Economic Commentaries

08

G-20 finance ministers met last week with little fanfare and little accomplishment. The ministerial communiqué alluded to a growing ineffectiveness of monetary policy while tilting toward the need for coordinated fiscal policy. China was the host country and it intimated that it would boost fiscal spending. Otherwise there was no joint action plan. Finally, G-20 denounced competitive devaluation as a means of boosting exports and growth.

For most countries fiscal policy will remain in a straitjacket near term so monetary policy will still be in focus. With deflation accelerating in Europe the central bank is likely to ease further. With anemic growth in the U.S. and the dollar remaining strong the Federal Reserve is likely to ease by deferring an interest rate increase while modifying its timetable for future increases.

In the current quarter U.S. real GDP growth appears to be running at a 1.5%-2% annual rate as consumption and construction benefit from favorable fundamentals and good weather. But inventories and trade will be drags and business investment remains anemic. Some activity may be being stolen from the spring as well so we have little expectation for any acceleration.

The economy is operating at stall speed and it is filled with cross-currents. The ISM manufacturing measure was below 50 for a fifth consecutive month in February. Trade is being dragged by a strong exchange rate and weakness abroad. Housing demand is weak despite low interest rates and continuing job growth. But the service sector is still in expansion mode and household balance sheets are in excellent shape, supporting consumer demand.

These cross-currents are beginning to show up in the labor market. Payroll growth has exceeded 200K per month over the past three months. And as we have been suggesting the labor participation rate has been rising, putting a brake on the slide in the jobless rate. But countering these is a paucity of goods producing jobs. Aggregate hours worked actually fell in February despite favorable weather and hourly earnings relapsed to a 2.2% yearly rate.

From a policy perspective this is not yet a recessionary condition. But thanks to the energy patch depression the U.S. profit picture has been poor. Historically this has been a harbinger of recession. With the exception of 1980-81 when inflation was rampant the Fed has never raised interest rates in the midst of a profits slump. It did so in December so markets will remain wary that the Fed has executed a policy mistake, creating wariness by consumers and business.

Our hope is that the economy will successfully navigate this period and avoid recession because we see some favorable changes ahead. Specifically the demand creating aspect of the commodity price bust may be beginning to take over from the capacity shrinking aspect of the bust without an inflationary consequence. And as the veil of uncertainty over the election gradually lifts we are hopeful for some mix of fiscal stimulus and tax and regulatory reform in 2017. This would reinforce a positive demand picture and lift the onus of policy from the monetary authority.

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