August 23, 2010
- Second-quarter economic growth will be revised down to 1 to 1.5 percent
- Growth below 2 percent won't prevent unemployment from rising
- New jobless claims have already jumped to a nine-month high of 500,000 since last year
The fledgling economic recovery is at a critical juncture. Recent reports indicate that the economy is slowing even more than earlier data had indicated, that the heretofore strong support from manufacturing is waning, and already-weak labor markets are getting even weaker. The loss of momentum is now so evident that the recovery is at increasing risk of stalling out.
As the risk mounts, policymakers are sure to face new pressure to act in coming months. The problem is that Capitol Hill is gridlocked in the face of upcoming elections and hesitant to spend more because of the deficit. Meanwhile, Federal Reserve officials continue to be divided over the outlook, and what and how much new action might be needed. All this is creating more uncertainty. New hesitancy by investors and businesses, who have an even muddier view of the future than they did earlier this year, is draining the recovery’s fuel.
Economic reports look increasingly worrisome. Since the Commerce Department’s July 30 report, which estimated second-quarter GDP growth of 2.4 percent, new data imply that the last quarter’s pace will be revised down sharply when Commerce issues a new estimate on Aug. 27, to as low as 1to 1.5 percent. The fear is that the second half may not be much better, as economists continue to mark down their forecasts. Analysts at J.P. Morgan Chase, who just three months ago expected second-half growth of 3.75 percent, last week cut their projection to 1.75 percent. “The recent softness of U.S. economic data, including an apparent shift toward a more defensive stance by corporations, points to a weaker near-term growth trajectory,” they said in a note to clients.
The third quarter is off to a shaky start. Economists say soft July retail sales imply that consumer spending is growing at an even slower pace this quarter than the first quarter’s subpar 1.6 percent rate. Plus, surprisingly downbeat results for August industrial activity in the New York and Philadelphia Federal Reserve districts suggest new weakness in the manufacturing sector, which up to now has been a leading force in this recovery.
Economic growth below 2 percent is too slow to prevent a renewed rise in the unemployment rate. Economists agree that the job markets are the linchpin of this recovery, and that increased business caution toward hiring would have dire consequences for both consumers and the economy. Already, claims for unemployment insurance have risen significantly in recent weeks, hitting 500,000 for the week of Aug. 14, a nine-month high. In the past, that level has been associated with either stagnant or shrinking payrolls. “This report indicates that the pace of firings and layoffs has increased and is a negative signal for the employment report in two weeks' time,” say economists at Barclays Capital.
With the economy at a crossroads, policymakers are in broad disagreement over what, if anything, needs to be done. Congressional Democrats face mounting obstacles from both Republicans and within their own ranks to new stimulus measures. New proposals are highly unlikely until November elections are over, given concerns about further additions to the deficit. But with growth fading, the economy is bound to become an even hotter political issue in coming months.
That leaves the Federal Reserve in the policy hot seat in the second half. Policymakers appear unusually divided, however, especially on the outlook for 2011, according to the minutes of the June meeting. Plus, the Aug. 10 decision to reinvest the proceeds from maturing mortgage-backed securities into new purchases of Treasury notes — for the purpose of keeping the Fed’s balance sheet at its current high level and long-term rates low — took the markets by surprise. The move, which implies only a modicum of new stimulus, came after several Fed officials had suggested no new actions were needed to support the economy.
In fact, in the past week, three Fed officials each offered a different interpretation of the Fed’s latest action. St. Louis Fed President James Bullard said the decision reflected the downgraded economic outlook. Minneapolis Fed President Narayana Kocherlakota said investors’ concerns that the action reflected a weaker economy were unwarranted. And Kansas City Fed President Thomas Hoenig suggested that the policy committee should not have made the move at all.
Aside from this apparent lack of policy cohesion, some economists are concerned that the Fed’s options are narrowing. Expectations for when the Fed will begin to lift short-term interest rates are starting to slip all the way into 2012. And with long-term rates already historically low, another major round of securities purchases, similar to the trillions in 2009, would likely have less stimulative impact on the economy than last year’s effort. Mortgage rates are already at historic lows with little evidence they are helping the housing market. “Even if the Fed pulls out everything in its arsenal, there is no guarantee that will pull the economy out of its doldrums,” says J.P. Morgan Chase economist Michael Feroli.
Recent trends will undoubtedly fuel the hype about a double-dip recession, deflation, and a Japanese-style lost decade. Post-recession upturns often cool off after inventories are restocked and pent-up demands by consumers and businesses, held back by the recession, are exhausted. If the slowdown in this recovery had followed any ordinary recession, then the risks would probably be a lot lower than they are now. However, this was no ordinary recession, and it required an unconventional and extraordinary policy response. New signs that the recovery is faltering may well justify a return to that kind of thinking.