JPM Explains Why The US Economy Is About To Hit A Brick Wall

JPM's head economist Michael Feroli just joined the bandwagon of other Wall Streeters in cutting Q4 GDP, trimming his prior forecast of 3.5% to 3.0%. However, as this is backward looking, it is largely irrelevant if confirming what we already knew: that the economy was certainly not growing as fast as the market implied it was (yes, the manipulated market is not the economy, no matter how much the Fed would like that to be the case). A bigger question is what should one expect from the future. Yes - an in vitro future, isolated from the daily rumor mill of what may or may not happen to the French rating tomorrow or the day after. It is here that there is nothing good to expect: 'we think growth will downshift from 3.0% in 4Q11 to 2.0% in 1Q12. Looking beyond the first quarter, we expect a growing private domestic sector will contend with a fading drag from the external sector and a persistent drag from the public sector." Yet where JPM falls short, is its optimistic view on the private sector. As David Rosenberg showed yesterday, the ratio of negative to positive preannouncements just hit a multi-year high, with the primary culprit being the strong dollar. Unfortunately for Feroli's bullish angle, the private sector will not do all that well at all if the EURUSD remains in the mid 1.20s or falls further. In fact, corporate earnings will likely be trounced, which in combination with everything else that JPM lists out, correctly, could make the second half of 2012 a perfect storm for economic growth, an event which Obama's pre-electoral planners are all too aware of. What is the only possible recourse? Why more QE of course. The only unknown is "when."

From JP Morgan on the past:

The J.P. Morgan forecast now estimates that GDP growth last quarter was close to 3%. Although this is down a little from our earlier estimate of 3.5%, it would still be the first GDP number to have a “3” in front of the decimal since the second quarter of 2010. A substantial part of the growth seen last quarter owes to firms building inventories after being very cautious about stockbuilding in 3Q, and we anticipate inventory-building accounted for about 1.3%-pts of the 4Q growth. In part because that onetime lift to growth will likely fade in the current quarter, we  anticipate that growth will downshift to around 2.0% in the first quarter of the year.

... and the future:

The fading of the lift from inventory rebuilding is one of a few reasons to believe growth this quarter will be slower than last quarter.

  • Retail gasoline prices were declining for much of the last few months of 2011. It does not appear that consumers will get a similar support from energy prices in early 2012.
  • Unseasonably warm weather at the end of the fourth quarter likely supported construction activity. The return to what, so far, appears to be somewhat more normal weather will remove this temporary stimulus.
  • Through November, exports have held in fairly well. This is not unusual: there is often a lag of a few months between when the fundamentals of  foreign trade change and when the trade flows themselves change. We expect the global slowdown to lead to slower export growth this quarter.

For all these reasons, we think growth will downshift from 3.0% in 4Q11 to 2.0% in 1Q12. Looking beyond the first quarter, we expect a growing private domestic sector will contend with a fading drag from the external sector and a persistent drag from the public sector.

Fading of external drags US nominal exports declined in both October and November; back-to-back declines in exports are relatively rare. Nonetheless, real export volumes have held up better, and through the three months ending in November real exports have increased at a 5.3% annual rate. Historically, global growth developments tend to be reflected in export performance with about a one-quarter lag. The J.P. Morgan global growth forecast (weighting countries by their trade shares with the US) bottoms in 4Q11 at 1.0%, and thus we see 1Q12 as the toughest quarter for US exporters. We anticipate that US growth will firm some as the year progresses, as the drag from net exports slowly dissipates. The J.P. Morgan forecast for US-trade weighted global growth projects an acceleration in growth among US trading partners from 1.0% in 4Q11 to 3.2% in 4Q12. Much of this acceleration is expected to occur in emerging markets, where stimulative policy actions are anticipated to boost growth. As this occurs, US exports should improve over the course of the year. [ZH: Best of luck of this happening with a soaring USD]


Persistence of internal drags

External developments should be a drag on the US economy in 2012, but a drag that fades over the course of the year. Another sector that should be a drag is government, though we expect that drag to persist throughout 2012. The fading of federal stimulus spending probably shaved off about 1/4%- to 1/2%-pt from growth last year, and we expect it will subtract about a similar amount in 2012.


Outside of stimulus-related spending, federal outlays should also be a drag. The winding down of operations in Iraq and Afghanistan should lead to an outright decline in defense spending. According to OMB estimates, after expanding by 0.3% of GDP in fiscal year 2011, defense outlays should decline by 0.4% of GDP in FY2012, the largest such contraction since the end of the Vietnam War in the early 1970s. Some of this contraction will not be manifest in the domestic economy: for example, reduced purchases from vendors in the theaters of operations have no  implication for US GDP. Even so, gauging from the NIPA data on foreign defense transactions, most—perhaps threefourths— of the decline in defense spending will be reflected in reduced purchases of US goods and services. Some of this drag may already be evident in 4Q11, as monthly data suggest a sizable pullback in defense spending.


While the federal fiscal thrust has gone from supporting the economy in 2009 to exerting a modest drag on it since 2009, state and local governments have been a steady drag on the economy since 2008. Given the large number of states and localities there is greater uncertainty gauging the future direction of fiscal thrust at this level of government. One data source, the Fiscal Survey of States conducted bythe National Association of State Budget Officers, points to spending growth in 2012 about in line with or a little slower than in 2011. This survey hasn’t always lined up with the spending patterns subsequently seen in the data, but it is at least indicative that the state and local government drag in 2012 may be in the same ballpark as in 2011.


Year to end with a bang


The expansion in domestic private activity against a backdrop of a fading external drag and a persistent public drag should produce a gradually accelerating pattern of growth. The end of the year, however, promises to deliver a serious wallop of policy uncertainty that could serve to slow growth. There are three major  fiscal policy issues set for the end of this year:


  • The automatic federal budget cuts (sequestration) of around $100 billion per year that kick in at the beginning of 2012. These cuts stem from the failure of the Supercommittee to reach an agreement late last year.
  • The expiration of the payroll tax holiday and extended unemployment benefits. We assume that these two measures, which are set to expire at the end of February, will be extended through the entire year. The fiscal hit here adds up to around $150 billion.
  • Finally, the Bush-era tax cuts are set to expire at the end of this year. On an accrual basis these are worth about $250 billion per year.

All in, current law has about $500 billion of fiscal tightening that will occur in January 2013. Current law will undoubtedly be changed, as no party wants to see that much tightening in that short a period. However, how current law is changed is extremely uncertain, and that uncertainty could restrain activity toward the end of the year.