The Compass Report: National economic analysis

Editor’s note: Following is the analysis from economic Jeff Collins related to the national economy. The analysis was part of The Compass Report for the second quarter of 2011. The Compass Report, managed by The City Wire and presented by Benefit Bank, is the only independent comprehensive analysis of economic conditions in the Fort Smith metro area. The data in the analysis represents a picture of the U.S. economy as of June 30, 2011.

National economic analysis — Jeff Collins

According to the “second” estimate of second quarter GDP the economy continued to expand for the eighth consecutive quarter. The annualized rate of growth for the quarter was 1%. This is an increase from the final first quarter estimate of 0.4% annualized real growth.

Analysts attribute slower growth to the impact of the European sovereign debt crisis, supply chain disruptions caused by lingering effects of the Japanese earthquake and tsunami, commodity price spikes, and finally the ongoing budget debate in Washington D.C. Reductions in government spending and employment over the first half of the year have also reduced growth.

Monetary policy, meanwhile, had been extremely accommodative with interest rates both long and short-term hovering at near record lows.

Finally, real GDP grew by 2.9% in 2010 according to the U.S. Bureau of Economic Analysis. This represented a substantial improvement from 2009 data which indicated an economy that contracted 2.6%. Analyst predictions are for GDP growth in 2011 to be between 1.5% and 2%.

LABOR DATA
Recent employment data suggest that the long depressed labor market has shown signs of modest recovery. The national unemployment rate stood at a seasonally adjusted 9.2% in June of this year, roughly 0.1% below the May rate and 0.4% below the June 2010 rate.

While the unemployment rate provides a lagging indicator of labor market performance, job gains provide a better measure of future direction of the economy. In June, the economy gained an estimated 46,000 non-farm jobs. Based on data from the U.S. Bureau of Labor Statistics, the economy added an estimated 813,000 jobs during the first half months of the year. This is substantially better performance than that observed for the first four months of 2010 during which the economy is estimated to have gained 395,000 non-farm jobs.

Disaggregating the employment data, most major sectors showed gains with the exception of financial activities which lost 18,000 jobs and government which lost 34,000 jobs in June. The sectors experiencing the largest overall gains were: transportation and warehousing, wholesale trade, durable goods, education and healthcare, and hospitality and leisure. Gains in education and health care were concentrated in the health care sub-sector. Of particular interest, construction employment lost 5,000 in June. Since early 2010, the sector has shown little employment growth. Obviously the construction sector remains depressed and continues to be a drag on the overall economy.

CONSUMER HEALTH
During the early stages of the recovery, a recovery that now seems at issue; the over-riding concern was the frailty of consumer demand. While consumers remain committed to reducing debt rather than returning to past spending levels, demand does appear to be modestly improved. 

Monthly data for personal consumption expenditures indicates improvement since the third quarter of 2009. Real personal consumption expenditures increased 0.4% in the second quarter of 2011, compared with an increase of 2.1% in the first quarter of the year. Disaggregating the data, durable goods decreased 5.1%, compared with an increase of 11.7% in the first quarter, and nondurable goods increased 0.4%, compared with an increase of 1.6% in the first quarter. Finally, services increased 1.4%, compared with an increase of 0.8% in the first quarter.

BUDGET BATTLE
The recently concluded battle over the federal budget did little to instill confidence in the financial markets or in U.S. consumers.

Poor performing labor markets coupled with slow output growth would, under normal circumstances, force fiscal action to address economic concerns and flagging demand. However, the current economic and political situation is anything but normal. The political rhetoric of the Congress and even the White House is firmly against adding to the burgeoning Federal debt by increasing spending. It is clear that long-term budget realities trump any desire for short-term job gains. This leaves the Federal Reserve, with its dual mission of stabilizing prices and insuring full employment, the singular governmental entity capable of providing stimulus to the macro-economy.

‘BALANCE SHEET’ RECESSION
Many economists have characterized the recession as a “balance sheet” recession in that the destruction of wealth led businesses and consumers to reduce debt and increase savings. This transition has significantly increased the cash balances of U.S. corporations.

It has also significantly reduced households’ willingness to fund consumption with credit. Reduced demand has had substantial implications for employment. Exacerbating the employment situation, many older Americans whose wealth was impacted by the recession find themselves prolonging their work lives, adding to the available supply of labor even as demand for products and services has declined.

In the face of criticism from the crop of Republican Presidential hopefuls, the Fed remains committed to stimulus although certainly not deaf to calls for fiscal discipline. Speaking at the Annual Conference of the Committee for a Responsible Federal Budget, Washington, D.C. on June 14, 2011, Fed chairman Ben Bernanke stated: “The task of developing and implementing sustainable fiscal policies is daunting, and it will involve many agonizing decisions and difficult tradeoffs. But meeting this challenge in a timely manner is crucial for our nation. History makes clear that failure to put our fiscal house in order will erode the vitality of our economy, reduce the standard of living in the United States, and increase the risk of economic and financial instability.“

The key to understanding the Fed’s position is recognizing the dual mission of the central bank. The short-run reality is the U.S. has considerable idle capacity in terms of industrial utilization as well as labor. There is also little upward pressure on prices or interest rates. The cost of increasing the money supply to stimulate output and employment growth would seem relatively benign.

However, continuing to pump money into the economy does not guarantee the policy goals will be met. Someone once referred to using monetary policy to stimulate the economy akin to pushing on a string. The Fed can create money but it can’t force consumers to open their wallets nor can it force businesses to invest. Moreover, should inflationary pressures build, the Fed will have no choice but to reign in the money supply, further dampening the prospects for growth.

INTEREST, INFLATION RATES
Despite signs of inflation, interest rates remain relatively low. For example, the target fed funds rate remains between 0% and 0.25%. Expectations are for the current range to be maintained through mid-2013, despite signs of inflation, stabilization in the labor market, and a modestly improving macro-economy.

Three Federal Open Market Committee board members voted against the policy action based on the target date preferring  previous language stating the target was expected to remain between zero and a quarter percent for the “an extended period.” Those voting against were, Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser.
None of the dissenting voters voiced the persistent concern of former member Thomas M. Hoenig, who consistently expressed concern that the continued high level of monetary accommodation implied increased risk of future imbalances and increased long-term inflation expectations leading to financial instability.

Longer term rates also remain well off historic averages. The rate for the 10-year U.S. Treasury Constant Maturity stood at 3% in June. The 30-year Conventional Mortgage rate was 4.51% for the same month.

The consumer price index (CPI), which is a measure of the average change in the price of goods and services over time, decreased a seasonally adjusted 0.2% in June and increased a non-seasonally adjusted 3.6% year-on-year.

The energy index decreased significantly (4.4% in June), particularly the indexes for gasoline and energy commodities (6.8% and 6.3%, respectively).

Food was up only slightly in June.

The gasoline index fell for the second consecutive month after rising 11 consecutive months. For the last 12 months the energy index was up 20.1%. The core rate, that is the CPI less food and energy, rose a modest 0.3% in June. For the last 12 months the core rate rose an estimated 1.6%. While up slightly from previous estimates, the rate remains historically very low.

The impact of the partisan bickering over the debt ceiling and fiscal policy can best be seen in the market volatility experienced immediately after an 11th hour agreement was reached between Congress and the White House.

The wild swings in the Dow Jones Industrial Average are clear indication of the pervasive uncertainty in the investor community. The markets should stabilize as economic data becomes available which provides investors with an indication of the overall direction of the U.S. economy.

That said, the impact on consumer confidence of the budget battles should not be underestimated.