U.S. Economy Bulldozes Market Jitters
Based on recent economic data for the U.S., growth remains strong. Real GDP in the last quarter grew at a healthy rate of 3.8%. Advanced estimates for this quarter indicate another period of robust growth at 3.9%. The unemployment rate remains constant at 4.7%, indicating a tight labor market. A falling dollar, coupled with inflation woes in foreign economies, resulted in export growth last quarter. The trade balance rose in September from $-57.6 billion to $-56.5 billion. Fiscal accountability is improving; deficits as a percentage of GDP fell from -1.9% in 2006 to -1.2% in November 2007.
Annual inflation rose to 3.5% in October, up from 2.8% in September. The U.S. dollar is down against major currencies; the Trade Weighted Exchange index is 73.93 in November, down from 75.91 in October.
Monetary Policy has been expansionary, with a 0.75 basis-point reduction in the federal funds target of 4.5% in October. The M2 stock expanded 0.34% in October, down slightly from 0.43% in September.
Markets are weary
With the housing market on the fritz and consumer confidence down, apprehensive investors seek safety. The 5-year treasury note rate is down to 3.496% at the end of month from 4.014% at the beginning of the month. The 3-month treasury bill rate is down to 3.042% at the end of month from 3.797% at the beginning of the month. Consumers are also concerned. Growth in household nonfinancial debt fell to 7.1% last quarter from 7.9% the quarter before. The consumer sentiment index is down 3.0% as retail sales slump and gas prices rise 38%.
Resolving the debate
Current economic activity seems to contradict market expectations. Leading economic indicators and a new Federal Reserve action indicate a bright economic future. Businesses inventories rose to 0.12% of GDP in the last quarter, up from 0.04% the quarter before:
Average labor productivity growth is up 4.9% compared to 2.2% the quarter before; it grew at its highest level since 2003: Weekly unemployment insurance claims were down 3.2% during the week November 10 through November 17.
In an effort to become more transparent, the Federal Reserve Bank increased the frequency of published economic forecasts to four times a year. In response to this signal, the Fed gains credibility, offering hope to the weary financial markets. According to the latest publication, the Fed projects solid economic activity through 2010, with 2.5% expected growth in 2008. The labor market is expected to remain tight, with unemployment rising just 0.1% to 4.8% in 2008. The housing market slump and reduction in consumer spending reduce the expected inflation forecast from 3.0% in 2007 to 2.1% in 2008. Given that the Fed's forecast agrees with the leading economic indicators, we expect the federal funds target to fall another 0.25 basis-points, but not further.
Possible recession-causing culprits are the decline of the U.S. dollar, the sub-prime mortgage crisis, or the high cost of crude oil. Different from previous recessions, 1973-1975, 1981-1982, 1990-1991, 2001, these culprits were expected. Rational expectations and the transparency of economic shocks eased the ability of firms and consumers to react to the shocks, and the economy prepares for a soft landing.
Do you have any thoughts? I welcome your comments. Best, Nonthruths
Sources: Board of Governors, Federal Reserve Bank of St. Louis, Bureau of Economic Analysis, Bureau of Labor Statistics, the Economist, and National Bureau of Economic Research.