Thursday, November 29, 2007

U.S. Economic Outlook

U.S. Economy Bulldozes Market Jitters

Economic muscle

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.

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