Economic Outlook: Hopes and Worries in an Election Year Gregory Daco Principal US Economist April 2012
Global Perspective: Bright Spots in Clouds of Uncertainty
Global Economy US growth: on a better track but still sluggish Emerging markets: slower growth but mostly doing well China soft landing is the most likely scenario Europe is in a mild recession meltdown risks have diminished Geopolitical tensions and social unrest in MENA Risk from oil prices has increased
The Global Expansion Is Likely to Remain Intact 10 (Real GDP, percent change) 8 6 4 2 0-2 -4 1990 1993 1996 1999 2002 2005 2008 2011 2014 World Advanced Countries Emerging Markets
Oil Prices A Growing Threat? Fundamentals weaker world growth, but little spare capacity US consumers have some offsets: employment, income, natural gas not so in Europe Growing Iran risk premium Accidental escalation of hostilities in the Gulf Some factors will limit oil price increases in medium-term A hard landing in China is a downside risk for all commodities Implication: Current oil prices = not a big threat to the recovery Temporary spike (say to $200) could do real damage
OPEC Spare Crude Oil Production Capacity 8 (Millions of barrels per day) 6 Range of Spare Capacity 4 2 0 2009 2010 2011 2012 2013 Source: IHS CERA
Debt A Report Card The United States has made significant progress on reducing private sector leverage Europe has not Poor growth + high debt + weak banks = highly toxic cocktail for Europe US growth is stronger, the population is aging more slowly, and the tax burden is lower than Europe Implications: The US has a political crisis Europe s crisis is both political and structural
Deleveraging Has Only Just Begun in the Ten Largest Developed Countries Japan France Spain United Kingdom Canada Italy Germany Australia United States South Korea (Total debt 1, percentage point change) 2008-2011Q2 2000-08 -50 0 50 100 150 200 1. Includes all loans and fixed-income securities of households, corporations, financial institutions, and government; 2. Or latest available Sources: National central banks; McKinsey Global Institute 2
Government Underlying Primary Balances, 2011 Greece Italy Sweden Switzerland Germany Iceland Estonia South Korea Luxembourg Belgium Israel Austria Eurozone Finland Denmark France Australia Czech Republic Netherlands Portugal Slovenia New Zealand Spain Hungary Norway Poland Ireland Canada United Kingdom United States Japan (Surplus or deficit as a percent of nominal GDP) Source: OECD -8-6 -4-2 0 2 4 6
Eurozone Sovereign Debt Financial tensions have eased thanks to the ECB s long-term repo operations Banks used funds to buy sovereign debt pushing yields lower Structural reforms progress in Italy and Spain has also helped ease tensions Greek restructuring was a non-event But Eurozone sovereign debt crisis far from resolved Greece, Portugal may need further assistance Italy and Spain need to continue structural reforms can they? Firepower of ESM/EFSF is being raised, but is it enough? ECB has hinted that it has done its part in solving the crisis, really?
Eurozone Outlook Short Term: Further contraction in first half of 2012 Real GDP contracting 0.5% in 2012 Austerity + Rising unemployment + Squeezed consumer purchasing power Eased sovereign debt tensions, better global growth, and lower inflation will support a second half recovery Medium Term: Growth limited over the medium term by need for extended fiscal tightening Structural reforms hurt growth in the near-term, but will lift potential growth over the long-term Weak demographics Risk: Failure(s) to meet fiscal targets and/or lack of progress on structural reforms
Real GDP Growth in Western Europe: Another Recession 4 (Annual percent change) 3 2 1 0-1 -2 Germany France United Kingdom Italy Spain 2010 2011 2012 2013 2014-2020
Real GDP Growth in the Eurozone s Trouble Spots 4 (Annual percent change) 2 0-2 -4-6 -8 Eurozone Greece Portugal Ireland 2010 2011 2012 2013 2014-20
Asian Growth Outlook Still Resilient Growth outlook remains resilient despite the EU recession, helped by continued US recovery and modest rebound in Japan While Chinese economic growth is expected to moderate in 2012, a soft landing is expected Inflationary pressures having declined, some easing of monetary policies The medium-term outlook for consumer spending remains bright, supported by the rising incomes of a growing Asian middle class Risk: Hard landing in China is a major risk to the medium-term regional growth
Real GDP Growth in Asia-Pacific: Still the Star Region 12 (Annual percent change) 10 8 6 4 2 0-2 China India Japan South Korea Indonesia 2010 2011 2012 2013 2014-2020 Taiwan
China: A Challenging Soft Landing Risks of a double squeeze downturn remain External demand weakness remains due to slowing exports to Eurozone Construction downturn is weighing down on house prices Declining house prices are exerting pressure on the banking sector Moderate domestic inflation is another sign of domestic demand weakness In the short-term, a soft landing is more likely Slowdown so far still much milder than the 2009 downturn Eurozone crisis should not have the same impact as the Great Recession Housing demand softness still mainly due to government tightening policies Easing inflation has provided more leeway for Beijing to relax monetary policy Risks for China are higher over the longer term Local debt bubble highlights inadequacies of China s state controlled banking sector Major export markets of the US and EU will undergo protracted demand consolidation Boost to China s exports due to its 2001 WTO entry will diminish over time
US Economic Outlook: Hopes and Worries in an Election Year
Looking Up Leading indicators showing clear improvements Bank lending rising to businesses and consumers Employment growth has improved Some pent-up demand is coming through, especially for vehicles Housing activity has bottomed - multifamily sector looks better Business capital spending continues to support growth
Employment Growth Catching Up With GDP Growth (Year-on-year percent growth) 4 3 2 1 0-1 -2-3 -4-5 -6 2005 2006 2007 2008 2009 2010 2011 2012 GDP Payroll Employment
A Few Caveats Data Quirks Have Helped Some Indicators, Notably Employment An exceptionally mild winter has helped recent data to run better than the seasonal adjustment procedures expect and the late-2008/early-2009 economic collapse has distorted seasonal adjustment patterns, flattering recent data External Risks Haven t Disappeared $4/gallon gasoline is a modest drag on growth; $5/gallon gasoline would derail the expansion Eurozone, China risks Domestic Risk: Too Much Fiscal Tightening Too Soon Without action, a major fiscal contraction is set for Jan 1, 2013 automatic spending cuts, expiry of Bush tax cuts, expiry of payroll tax cut and emergency unemployment benefits
Consumers: Some Momentum Building
Consumer Sentiment Off the Floor 120 (Reuters/University of Michigan Index, 1966=100) 110 100 90 80 70 60 50 1978 1982 1986 1990 1994 1998 2002 2006 2010
Household Net Worth: Climbing Out of a $16 Trillion Hole 70 (Trillions of U.S. dollars) 60 50 40 30 20 1995 1997 1999 2001 2003 2005 2007 2009 2011 23
Household Deleveraging: Are We Done Yet? (Household liabilities, percent of disposable income) 140 130 120 110 100 90 80 70 60 1980 1985 1990 1995 2000 2005 2010
Gasoline Burden: No Relief In Prospect, But Not Much Higher Than 2011 450 400 350 300 250 200 150 Every 10 cents on the pump price costs consumers $11 billion per year (0.10% of disposable income) 2008 2009 2010 2011 2012 2013 2014 4.50 4.00 3.50 3.00 2.50 2.00 1.50 Consumer Spending on Gasoline and Motor Oil (Left scale, bil. of US$, annual rate) Pump Price of Gasoline, all grades (Right scale, dollars per gallon)
Consumption Has An Income Problem 5 4 3 2 1 0-1 -2-3 (Percent growth, real) 2006 2007 2008 2009 2010 2011 2012 2013 2014 Real Consumption Real Disposable Income
Business Sector: Cautious Optimism
Key Leading Indicators Have Improved 65 (ISM Diffusion Indexes, 50 = breakeven) (NFIB Index, 1986=100) 60 55 50 45 40 35 30 2007 2008 2009 2010 2011 2012 ISM Manufacturing (L) ISM Non-Manufacturing (L) ISM = Institute for Supply Management; NFIB = National Federation of Independent Business 28
Business Capital Spending Cycle: Construction Lags 30 (Percent change annualized rate, real spending) 20 10 0-10 -20-30 -40 2008 2009 2010 2011 2012 2013 2014 Software & Equipment Buildings
The Housing Cycle: Beginning to Turn
Multi-Family Housing Activity: Turning Higher 0.4 (Multi-family housing starts, millions, annual rate) 0.3 0.2 0.1 0.0 2007 2008 2009 2010 2011 2012
Low Home Prices and Mortgage Rates Push Housing Affordability to a New High 2.5 (Index, higher values=better affordability*) 2.0 1.5 1.0 0.5 1981 1986 1991 1996 2001 2006 2011 * An index above 1.0 indicates that family earning the median income has more than enough income to qualify for a mortgage loan on a median-priced home, assuming a 20% down payment. January 2012: Median income of $60,900; median-priced existing single-family home of $154,000; down payment Copyright 2012 of 20%, IHS Inc. All or Rights $32,000 Reserved. Affordability Index at 2.0. 32
Housing Starts Beginning A Long Climb: Prices Bumping Along The Bottom Now 2.50 2.25 2.00 1.75 1.50 1.25 1.00 0.75 0.50 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Housing Starts (LS, millions of units) FHFA House Price Index (RS, purchase-only index, 1991Q1 = 100) 230 220 210 200 190 180 170 160 150
Foreign Trade: Small Drag in 2012
Export Growth Cools as Trading Partner Growth Cools 15 10 5 0-5 -10 (Percent growth year-on-year) 6 4 2 0-2 -4-15 2002 2004 2006 2008 2010 2012 2014-6 Export Growth (Left Scale) Trade-Weighted World GDP Growth (Right Scale)
The U.S. Dollar: Secular Weakness Against Emerging Market Currencies 1.6 (2005=1.0, inflation-adjusted) 1.4 1.2 1.0 0.8 0.6 0.4 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 Major Currency Index Other Important Trading Partners Index
Inflation Interest Rates Federal Reserve
Inflation Expected to Ease 6 (Percent change from a year earlier) 5 4 3 2 1 0-1 -2 2007 2008 2009 2010 2011 2012 2013 2014 All-Urban CPI Core PCE Price Index
What Will the Fed Do? Opinions differ at the Fed on how much slack remains in the economy but the opinions that really matter think plenty The Fed is waiting to see whether growth accelerates to match the recent improvements in the labor market QE3 is not likely, but it may still try sterilized MBS purchases to try to help housing Federal funds rate probably near zero till early-2015 Continued sharp labor-market improvements would mean no further easing and (eventually) a re-think on the low rates horizon
Federal Funds Rate to Stay Near Zero Until 2015: Long Rates Stay Low 7 (Percent) 6 5 4 3 2 1 0 2000 2002 2004 2006 2008 2010 2012 2014 Federal Funds 10-Year Treasury Yield
Fiscal Policy: The Cliff is Approaching
Key Fiscal Deadlines Approaching September 30, 2012: Continuing Resolution needed if no budget is in place for FY2013 November 6, 2012: Election Day January 1, 2013: Spending sequester kicks in; Bush tax cuts expire; payroll tax cut / emergency unemployment benefits will expire again A fiscal contraction of around 2.5% of GDP will hit if nothing is done January 2013: New Congress, Presidential inauguration First half 2013 (probably): Debt ceiling will need to be raised again
The 2013 Fiscal Cliff $ Billions Percent of GDP Spending Cuts - Sequestration 95 0.6 Bush Tax Cuts Expiry 160 1.0 Payroll Tax Cut Expiry 118 0.7 Emergency Unemployment Insurance Expiry 30 0.2 Total 403 2.5 Expiry of AMT Relief 120 0.7 Extreme Total 523 3.2 Source: IHS calculations based on OMB and CBO estimates
Our Fiscal Policy Assumptions Politicians are not foolish enough to take us over the fiscal cliff After November elections Compromise Discretionary spending caps from debt-ceiling agreement No automatic spending cuts replaced by entitlement savings and tax increases determined after the 2012 elections beginning in 2014 not 2013 Payroll tax cut and emergency UI benefits extended in 2013 later phased out, not suddenly removed These assumptions stabilize the debt-to-gdp ratio by mid-decade
The Federal Budget Gap: We Expect Action On Both Sides of the Ledger 26 (Percent of GDP) 24 22 20 18 16 14 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020 Revenues Expenditures
Sufficient to Stabilize the Federal Debt Burden 80 (Federal debt in the hands of the public, percent of GDP) 70 60 50 40 30 20 1980 1985 1990 1995 2000 2005 2010 2015 2020
The Economy and the Presidential Election: Presidential Election: What Does the IHS Global Insight Election Model Say?
Presidential Election Model Drivers Election Model forecasts incumbent party s share of 2-party vote Key Election Model Drivers and Projections: Unemployment in Q3 2012 (8.2%) Real per capita disposable income growth Q3 2012 (0.4% y/y) Election Model delivers Obama vote share 44.5% Every 1% off unemployment adds 2.1% to Obama vote Every 1% on income adds 1.6% to Obama vote Obama vote hits breakeven (50%) with unemployment 7.5%, income growth 3.0%
The Election Model Says the President Should Be Facing an Uphill Battle 65 (Percentage of 2-party presidential vote for incumbent party) 60 55 50 45 40 48 52 56 60 64 68 72 76 80 84 88 92 96 00 04 08 12 Actual Predicted
Risks and Alternatives
GDP Growth Outlook 6 (Annualized rate of growth) 4 2 0-2 2011 2012 2013 2014 Baseline (60%) Pessimistic (20%) Optimistic (20%) 51
Unemployment Outlook 10 (Percent) 9 8 7 6 5 2008 2009 2010 2011 2012 2013 2014 Baseline (60%) Pessimistic (20%) Optimistic (20%) 52
Business Implications
Implications and Bottom Line Recent signals are encouraging Most likely outcome: Continued but Moderate growth Annual growth doesn t beat 3% until 2014 (helped, at last, by a vigorous housing revival) Fed may still try to do more to help Immediate Risks = Oil + Europe Huge fiscal uncertainty key January 1 deadlines loom US elections will present choices on the size and role of government but may not deliver a clear verdict
U.S. Economic Growth by Sector (Percent change unless otherwise noted) 2011 2012 2013 2014 Real GDP 1.7 2.2 2.4 3.4 Final Sales 2.0 1.9 2.5 3.5 Consumption 2.2 2.1 2.2 2.4 Light Vehicle Sales (Millions) 12.7 14.2 14.9 15.7 Residential Fixed Investment -1.3 9.7 16.3 25.5 Housing Starts (Millions) 0.61 0.74 1.01 1.40 Business Fixed Investment 8.8 6.8 6.1 7.9 Federal Government -1.9-1.8-3.6-2.8 State and Local Government -2.2-1.4-0.6 0.3 Exports 6.7 4.2 7.1 7.5 Imports 4.9 4.1 3.8 4.0
Other Key Indicators (Percent unless otherwise noted) 2011 2012 2013 2014 Industrial Production (% growth) 4.0 4.6 3.1 3.5 Employment (% growth) 1.2 1.6 1.7 1.8 Unemployment Rate 9.0 8.2 7.9 7.3 CPI Inflation 3.1 2.2 1.7 1.9 Oil Prices* (Refiners, $/bbl) 102 113 113 111 Core PCE Price Inflation 1.4 1.7 1.5 1.9 Federal Funds Rate 0.10 0.10 0.10 0.11 10-year Government Bond Yield 2.79 2.24 2.66 2.91 Dollar (Major Currencies, 2005=1) 0.85 0.87 0.88 0.87 *Oil Price is the Average Refiner Acquisition Price of Crude Oil
Thank You for Your Participation! Gregory Daco Principal US Economist IHS Global Insight gregory.daco@ihs.com