumed gradually rising prices, in line with the predictions by our commodity strategists. But this still leaves us with an unanticipated oil price increase of 20% in a short period, which is at least partly driven by worries about future supply rather than just strong demand in the global economy. According to our econometric analysis, each 10% increase in prices takes an average of 0.2 percentage point off annualized real GDP growth over the following two years, with a peak impact of 0.5 percentage point after 4 quarters. This implies that the unexpected price increase could reduce growth by ½ point over the next year, and perhaps by as much as 1 point in late 2011/early 2012. At this point, we emphasize that this is just a risk, not a change in the forecast, as our commodity strategists expect part of the near-term price increase to reverse if the situation in the Middle East stabilizes. But we are now clearly moving into riskier territory.
6. The other risk is the renewed move toward fiscal restraint. Our baseline forecast of 4% growth in H2 already assumes that fiscal policy will subtract about 1 percentage point from growth in 2011, due to a combination of federal discretionary spending cuts, the roll-off of various provisions in the 2009 fiscal stimulus package, and state and local restraint. But a full implementation of the House-passed spending cuts (known as H.R. 1 in congressional jargon) would imply additional downside growth risk in mid- to late 2011. Again, that’s a risk rather than a change in the forecast because we ultimately still expect a compromise between H.R. 1 and the president’s call for a 5-year freeze in nondefense discretionary spending. And eventually, fiscal policy will need to tighten anyway because the current structural deficit is much too large to be sustained over the longer term. But if this tightening occurs more quickly than expected, that would likely weigh on near-term growth and, in turn, reduce the likelihood of tighter monetary policy.