Jan Hatzius' First 2013 Mea Culpa: "Glass Half Full"
Back in late 2012, Goldman's Jan Hatzius did precisely what he did at the end of 2010: predicted that after many years of delays, the US economy would finally soar higher on the back of the reignition of the virtuous cycle driven by now endless Fed micromanagement of virtually every aspect of the economy. We mocked him in 2010 (6 months later he pulled his call following a series of embarrassing mea culpas), and did the same in 2012.
So here we are, 8 months later, and this much-delayed recovery has been "delayed" again - just as we thought. Of course, once bitten by the fringe blogosphere, Jan is not willing to pull his recovery call for the second time in a row despite deteriorating GDP and employment data, and instead (like everyone else) if placing his faith with the Fed, despite five consecutive years of disappointment from St. Ben. Maybe this time it will be different... although it won't. In the meantime, from a glass fully full (which is where it was supposed to be by this time in the year), the Goldmanite has now reduced his economic assessment to half that.
From Goldman's Jan Hatzius:
Glass Half Full
1. The July employment report was on the softer side, with downside surprises in the establishment survey—payrolls, hours, and wages—that were only partially offset by a decent household survey. But other recent indicators such as Q2 GDP, the ISM manufacturing index, and initial jobless claims have beaten expectations. The upside surprises have pushed our current activity indicator (CAI) to a preliminary 2.8% in July and our US-MAP surprise index into solidly positive territory. Overall, we therefore take a “glass half full” view of the recent data.
2. Although inflation remains well below the Fed's 2% target, there are some signs that it is bottoming out. The core PCE index rose 0.22% in June, and the year-to-year rate is now back up to 1.22% from the 1.06% reported a couple of months ago (mostly because of revisions). Over the next few months, inflation is likely to edge up. PCE health care service prices are likely to rebound from the first outright quarterly drop in over 50 years, and the hurdle for an increase in the year-to-year rate is low because we are dropping out very weak sequential inflation readings in 2012Q3.
3. We still expect Fed officials to taper QE at the September 17-18 FOMC meeting, but to offset the impact on financial conditions by reinforcing the forward guidance for the funds rate. There are two broad possibilities for how this might happen. First, they could simply lower the 6.5% unemployment threshold. Second, they could make the unemployment threshold depend on inflation and/or labor force participation; thus, inflation below 2% or a further decline in participation would imply a threshold of less than 6.5%. We interpret the fact that the FOMC this week “reaffirmed its view” that policy would need to stay highly accommodative even after the end of QE3 as a hint that the guidance will indeed be strengthened further.
4. The FOMC statement did not signal explicitly that this shift in the “mix of instruments” will occur in September, and a later move is possible. But Chairman Bernanke’s various appearances over the past few weeks have prepared the ground for such a shift, and the market seems to have digested it. The Fed leadership transition also argues for September rather than December, as it creates an incentive to make the December meeting—which is likely to be close to the confirmation hearings for the new Fed chair—less rather than more eventful.
5. Federal spending cuts and the lagged effects of earlier tax increases will continue to weigh on growth in the second half of 2013. That is why we expect real GDP growth to accelerate only gradually from 1.7% in Q2 to 2½% in Q4. But under our baseline assumption of an increase in the federal debt ceiling that involves no fresh spending cuts beyond those already in the legislative baseline, the fiscal drag is likely to abate sharply thereafter. This is the key reason why we continue to forecast a pickup in real GDP growth to 3%+ in 2014. [ZH: and if that fails, there is always 2022]
6. Barring renewed adverse shocks, we expect this pickup to set the stage for a lengthy period of above-trend growth. This is partly because we lean towards the optimistic end of the spectrum with regard to the US economy’s supply-side potential. Admittedly, labor productivity growth has disappointed in recent years, with an average gain of just 1.4% (annualized) since the start of the recovery. But as Kris Dawsey noted in Friday’s US Economics Analyst, the reason seems to lie mostly in cyclical capital spending weakness. [ZH: which has been the case and will be the case as long as the Fed is around] Total factor productivity—the component of GDP growth that cannot be explained by changes in capital or labor inputs—has remained quite healthy, averaging 1% over the past four years. As capital spending rebounds, labor productivity growth should rebound as well. [ZH: yeah... "should"]
7. The pattern of labor market improvement across states also argues against the notion of deep-seated structural changes in the US economy. By and large, those states that suffered the biggest labor market slumps have seen the fastest recoveries. We recently showed that unemployment in the “sand states” of California, Florida, Arizona, and Nevada—which saw the biggest housing bubbles and consequently the biggest busts—has fallen by 1.7 percentage points over the past year, compared with just 0.5 percentage points elsewhere. Weakness in labor force participation has played a role in this decline, but so has stronger-than-average employment growth. The strength in the sand states is also consistent with the notion that the labor market slump of 2007-2009 was mostly a cyclical downturn that should give way to a period of strong and largely inflation-free job growth once the demand side of the economy has healed sufficiently.
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