Tool | May 2013
Kiplinger's Economic Outlooks
Last updated: April 26, 2013
The sprint in growth at the start of the year has turned into a slouch, and gains will remain subpar until late in the year. A sense of uncertainty stemming from higher taxes, ongoing budget uncertainties and questions about the impact of forced government spending cuts is making businesses and consumers cautious, contributing to the third consecutive spring swoon.
But there are sound reasons to expect momentum to rebuild by fall, when improving consumer spending and business investment, along with increased construction activity and a generally better housing market, will add some punch to expansion. There are signs that Congress is feeling pressure to mitigate some of the most threatening aspects of the budget sequestration, which took effect on March 1 and began to bite in April. But it remains unclear whether the country will enter fiscal year 2014, which begins October 1, still under a sequester, requiring another round of spending cuts. The Obama administration wants to replace across-the-board cuts with more selective ones that set specific spending limits and directions for the hundreds of government programs, agencies and departments. But the issue is part of a broader political dispute about how to reduce deficits and handle a new debt-ceiling debate coming this summer. By fall, some of the fog of battle may be lifted, giving businesses more incentive to invest for expansion.
The 2.5% pace of growth (annualized) in the first quarter was a snap back from last year’s closing quarter and will wane in the second and third quarters. Though the pace was somewhat below expectations, even slower expansion -- in the range of 1.5% -- is likely over the spring and summer. Still, it is growth. Inventories were rebuilt at the beginning of 2013, adding to gains over the three-month period. But that will trim the pace of restocking over the summer months. And consumer spending, which held up relatively well early in the year, will be dented by the impact of coming government furloughs. Plus, higher Social Security and other taxes will grind down disposable income as the year wears on.
For all that, there is still durability in the economy -- the housing and automotive sectors will be economic bulwarks this year and next -- that will keep the country out of recession. The pattern will be uneven: a strong start, followed by spring and summer softness, then a pickup by fall, yielding GDP growth for the year as low as 1.75%.
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A significantly brighter jobs picture during April suggests the U.S. expansion is weathering the impact of government budget cuts, higher taxes and deepening recession in Europe, and will keep growing moderately. The fear that taking $85 billion of spending out of the economy on top of higher Social Security taxes might create a rolling downturn has so far not been borne out, as a stronger-than-forecast 165,000 jobs were created in April. Furthermore, job totals for February and March were revised up by a total 114,000 to 332,000 and 138,000, respectively.
But coming growth will be modest, coming mostly from services, while the economy’s industrial side struggles. Manufacturing employment was flat in April and 6,000 construction jobs were lost, a signal that slower global growth is bearing down on production activity. And it calls into question whether job gains at an average 196,000 a month so far this year will be sustained in coming months. Another 11,000 government jobs were shed, on top of 16,000 in March, while the private sector added 176,000 to payrolls in April.
Moreover, the average workweek shortened in April, slipping to 34.4 hours from 34.6 in March, and hinting at slower gains in output ahead. That may be where the federal budget sequestration is most clearly reflected, because many government agencies are making spending cuts by imposing furloughs rather than dropping people from payrolls entirely. Reducing hours of work can be a first step toward head count reductions, but that generally occurs only after some months of shortened workweeks. Meanwhile, average hourly pay edged up four cents to $23.87, a positive development in the face of recent data that suggested consumers are dipping into savings to keep spending.
Businesses seem more willing to add to payrolls than economists had thought, but Washington remains a hurdle for them. Though the April jobs report shows that sequester has not yet slowed hiring, lawmakers aren’t close to agreeing upon a replacement measure for the clumsy, across-the-board spending reductions. Unless they do so, budget cuts of similar percentages for fiscal year 2014 will fall into place on October 1. Cuts for this fiscal year, which ends on September 30, may not have been fully felt yet. In addition, new battles over hiking the debt limit are nearing. The resulting continued uncertainty for businesses will act as a brake on willingness to commit to long-term investments that create more jobs.
Last updated: May 17, 2013
There’s no reason to anticipate an end to the lengthy period of extremely low interest rates anytime soon. The economy regained some momentum in the first three months of this year, growing at a 2.5% rate after a scant 0.4% pace in last year’s fourth quarter, but it’s headed for a softer second and third quarter before picking up the pace late in the year. Any discussion among Federal Reserve policymakers about raising the federal funds rate -- at a historic low between zero and 0.25% since December 2008 -- is far in the future. The Fed has made clear it wants to keep ultra-easy monetary policy in place to try to stimulate faster growth and ratchet down unemployment more swiftly. Before it starts to raise rates -- which may not happen until late 2014 or early 2015 -- the central bank will begin winding down quantitative easing policies that include massive purchases of Treasury and mortgage-backed securities to pump liquidity into the economy. Despite worries among some Federal Open Market Committee members that the central bank may be stoking long-term inflation, the Fed will stick with low rates until it is clear that the economy is on firmer footing and job markets are generating a more reliable hiring pace -- 200,000 jobs a month or more. That means the prime rate will stay at 3.25%.
A modest uptick in long-term rates could occur later in the year. The housing sector is continuing to strengthen, and gains in monthly employment, while not robust, will draw some attention to the possibility for future inflation. That will put some upward pressure on long-term rates. But with U.S. GDP set to grow by only 2% this year, no big hike in rates is coming. Ten-year Treasury notes will reach about 2.25%, up from their current 1.9%, and 30-year mortgage rates will edge up to about 3.75% from 3.4%.
There are some wild cards, most of them government related, that could affect interest rates. Politicians set aside feuding over raising the debt limit earlier this year, but they‘ll soon resume maneuvering over the debt limit and on next year’s spending bills. The statutory debt limit, which has been suspended until May 18, will kick back in on May 19, forcing Treasury to use extraordinary measures to keep the U.S. from defaulting on debts and let it continue to borrow. Now that rising revenues from a slowly but steadily growing economy are creating some breathing room, it’s likely to be September or October before there’s a real threat of default. Still, the last time that dueling political parties threatened to bring the country to a historic default, in 2011, Standard & Poor’s lowered its AAA credit rating on Treasuries. While the move had only a small effect on interest rates, that won’t be the case this time if the remaining two credit agencies, Moody’s and Fitch, lower their ratings. If negotiations over the debt limit and spending deadlock, look for long-term rates to climb by at least half a percentage point. In addition, speculation within the financial markets about when and how the Fed might alter its asset purchase program -- either scaling up buying or tapering it back -- is continuous and intense. Any alteration in purchase size would not necessarily affect rate levels, but it would create more volatility.
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Though prices will edge up a bit later in the year, soft global growth is restraining commodity prices and keeping inflation bottled up. The Consumer Price Index will post about a 2% rise for the full year, a little above the 1.7% registered in 2012, but still well below a level that will trigger interest rate increases. In fact, Federal Reserve officials have registered surprise and a degree of concern that prices so far are running at a level so far under the pace that the central bank considers necessary to support growth and foster hiring and investment. Consumer prices followed up a 0.2% decline in March with a 0.4% decline in April. Both declines were largely because of back-to-back drops in energy costs.
A combination of influences is driving energy prices down: The soft pace of U.S. growth, a cooling in China’s economy and the long-running recession in Europe. That will reverse, at least to a degree, when U.S. growth picks up later in the year and Europe begins to turn the corner, preparing for expansion in 2014. Also later this year, food prices are likely to put some pressure on inflation; they still do not fully reflect the impact of last year’s severe drought. It takes months for the resulting thinning out of animal herds (because producers lack feed for them) to fully show up in reduced supplies and higher prices at supermarkets. So look for pork, beef and dairy products to climb. Restaurants also have been steadily nudging prices up, though there is a limit to how much they can hike menu prices with modest economic growth pinching disposable incomes.
Core inflation, which excludes volatile food and energy products and is closely monitored by the Fed, is muted and will stay that way. Core CPI was up just 0.1% in each of March and April, and it’s unlikely to top 1.2% for the full year. That’s little more than half the 2% rate the Fed targets for core price rises and means the central bank has lots of room to keep adding pump-priming stimulus to the economy. After its last policy-setting meeting at the start of the month, the Fed noted that it might even increase bond buying (part of its quantitative easing policy) before it scales it back. The Fed wants to see the unemployment rate down to 6.5% and inflation running no more than a half percentage point above its 2% target before it raises rates. The soft rate of core price rises shows the Fed is nowhere near its target.
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Look for business fixed investment to firm modestly as the year wears on. But corporate wariness about Washington's inability to get past political infighting over budgets will hold growth this year to about 4%, half the 8% gain posted in 2012. So far this year, the business investment picture has been mixed. Orders in the opening months have been volatile -- down in January, primarily because of declines in defense orders, before rebounding in February on strong aircraft demand and continuing robust new-car sales. Uncertainty about the outcome of government budget battles and the prospect of another political fight over raising the debt limit continues to sap businesses' willingness to commit to expansion, though the overall tone of spending is positive.
Growth will be concentrated in a few key areas, however: information and technology, as companies seek to boost output without adding to payrolls. Equipment for drilling and exploration of oil and gas. Sophisticated machine tools, as manufacturing expands. Plus machinery for the thriving auto industry, to make everything from batteries to dashboard electronics. And equipment to meet rising demand from homebuilders -- earthmovers, power tools, etc. Lowe's, for example, is planning to open 10 additional stores.
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Headed for the highway this Memorial Day weekend? You’ll be happy to know that gasoline prices will behave for the most part. After a slow, steady rise in recent weeks, the national average price of regular unleaded figures to stick close to today's $3.66 per gallon, and may even retreat a cent or two. One exception: the Midwest, where refinery problems have brought about steeper price increases that figure to linger through the long weekend.
Truckers will see fairly steady prices for diesel, with little change from the current average of $3.89 per gallon. We see diesel hitting about $3.95 by the time summer begins next month.
A small decline for crude oil should help keep a lid on motor fuel prices for now. At about $94 per barrel, West Texas Intermediate, the U.S. benchmark for crude, has eased slightly from a week ago after a strong spring rally. Odds are, crude will hover near $95 in coming days: high enough to support gasoline prices at their current levels but not high enough to instigate further increases.
Weak demand for natural gas figures to spark a price pullback in the near term, on the heels of the recent rise from $3.90 per million British thermal units to about $4.20. The increase is a response to Uncle Sam’s approval of a new terminal on the Gulf Coast. The terminal will export liquefied natural gas to overseas markets, bringing about new markets and demand for America’s growing gas supplies. But note that the exports won’t start flowing for several years.
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Gains in the housing market will solidify this year, adding to the industry's strong 2013 start. That's especially good news, as it will help make up for softer government spending and export growth, which had been the stalwarts of the economic recovery. Look for housing to add at least half a percentage point to GDP this year, with all the major indicators of growth rising. It'll be just the second year since 2005 that all measurements see positive gains, although growth will be unevenly distributed across states, which are in different stages of recovery.
Overall, we anticipate sales of existing homes to climb about 7.5% from last year's 4.65 million -- the first time in five years that sales will reach the 5-million mark, with somewhat stronger growth in the second half than in the first. With inventory unusually tight, the pace of existing home sales climbed 0.6%, from an annualized rate of 4.94 million in March to 4.97 million in April, the highest rate since November 2009. Growth of new-home sales, which climbed 20% last year, will accelerate to about 36% in 2013, with about 500,000 new homes purchased.
In April, housing inventory jumped 12 percent to 2.16 million. That’s 5.2 months' worth of sales, up from 4.7 months’ worth in March. Even with two consecutive months of increase, supplies are still below the six-month level, which is considered a healthy mix of supply and demand. In some areas, the shortage of inventory is significant, leading to multiple bids from buyers and faster-than-expected price growth. Although inventories will rebound as the spring listing season marches on, the tighter supply is spurring quick sales in high-demand regions, such as California and Arizona. Other areas, like New York and Florida, still face a glut.
Construction of at least 950,000 new homes will begin in 2013, a 22% jump over last year's 780,000 starts. As builder confidence grows and inventory remains tight, look for the pace of starts to climb. Housing starts reached an annualized pace of 853,000 in April, a nearly 17 percent decline from March’s pace, which topped 1 million. While starts saw a significant drop, housing permits soared to an annualized pace of 1.02 million in April, 35 percent higher than March’s pace of 890,000. Permits remained higher than sales, an indicator that home sales will continue to pick up in the next few months. Though less than last year's 28% increase, the 2013 annual gain will be the fourth in a row for housing starts.
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Though retail sales are far from sizzling, they show enough resilience to push back fears about the kind of sustained pullback in consumer spending that would choke off growth. For the full year 2013, a gain in the 4% to 4.5% range seems likely, especially in view of forecasts for new-car sales to climb about 5% to 15.3 million units. While that’s less than last year’s overall 5.2% growth, prospects for an acceleration in 2014 are good. By then, consumers will have adapted to tax policy changes made this year, and improved monthly job creation will add more reliably to disposable incomes.
Meanwhile, the slim 0.1% rise in April sales -- in the face of expectations for a second straight monthly decline -- showed consumers still willing to spend in the face of fiscal headwinds ranging from higher Social Security taxes to federal budget sequestration. Stronger new-car sales helped, but gains also were posted for a range of other products, from building materials to department store goods. That points to some carryover of demand from the first quarter of the year. Cheaper gasoline prices at the pump, which led to a lower April sales total, may reverse during the busier spring and summer driving season. Excluding autos, which account for about one-fifth of monthly business, April retail sales fell 0.1%.
Second-quarter sales will be constrained by slow growth in personal income that’s likely to carry into fall, before a more vigorous sales pace appears. Take-home pay remains under pressure and there are recent signs that consumers are growing more cautious about incurring credit card debt to sustain their spending. Looking ahead to the second part of the year, recent pickups in the monthly rate of new job creation, together with rising home prices and stock market gains, should encourage spending. It will be a lagged benefit, however, because other concerns, such as uncertainty about lawmakers’ plans for raising the debt limit and dealing with long-term deficits, continue to create caution about longer-term commitments.
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The U.S. trade deficit will expand modestly this year, by about 2%, as stronger second-half growth fuels more demand for imported goods. But that will follow a choppy first half, as the economy adjusts to a spring and summer lull that temporarily dampens consumers’ appetites for foreign-made goods at the same time that some key overseas markets are in recession. The pattern began to emerge in March, as a sharp drop in imports helped shrink the monthly deficit by 11% to $38.8 billion from February’s $43.6 billion. Consumer goods imports dropped by $3.4 billion, with other key categories posting similar sharp falls. Capital goods imports fell by $1.5 billion and auto imports were down $771 million — all signs of a slower pace of economic activity, which will last until late fall.
Exports are being restrained by recession in Europe, a condition unlikely to change anytime soon, and by more moderate growth in China. For the full year, it will be a struggle to match the 4% increase in exports posted during 2012. Exports dipped 0.9 percent or $1.7 billion in March and a slowing global economy plus some recent strengthening in the U.S. dollar (up about 1.5% on a trade-weighted basis to date this year) highlight the uphill nature of the bid to raise foreign sales. Some factors affecting exports may be temporary, however. For example, food exports dropped 7.4% in March, largely because of fewer soybeans exports. Last year’s drought sapped soybean supplies and sent prices higher. The deficit with China fell to $17.9 billion in March, its lowest level in three years, though that was largely because of a slump in consumer imports that is expected to reverse late in the year, when our economy regains momentum. China remains an attractive market for exports of U.S.-made goods, with growth forecast at 8% this year and 8.2% in 2014. Though that’s scaled back from earlier projections, it’s still robust compared with gains in most of the rest of the world.
Imports will pick up steam as the year goes on, likely registering a 5% rise. The growth will come in the second half, when consumers’ anxiety, stemming from fiscal concerns and tax hikes at the start of the year, has relaxed. Some of the caution, which weighs on spending, should ease later in the year and make consumers more confident about opening their purses. But for now, domestic demand is sluggish. Imports slumped by 2.8%, or $6.5 billion, in March; imports from China, a main source of imported consumer goods, were down by a double-digit margin. Some changes in import patterns, such as the $1.4-billion drop in imported petroleum products during March, may be long-term structural adjustments. The oil import decline reflects not only lower prices but also a growing U.S. self-sufficiency in oil production.