Pricey oil could stifle US recovery
The outlook for the American economy is improving. That was the message from the Federal Reserve last Wednesday, as the US central bank issued new forecasts showing faster GDP growth and lower unemployment. But no, America’s economic prospects are actually getting worse. That was the clear implication of disappointing official growth numbers published less than 48 hours later. The US economy expanded 2.2pc during the first quarter, we learnt, well-below market expectations and sharply down from the 3pc growth rate notched-up during the final three months of 2011.
The economic news flowed thick and fast last week. The UK has just slipped back into recession, albeit on preliminary first quarter data. The eurozone too, continued to vex financial markets, with Sarkozy now in serious danger of losing the French Presidency and the “hard-as-nails” Dutch government quitting after rows over tighter spending plans.
The US, though, remains by far the world’s largest economy – a major, perhaps the major fundamental determinant of global investor sentiment. “Better data from America” has been central to the case of those arguing that the worst is over and the world economy is now staging a broader recovery.
So, amidst conflicting data, the pivotal economic question remains. Will the US achieve “lift-off”, generating the strong and sustainable growth needed to rescue the West from our near half-decade in the economic doldrums? Or are we now seeing, for the third consecutive year, an American spring-time stall?
After its two-day meeting last week, the Federal Open Market Committee, a panel of forecasters and rate-setters within the Fed, predicted that US GDP will expand by 2.4pc-2.9pc this year, significantly up from its January forecast of 2.2pc-2.7pc. Unemployment could fall from 8.2pc today to as low as 7.8pc by the end of 2012, the Fed said. That would be much better than the 8.2pc-8.5pc jobless forecast the central bank published at the start of this year.
The official GDP numbers, though, from the Department of Commerce, were far more down-beat, with a much slower than expected first quarter expansion. Retail spending was strong, with household purchases up 2.9pc and house-building itself growing at its fastest rate in almost two years. This positive consumer sentiment was masked, though, by ebbing corporate confidence. Investment was flat and business inventories made only a meager contribution.
Digging deeper into the official numbers, it is worth noting that real disposable incomes rose just 0.4pc during the first quarter. US consumers only managed to maintain robust spending growth by putting even less money aside, the savings rate falling from 4.5pc to 3.9pc over the first three months of the year. That’s why many economists, attributing strong first quarter spending to the warm US winter, now expect slower consumption between April and June. That could compound flagging corporate sentiment and drag down GDP growth even more.
This seeming inconsistency between the Fed’s view, and the official numbers, is compounded by signs of a significant divergence of opinion within the Fed itself. The FOMC kept the headline Federal Funds interest rate on hold at 0-0.25pc last week and Chairman Ben Bernanke told reporters that, despite the FOMC’s improved forecasts, economic conditions were likely to mean rates stayed at that level at least until the end of 2014.
But the fine-print of the FOMC report shows that just four of the committee’s 17 members are predicting that such ultra-low rates will last that long, down from six in January. With inflation rising, the majority of Fed economists, and a growing majority, think such rock-bottom borrowing costs won’t be appropriate for too much longer.
Questioned about this dissent among his ranks, Bernanke attempted to make near-metaphysical distinctions between individual opinions on the FOMC and the committee’s collective view. FOMC members were “extremely comfortable” with the late-2014 tightening guidance, Bernanke insisted, and forecasts by central bank officials are, anyway, “just inputs into a decision process”.
Just in case anyone thought Bernanke might not be in charge, the Chairman then gave a clear signal that, whatever anyone said about rising inflation or rosier growth, he certainly hasn’t ruled-out another round of quantitative easing – or QE3. “We remain entirely prepared to take additional balance sheet actions,” Bernanke said. “Those tools remain very much on the table, and we will not hesitate to use them, should the economy require additional support”.
On cue, equity markets rallied. The prospect of yet another dose of Fed funny-money meant that Wall Street recorded its best week in a month and a half, with the S&P500 breaking 1,400 for the first time since early April. While there were some good earnings numbers last week – from the likes of Apple and Amazon – other US corporate results, such as those from Caterpillar, disappointed. Yet despite the mixed earnings numbers, and an even more mixed economic outlook, share prices still surged in anticipation of another QE “sugar rush”, as traders concluded the “Bernanke put” was back on.
Rhetorical theatrics aside, and having just spent a week in the US, I worry that this recovery might yet falter. America is doing better than some of the other major economies, no doubt, and the chances are that this year’s GDP growth will beat the 1.7pc expansion of 2011. The US housing market is showing signs of life, with survey data pointing to price rises for the first time in 10 months.
While employers took on just 120,000 new workers in March, the lowest monthly increase since October, they still added 635,000 to their payrolls during the first quarter as a whole, the biggest gain since the first three months of 2006. It’s also worth adding that, as in the UK, these disappointing preliminary GDP numbers must be treated with caution. Revisions are likely to happen, so first-quarter growth in the US growth could yet be higher than 2.2pc.
Having said that, expensive oil remains America’s Achilles heel. Despite having fallen almost 3pc over the last month, WTI crude remains 6pc up year to date. The cost of a gasoline is pushing $4/gallon, some 20pc higher than at the start of the year. Given that the US is, by a very long way, the world’s largest crude importer, this price reality will continue to weigh on consumer and business sentiment.
Then we must consider the so-called “fiscal cliff” – that fact that a range of tax cuts are set to expire at the end of 2012, with potentially serious implications for both household and corporate spending. The ending of social security and income tax reductions passed by the previous Bush government, together with other business allowances, could see America’s tax bill rise by $500bn in 2013, close to 3pc of the economy’s total output.
Amidst the data thickets, some perspective is needed. America is recovering. In real terms, US GDP is now above its 2007 peak. And given that the US economy remains almost three times bigger than China, that’s important positive news for the broader global economy.
But, consider also, what it has taken to generate that growth. US government debt, some $9,000bn in 2007 is now $15,500bn, up more than 70pc. The Fed’s balance sheet, with QE3 still to come, has ballooned from $860bn five years ago to $2,800bn today, a staggering 230pc rise.
It’s not clear when investor confidence in US T-bills will weaken but weaken it ultimately will. Unless America takes drastic steps to get on a sustainable fiscal course, it’s only a matter of time before concerns about American sovereign debt flare up, just as they have in Europe.