This guy has a good track record. We should listen!
Despite the fact that our US outlook has been well below consensus, most indicators have surprised us to the downside over the past three months. In this comment, we summarize those results relative to our early June “road map” and extend this road map into early 2011.
The list of weaker-than-expected indicators is extensive, covering consumer spending except auto sales, confidence, housing activity, durable goods orders, payrolls, claims, and the all-items CPI. In fact, only industrial output and the Institute for Supply Management’s (ISM’s) manufacturing index surprised us significantly to the strong side, though the unemployment rate and core inflation were also firmer than expected (i.e., lower for unemployment).
Looking ahead to the fourth quarter of 2010 and the first quarter of 2011, we expect: (1) sluggish consumer spending, (2) rebounds in starts and sales from post-tax-credit paybacks (but further declines in construction outlays), (3) a stall in industrial activity, (4) renewed (but modest) labor market deterioration, and (5) a slight slowing in core inflation.
Three months ago we issued a road map for the slowdown in US growth that we anticipated for the second half of 2010. As has become our custom, we evaluate the progress to date, and are extending the road map into early 2011. With the slowdown already in place, the revised road map becomes one that we think will be consistent with a sluggish 1½% annualized growth rate.
Despite the fact that our US outlook three months ago was well below the “consensus” view, most indicators surprised us to the downside. In particular, reports on housing activity, consumer spending on items other than motor vehicles, and consumer confidence came in well below the levels we regarded as consistent with our forecast for real GDP growth to slow from a 3% annual rate in the first half of 2010 to a 1½% rate in the second half; data on initial claims, payrolls, and durable goods were also weaker than we expected. Upside surprises were confined mainly to industrial production and the Institute for Supply Management’s (ISM’s) manufacturing index; in this latter case the jury is still out, as our milepost was for the ISM index to fall below 55 in the fourth quarter. Core inflation was also firmer than we expected. On balance, these results are consistent with the fact that real GDP growth was weaker in the second quarter than we then expected and could still have downside risk in the current quarter despite this morning’s better-than-expected trade balance. Meanwhile, about a month ago we marked up our core inflation forecast modestly, reflecting the higher-than-expected results and upward revisions to data stretching back much farther.
Looking ahead, we envision a road map for the fourth quarter of 2010 and the first quarter of 2011 with the following landscape:
1. Very slow growth in consumer spending. For both quarters, we expect real consumer spending to increase only 1% at an annual rate, which implies gains of slightly less than 0.1% per month. Vehicle sales will probably rise somewhat faster, though we do not expect them to crack the 12-million annualized barrier on a sustained basis. In turn, the implication for (nominal) nonauto retail sales is for increases averaging 0.2% per month. Confidence indexes, which suffered unexpected setbacks in recent months, are apt to fluctuate around their latest readings.
2. Rebounds in housing starts and home sales from severe post-tax-credit paybacks, but to levels that remain depressed. The latest observations on home sales and, to a lesser extent, housing starts reflect an unexpectedly sharp payback following the expiration of the homebuyer tax credit. The levels to which sales have fallen are thus well below their ultimate settling points in our view. We therefore expect some improvement, albeit to sales rates that remain extremely low by longer-term historical standards – about 375,000 to 400,000 for the annual rate of new home sales and about 5 million for sales of existing units. Starts of single-family units should exhibit a similar, though less pronounced pattern. Reflecting the decline in starts and the weak fundamentals in other sectors of the construction industry, outlays for construction projects should trend lower throughout the period.
3. A stall in industrial activity. Although manufacturing output and the ISM’s index for that sector have surprised us to the upside in recent months, both our analysis of the inventory cycle (if it’s not over, then it’s moving into a phase of unintended and/or unsustainable accumulation) and key indicators (differences between indexes of new orders and inventories in various surveys, including the ISM’s) point to a significant deceleration in the near term. Specifically, we look for the ISM index to drop to 50 or below by the first quarter of 2011 and for industrial output to grind to a virtual halt on a similar timetable. As durable goods orders have already signaled in coming months, we expect little net change in such orders, with risks tilted to the downside.
4. Renewed labor market deterioration. As business firms seek to protect margins in an environment of sluggish growth, net hiring is apt to come close to stalling as well, putting the unemployment rate under renewed upward pressure. Specifically, we expect payroll gains to slow to 25,000 per month (ex Census workers) and the jobless rate to drift up to 10% over the next half year. Initial claims have never fallen to a rate that was consistent with payroll growth. That plus the presumption that control over headcount will focus on limited hiring rather than renewed firing suggests that claims will remain roughly where they have been during most of 2010.
5. A slight slowing in core inflation. As already noted, core inflation has been a bit higher than we anticipated in recent months, though the pattern is still one of gradual—if uneven--deceleration. We expect that to continue in coming months (quarters, years, and possibly decades), with monthly increases slipping once again below 0.1% on average in early 2011.
