U.S. Economic and Interest Rate Outlook - January 2013
January 16, 2013
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- 2012 closed on a soft note; fiscal drag and associated uncertainty will limit US performance in coming quarters
Incoming reports have suggested diminished economic momentum in the fourth quarter; the final take will be published in the GDP report at the end of this month. Real GDP is predicted to have risen at an annual rate of only 1.5% in the last three months of the year, about the half the pace seen in the third quarter. If this forecast is accurate, on a Q4-to-Q4 basis, real GDP will have advanced at a very moderate 2% pace in each of the past two years.
The fiscal cliff deal erased many unknowns about taxes but left the spending part of the budget equation unclear. The debt ceiling stalemate is another issue that will continue to haunt financial markets in the next few weeks. Our working assumption is that both fiscal challenges will be resolved such that spending cuts will be less than specified in current law and the nations statutory debt limit will be raised before the Treasury Department is forced to stop or reduce any Federal payments.
US Economic Outlook
Key elements of the current forecast:
- Consumer spending is expected to begin the year fairly slowly, as the impact of higher taxes (especially the reversion of payroll taxes to more normal levels) takes hold. The trajectory of spending should improve gradually through the year, but will remain limited by ongoing deleveraging and very modest gains in household income.
- Looking ahead, the fundamentals of the housing sector are supportive of continued growth in 2013. Although mortgage rates and housing affordability favor a strong trend for home sales, tight mortgage underwriting standards will cap the size of gains from sales and construction of homes. Nonetheless, demographic factors and growth in employment (albeit moderate) will lift sales and residential investment expenditures. This, combined with other positive developments in the housing sector, supports expectations of a continued moderate upward trend in home prices. It is noteworthy that the CoreLogic Home Price Index has posted year-to-year gains each month since December 2011.
- Capital spending plans of businesses are not suggestive of a pickup in activity in the very near term. A part of the prevailing pessimism is traced to remaining fiscal uncertainty, which continues to cloud the outlook for sales and profits.
- The projected soft growth among trading partners of the US points to only a small export contribution to overall GDP growth during the quarters ahead.
- The outlook for government spending in 2013 is not promising. Federal government outlays are nearly certain to decline. With state governments making some progress towards better fiscal health, this sector is expected to be much less of a drag on GDP as this year unfolds.
- The unemployment rate declined to 7.8% during the fourth quarter of 2012. A likely increase in the participation rate and tepid hiring conditions should translate into a very modest drop in the jobless rate to 7.3% by the close of 2013.
- The Consumer Price Index posted a 1.7% gain in 2012, reflecting lower energy prices during the year, while the core price measure advanced 1.9% in 2012, a small deceleration after a 2.2% increase in 2011. Barring surprise hikes in commodity prices, inflation for the most part is projected to be non-threatening given the projection of demand conditions in the economy. It is also important to note that inflation expectations remain well-anchored.