The United States: Fiscal Facts and Fantasies Presented by: Nigel Gault Chief U.S. Economist IHS Global Insight
Subdued Recovery: Tailwinds Battling Headwinds
The U.S. Recovery: Tailwinds More sectors contributing; not just an inventory-driven recovery Strong manufacturing growth Financial markets healing Large businesses are flush with cash Labor market is improving Stimulus from December s tax package 3
The U.S. Recovery: Headwinds Consumers and businesses remain cautious No housing recovery Rising commodity prices are squeezing real incomes The oil price rise could turn into a major shock Japan shock will temporarily disrupt the automotive sector State and local budget cuts continue Federal fiscal tightening is coming 4
Growth Indicators Showing Signs Of Weakening
Key Leading Indicators Show Growth, But Are Slipping 65 60 55 50 45 40 35 (ISM Diffusion Indexes, 50 = breakeven) 101 98 95 92 89 86 83 30 2007 2008 2009 2010 2011 Manufacturing Index Nonmanufacturing Index NFIB Small-Business (RS, Optimism Index, 1986=100) 80 6
Cautionary Sign: Initial Unemployment Insurance Claims Have Turned Higher 525 (Initial unemployment insurance claims, thousands) 500 475 450 425 400 375 350 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 4-Week Moving Average Actual 7
2011 Growth Expected to Be Backloaded 4.0 (Annualized real rate of GDP growth, Q/Q, percent) 3.5 3.0 2.5 2.0 1.5 2010 2011 2012 2013 8
The Housing Cycle: Still at the Bottom
Mortgage Applications for House Purchase Sank After Tax Credit Expired 300 (Mortgage applications for purchase, index, Mar.16,1990 =100) 250 200 150 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 4-Week Moving Average Actual 10
Demand Shortfall: Household Formation Has Plunged 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25 (Millions of households) 357,000 households added in year to March 2010 a post-world War II low 0.00 Mar 01- Mar 02 Mar 02- Mar 03 Mar 03- Mar 04 Mar 04- Mar 05 Mar 05- Mar 06 Mar 06- Mar 07 Mar 07- Mar 08 Mar 08- Mar 09 Mar 09- Mar 10 Source: Census Bureau 11
Supply Excess: The Housing Overhang 3.0 (Proportion of homeowner inventory vacant and for sale, percent) 2.5 2.0 1.5 1.0 0.5 1975 1980 1985 1990 1995 2000 2005 2010 Source: Census Bureau 12
Housing Starts Have Hit Bottom: Prices Not Quite There Yet 2.4 2.0 1.6 1.2 0.8 0.4 0.0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 225 215 205 195 185 175 165 Housing Starts (LS, millions of units) FHFA House Price Index (RS, purchase-only index, 1991Q1 = 100) 13
The Consumer : Signs of Life, But Now Threatened By Another Oil Spike
Employment Is Turning 300 200 100 0 Private Payroll Employment* 12 10 8 6 Unemployment Rate** -100 4 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 34.6 34.4 34.2 34.0 33.8 33.6 Length of Workweek*** Average Hourly Earnings Growth**** Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 4 3 2 1 0 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 *Thousands, monthly change, SA; **Percent; ***Hours, SA; ****Nominal, percent year-over-year 15
Energy and Food Prices Have Climbed... 140 120 100 80 60 40 20 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2.0 1.8 1.6 1.4 1.2 1.0 0.8 Oil Price (LS, WTI, $/barrel) PPI Farm Products (RS, index, 1982=1.0) 16
...Driving the CPI Higher And Hurting The Consumer s Purchasing Power (Percent change unless otherwise noted) CPI Components (rates of increase) 2009 2010 2011-0.3 1.6 3.0 Core 1.7 1.0 1.5 Energy -18.1 9.6 15.3 Food 1.8 0.8 3.9 Components (contributions) Core (77.7%) 1.3 0.7 1.1 Energy (8.6%) -1.7 0.8 1.3 Food (13.7%) 0.2 0.1 0.5 CPI weights as of Dec 2010 in parentheses Note: The 2011 payroll tax cut is worth 1.0% of disposable income, so it has been more than offset by higher inflation. 17
Consumer Spending Stabilizing, But Not a Strong Driver of Recovery 6 (Annualized rate of growth) 4 2 0-2 -4 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 18
Business Investment: A Mixed Picture
Business Equipment Demand Recovering 70 (Non-defense capital goods orders ex-aircraft, 3-mo moving average, $ billions) 65 60 55 50 45 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 20
Nonresidential Construction: Architects Billings Just Above Neutral 65 (Diffusion Index) 60 55 50 45 40 35 30 1995 1997 1999 2001 2003 2005 2007 2009 * Source: American Institute of Architects 21
Business Capital Spending Cycle: Construction Lags 45 (Percent change annualized rate, real spending) 30 15 0-15 -30-45 2007 2008 2009 2010 2011 2012 2013 Software & Equipment Buildings 22
Foreign Trade: A Key Driver of Growth
Export Growth By Destination 30 (Percent growth in 12-month-moving average, merchandise exports, Feb 2011) 20 10 0 Total (100%) Latin America (23%) Pac Rim (25%) Canada (19%) Other (10%) Europe (22%) Export shares are in parentheses. Latin America includes Mexico. 24
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 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 Major Currency Index Other Important Trading Partners Index 25
Exports Expected to Outpace Imports 40 (Percent change annualized rate, volumes) 20 0-20 -40 2008 2009 2010 2011 2012 2013 Real U.S. Exports Real U.S. Imports 26
Inflation and Interest Rates
Core Inflation Is Bottoming Out: Oil and Food Driving Headline Inflation Higher (Percent change from a year earlier) 6 5 4 3 2 1 0-1 -2 2006 2007 2008 2009 2010 2011 2012 2013 All-Urban CPI Core PCE Price Index 28
Federal Funds Rate to Stay Near Zero Until 2012: Long Rates Rise But Only Gradually at First 7 (Percent) 6 5 4 3 2 1 0 1999 2001 2003 2005 2007 2009 2011 2013 Federal Funds 10-Year Treasury Yield 29
Fiscal Facts and Fantasies
Will The U.S. Ever Stabilize the Public Debt? You can always count on Americans to do the right thing - after they've tried everything else. Winston S. Churchill 31
Fiscal Facts The federal fiscal trajectory is wholly unsustainable Spending is high, revenues are low S&P has issued a downgrade warning, but markets have not panicked 10-year Treasury yields are not far above 3% Politicians are now getting more serious; they know something must be done There is a huge philosophical divide over how to cut the deficit There are elections in 2012 (isn t that the place to argue things out?) There is a looming flashpoint before 2012: The debt ceiling must be raised. Drop-dead date currently August 2. 32
Fiscal Fantasies The deficit can be stabilized just by cutting spending Tax cuts can pay for themselves Only the rich need pay more taxes Spending can be cut just by getting rid of waste and inefficiency Medicare can continue as is Defense can t be touched Austerity in current conditions is expansionary Everybody must give a little ground on their fantasies to allow a comprehensive deficit-reduction plan. Unlikely before the elections. 33
The Federal Budget Gap 26 (Percent of GDP) 24 22 20 18 16 14 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020 Revenues Expenditures 34
Federal Debt Projections 80 (Percent of GDP) 75 70 65 60 55 50 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 IHSGI (May) Ryan (Apr) Obama (Feb) Bowles-Simpson (Dec) 35
Federal Deficit Projections 12 (Percent of GDP) 10 8 6 4 2 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 IHSGI (May) Ryan (Apr) Obama (Feb) Bowles-Simpson (Dec) 36
Federal Spending Projections 26 (Percent of GDP) 25 24 23 22 21 20 19 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 IHSGI (May) Ryan (Apr) Obama (Feb) Bowles-Simpson (Dec) 37
Federal Revenue Projections 21 (Percent of GDP) 20 19 18 17 16 15 14 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 IHSGI (May) Ryan (Apr) Obama (Feb) Bowles-Simpson (Dec) 38
Entitlements and Interest Make It Hard to Cut Federal Spending 25 (IHSGI May Baseline, percent of GDP) 20 15 10 5 0 2000 2003 2006 2009 2012 2015 2018 2021 Defense Social Security Nondefense Goods & Services Medicare/Medicaid Interest Other 39
Summary Tables and Implications
U.S. Economic Growth by Sector (Percent change unless otherwise noted) 2010 2011 2012 2013 Real GDP 2.9 2.7 2.9 2.8 Final Sales 1.4 2.7 2.9 3.0 Consumption 1.7 2.8 2.4 1.9 Light Vehicle Sales (Millions) 11.5 12.7 14.6 15.8 Residential Investment -3.0 0.4 24.0 27.9 Housing Starts (Millions) 0.59 0.63 1.02 1.42 Business Fixed Investment 5.7 8.3 8.1 5.8 Federal Government 4.8 0.1-3.2-3.3 State and Local Government -1.4-1.9-1.4 0.3 Exports 11.7 7.5 9.5 8.3 Imports 12.6 4.8 6.4 4.0 41
Other Key Indicators (Percent unless otherwise noted) 2010 2011 2012 2013 Industrial Production (% growth) 5.3 5.3 3.6 2.6 Employment (% growth) -0.7 1.2 1.8 1.8 Unemployment Rate 9.6 8.8 8.3 7.8 CPI Inflation 1.6 3.0 1.8 2.0 Oil Prices (WTI, $/bbl) 79 102 104 108 Core PCE Price Inflation 1.3 1.2 1.6 1.7 Federal Funds Rate 0.18 0.16 1.28 3.43 10-year Government Bond Yield 3.21 3.53 3.86 4.66 Dollar (Major Currencies, 2005=1) 0.90 0.83 0.86 0.88 42
Implications Recovery muted by historical standards; growth stays just below 3% Higher oil and food prices are offsetting the payroll tax cut stimulus Core inflation has bottomed but won t rise rapidly Fed will stay the course on QE II; no QE III Fiscal tightening on the way, but the big issues (entitlements, taxes) probably won t be tackled soon Key Risks: Middle East turmoil / renewed commodity price spike Housing Federal Deficit is it ok to wait till after 2012 for the big fix? 43
Thank You for Your Participation! Presented by: Nigel Gault Chief U.S. Economist IHS Global Insight