Volume 59 | Number 7
Confidence in the expansion is waning as the new stimulus at the start of the year has failed to accelerate growth from the tepid pace of 2010 and now the expiration of earlier stimulus packages will act as a headwind as we head into 2012. After a year of 2.8% real GDP growth in 2010, this year’s $220 billion stimulus package giving a 2% payroll tax holiday and 100% expensing on equipment investment has failed to lift growth. Estimates for growth in the first quarter appear likely to be revised up to 2.2% (from 1.8% originally), but the second quarter is growing at only 3%-3.5%. Where weather may have played a role in the first quarter, the Japanese supply chain disruptions have offset most of the expected rebound in the second quarter. The optimism on employment gains that prevailed early in the year is being squashed by the recent rise in initial claims for unemployment back above the 400,000 level. The consensus among firms appears to be for no better than 3% growth in the coming year, generating little reason to hire or invest in capital expansion in the US given the slack in both labor and capital that already exists.
Critically, the 1.5% of GDP stimulus at the start of the year – combined with the Fed’s QE2 – has only sustained real GDP growth at last year’s pace. Starting at mid-year, we will see the end of QE2 (though the Fed will not allow its balance sheet to shrink) and the impact of fiscal tightening at the state and local level as those governments wean themselves off earlier federal subsidies. At the start of 2012, the 2% payroll tax holiday will end and the 100% expensing option will be cut to 50% for 2012. The payroll tax cut alone is expected to represent a 0.8% of GDP drag on growth – falling all in the first quarter it will cut real personal disposable income growth by 4% at an annual rate. The tax cut had boosted first quarter 2011 real disposable income by 3.3% at an annual rate (it was partially offset by the loss of earlier subsidies), generating a 6.9% rise in spending power. This helped lift first quarter consumption at a 6.6% annual growth rate. Unless the tax holiday is extended – which seems highly unlikely in the current political environment – it should have a more than opposite effect in the first quarter of 2012. Expiration of extended unemployment benefits, the decline in expensing, and some residual effects from the expiration of earlier stimulus bills could represent up to a 1.5% drag on the US economy in 2012. Normally, this would not be a problem as the stimulus would have boosted the economy beyond escape velocity and the private sector would be generating growth above potential on its own. Now, the end of stimulus provides a head wind for 2012 – just as it did in 2011 – but with no new aid likely.
Indeed, the debate over the debt ceiling is only likely to add to the projected fiscal drag going into 2012. With the Gang of Six apparently breaking up, the discussions led by Vice-President Biden are now the front and center. News reports suggest that $150 billion to $200 billion in cuts are currently agreed to – but discussion are for trillions more. How real spending cuts announced by these proceeding are is subject to interpretation – as the “cuts” announced in the most recent round of negotiation appear all to have been in appropriations for programs that were not spending the money anyway. Actual spending rose after the negotiations due to various emergency spending measures. Regardless, Washington is not currently talking about fresh fiscal stimulus. Given Federal Reserve Chairman Ben Bernanke’s strong predilection not to repeat the 1937 mistake – where both fiscal and monetary policy were tightened and the Great Depression prolonged – it seems unlikely that the Fed will be tightening any time soon.
Dr. Copper, the metal with a Ph.D. in economics, peaked in mid-February and has fallen just over 10% since then. The ten year note peaked a week before copper at 3.72% and had fallen to 3.15% on Friday – roughly a 15% decline. This week, we learned that the index of leading indicators had fallen -0.3% in April, after strong gains of 0.7% in March and 0.9% in February. However, of the 1.3% rise in the leading indicators over the past three months, narrower interest rate spreads (caused by the falling 10 year note rate) have accounted for 1.1% of the move. Typically, the interest rate spread works as a leading indicator because short rates are rising as the Fed tightens monetary policy. The ratio of the coincident to lagging indicators – which many consider a better lead indicator of the economy as it is less volatile – also fell by -0.3%. This series peaked in January and has fallen each of the past three months for a total of -0.8%. Bad news comes in threes – and these three widely respected indicators of economic growth are all confirming the slowdown now becoming obvious in the reported GDP and production data.
Adding to our concern, this week the Philadelphia Fed Index plunged to 3.9 in May — from 18.5 in April and 43.4 in March. The consensus expectations had been for a rise to 20.0! New orders led the drop, falling to 5.4 in May from 18.8 in April and 40.3 in March. Only the employment index was stronger at 22.1 from 12.3. Expectations on capital outlays were also stronger at 23.1 from 20.0. We view hiring and investment plans as lagging indicators compared to orders and expect these will soften in coming months if the slowdown is confirmed – which we expect.