US Economics AnalystIssue No: 10/48December 3, 2010 FOR THOSE PERMISSIONED: Goldman Sachs Global ECS Research at https://360.gs.com A Road Map for Transition to Above-Trend Growth Earlier this week we upgraded our US growth The Private Sector Surplus outlook for 2011 and extended it into 2012. Starts to Shrink The growth rates we now expect—2.7% (vs. Percent of GDP Percent of GDP 2.0% previously) for 2011 and 3.6% for 10 10Jan Hatzius 2012—put us slightly above the consensus for 8 firstname.lastname@example.org 2011 and probably more clearly above the yet-212 902 0394 6 6 to-be-published consensus for 2012. 4 4Ed McKelvey The revision reflects the accumulation email@example.com evidence that the underlying pace of demand 2 2212 902 3393 has strengthened despite fiscal restraint and an 0 0 incipient turn in the inventory cycle. RelativeAlec Phillipsalec.firstname.lastname@example.org to the road map we laid out in early -2 -2202 637 3746 September, US factory output has held up in -4 Private Sector Financial Balance* -4 the face of the inventory correction, the laborSven Jari Stehn market has generally been firmer (though not -6 60 65 70 75 80 85 90 95 00 05 10 -email@example.com in November), and consumer spending has * Incom e less spending, households and businesses. Dotted line denotes forecast.212 357 6224 been stronger. We take this as evidence that Source: Department of Commerce. the private-sector surplus has started to shrink.Andrew Tilton High Unemployment Prevents firstname.lastname@example.org With a new forecast comes a new road map. Increase in Core Inflation212 357 2619 Its landscape has five main features : (1) solid, 5 if unspectacular, growth in consumption, (2) Change in Core PCE Inflation Over Next 2 YearsDavid Kelley moderate gains in industrial activity, (3) only 4 Annual Data, Unemployment > email@example.com anemic recovery in housing, (4) more 3 8% has meant212 902 3053 declining inflation improvement in the labor market, though with for at least the (percentage points) 2 next 2 years. only a modest drop in unemployment, and (5)Maria Acosta-Cruzmaria.firstname.lastname@example.org persistently low core inflation. 1 0212 902 6709 On these last two points, the history of unemployment and core inflation is clear: -1 since at least the late 1950s (when the data -2 begin), core inflation has never risen in the two -3 years following a year in which the jobless rate exceeded 8%. With core inflation already well -4 3 4 5 6 7 8 9 10 11 below the Fed’s “mandate-consistent” level of Unemployment Rate just under 2%, it is hard to justify expectations Source: Department of Labor. Department of Commerce. of rate hikes anytime in the next two years. Today’s labor market report for November was a disappointment with no silver linings. Payrolls rose much less than anyone expected, and the jobless rate ticked up. That said, other labor market indicators—claims and the ISM’s nonmanufacturing employment index to name a couple—point to gradual improvement. Important disclosures appear at the back of this document.
GS Global ECS US Research US Economics AnalystI. A Road Map for Transition to Above-Trend GrowthThe US growth outlook has brightened significantly inrecent weeks. As a result, earlier this week we Exhibit 1: The Private Sector Surplusupgraded our US outlook for 2011 and extended it Starts to Shrinkinto 2012.1 In summary, we expect: Percent of GDP Percent of GDP 10 101. Stronger growth. We now think real GDP 8 8 growth will remain at last quarter’s 2.5% annual rate through early 2011 and then increase over the 6 6 following year to a 4% annual rate. On an annual average basis, this implies growth of 2.7% in 4 4 2011, versus 2.0% previously, and 3.6% in 2012. 2 2 These figures put us slightly above consensus in 2011 and probably more clearly above it in 2012. 0 02. Slowly declining unemployment. Assuming a -2 -2 2½% potential growth rate, our outlook for real Private Sector -4 Financial Balance* -4 GDP implies that the jobless rate will fall, but only to about 8½% by year-end 2012. Most of -6 -6 this decline occurs in 2012; over the four quarters 60 65 70 75 80 85 90 95 00 05 10 of 2011 we expect only a modest reduction, to * Income less spending, households and businesses. Dotted line denotes forecast. Source: Department of Commerce. about 9¼%.3. Low core inflation. Although we expect growth This view turned out to be correct. Between mid-2006 to rise materially above its potential rate over the and mid-2009, the private-sector balance rose sharply, next two years, the US economy will still be as shown in Exhibit 1. This 12.5-point move—the operating with considerable slack throughout the largest in at least 60 years—triggered the deepest period. Therefore, core inflation should remain recession in post World War II US history. low—as measured by either CPI or PCE prices— at about ½% (year-to-year) through 2012. In 2009, the private-sector surplus began to shrink. However, we maintained a below-consensus view,4. Highly accommodative monetary policy. Faced predicting that real GDP growth would slow to a with high unemployment and low core inflation below-trend pace during 2010. We reasoned that the throughout the forecast period, Fed officials are incipient reversal in the private-sector balance and the highly unlikely to raise interest rates in 2011 and, upswing in GDP it produced were due to temporary we think, also in 2012. The outlook for asset factors—namely, the fiscal stimulus enacted in purchases (LSAPs) is less clear in light of the February 2009 and the positive inventory cycle, which pick-up in growth and the backlash against the probably would not have kicked in without the strong renewal of such purchases. On balance, we growth support from fiscal (and monetary) stimulus. expect more LSAPs, but cumulating only to $1trn With underlying final demand—i.e., the growth in (versus $2trn previously), and we are not very GDP less the fiscal and inventory effects—still confident of this call. stagnant, we thought the US economy would slow during 2010, as indeed it did.A Slower Pace of Private-Sector DeleveragingOver the past five years, we have been quite So why do we now expect growth to pick up? Wepessimistic about the US economic outlook. This was think that the pace of private-sector deleveraging isbecause we expected downturns in the housing and slowing in an environment of somewhat lowermortgage markets to trigger a substantial increase in debt/income ratios, improving credit quality, andthe private sector financial balance—the gap between moderating lending standards. In turn, the rise inthe total income and total spending of US households spending relative to income is starting to generateand businesses. In turn, we thought this weakening in positive multiplier effects via a stronger labor market,private-sector demand would cause growth to slow as and this is feeding back into stronger income growth.the government and foreign sectors failed to take upthe slack.1 See “A Brighter US Economic Outlook,” US Daily Comment, December 1, 2010.Issue No: 10/48 2 December 3, 2010
GS Global ECS US Research US Economics AnalystUpside Surprises in the Recent Data Flow CPI and the PCE measures of core inflation haveConsistent with this view, the data flow has improved fallen to their lowest year-to-year rates on recordnoticeably during the last few months, both relative to (since the late 1950s).our expectations and to those of forecasters in general.The surprises relative to consensus show up clearly in A Road Map for 2011our US-MAP readings, which have generally swung to With a new forecast comes a new road map. Whilethe positive side in recent weeks. Relative to the road we continue to focus mainly on the next six monthsmap we published in early September, the data have (think of this as the first half of 2011), we have alsosurprised us to the upside in three key sectors:2 provided guidance for the second half. The details are provided in the table at the end of this article, on page1. Manufacturing output has held up much better 5. The landscape has the following main features: than we had anticipated. As the inventory cycle appeared to be nearing an end, we expected a near 1. Solid, if unspectacular, growth in consumption. hiatus in industrial activity during the second half We expect real consumer spending to grow at a of 2010, with the ISM index projected to fall 2½% annual rate during most of 2011—slightly below 50 by early next year. This is clearly not less than the recent pace—before reaccelerating to where the factory sector is headed, as orders and a 3% rate in the fourth quarter. The slower pace factory output have also been much stronger than reflects our expectation of modest fiscal restraint we anticipated. We think the explanation lies in (even with tax cut extensions), rising oil prices, the close link between inventory accumulation and an upward trend in mortgage rates. It implies and imports of goods.3 If so, then the inventory monthly gains of only about 0.2%, on average, correction, which has also come a bit later than until late next year. Vehicle sales will probably we thought likely, will have a disproportionate continue to crawl slowly higher, to a 12½ million- effect on foreign rather than domestic production. unit rate at mid-2011 and a 13 million rate at year- end, as shown in Exhibit 2. The implication for2. So has the labor market. Although initial claims (nominal) nonauto retail sales is for average for jobless benefits have been in the 425,000-to- monthly gains of 0.4%-0.5% and 0.5% in the first 475,000 range of the September 2010 road map, and second halves of 2011, respectively. they have developed a clearer downward trend Confidence indexes, which have remained at than we thought likely. Nonfarm payrolls and the fairly low levels despite the pickup in jobless rate were both weaker than we expected in consumption growth, are apt to trend slowly November, but in general both of these indicators higher throughout the year. have surprised to the high side in recent months. 2. Moderate gains in industrial activity. Although3. Consumer spending has been firmer as well. manufacturing output and the ISM’s index for that Real personal consumption rose 2.9% at an annual sector have outrun our expectations, we continue rate in the third quarter, and it is tracking into the to look for moderation in the near term. The main fourth quarter at about the same rate. This is almost twice as fast as we expected three months ago, probably at least in part because the labor Exhibit 2: Spending Indicators Should market was not as weak as we expected. The Improve Gradually surprises showed up in both unit auto sales and Millions of units Average monthly change, in percent core retail sales. 20 1.00 0.75In two other areas, however, the data have fallen short 18of our below-consensus expectations. First, the 0.50housing market has been even weaker than we had 16anticipated. Home sales and starts have declined since 0.25September, and house prices have fallen more quickly. 14 0.00The pace of disinflation more generally has also beeneven more pronounced than we had anticipated in -0.25 12recent months. While headline figures have runsomewhat higher, due to strong energy prices, both the -0.50 10 Auto Sales (lef t) -0.752 See “A Road Map for Sluggish Growth,” US Daily Core Retail Sales (right) Comment, September 9, 2010. 8 -1.003 See “Can the Import Surge be Explained by the 00 02 04 06 08 10 Inventory Cycle?” US Daily Comment, November 11, Note: Dotted lines denote forecasts. 2010. Source: Department of Commerce. Autodata Corporation.Issue No: 10/48 3 December 3, 2010
GS Global ECS US Research US Economics Analyst Exhibit 3: Look for Sturdy Gains in the Exhibit 5: Expect Gradual Healing in the Industrial Sector Labor Market Percent change, quarter ago Index Thousands Thousands 15 65 400 250 300 10 60 200 350 5 55 400 0 0 450 50 -200 500 -5 550 45 -400 -10 600 Industrial production (lef t) 40 Payrolls (ex Census, lef t) 650 -15 -600 ISM (right) Payrolls (GS Fcast, lef t) 700 -20 35 Initial Claims (right, inverted) 00 02 04 06 08 10 -800 750 00 01 02 03 04 05 06 07 08 09 10 11 Note: Dotted line denotes f orecast. Source: Institute for Supply Management. Federal Reserve Board. Source: Department of Labor. Exhibit 4: Existing Home Sales Should Exhibit 6: High Unemployment Prevents an Dominate the Real Estate Market Increase in Core Inflation Millions of units Millions of units 5 7.5 1.5 Change in Core PCE Inf lation Over Next 2 Years 4 Annual Data, 1960-2007 Unemployment > 3 8% has meant 6.0 1.2 declining inflation for at least the (percentage points) 2 next 2 years. 4.5 0.9 1 0 3.0 0.6 -1 -2 1.5 0.3 Existing Home Sales (left) -3 New Home Sales (right) 0.0 0.0 -4 00 02 04 06 08 10 3 4 5 6 7 8 9 10 11 Note: Dotted lines denote forecasts. Unemployment Rate Source: Department of Commerce. National Association of Realtors. Source: Department of Labor. Department of Commerce. reason is our analysis of the inventory cycle, ownership more affordable, the large overhang of which is either over or moving into a phase of vacant existing units is apt to absorb most of any unintended and/or unsustainable accumulation. increase in demand that develops as the economy Even though foreign producers are apt to shoulder and the labor market improve. This dominance of a disproportionate share of the correction in this existing home sales in the market for residential imbalance, some slowing in US factory output is real estate is already evident in the fact that they already evident. In the first half of 2011, we look fell only about one-third as much as sales of new for gains in the manufacturing component of the homes during the slump in this sector, as shown in industrial production index to average ¼% per Exhibit 4. (The axes in this exhibit are scaled to a month, with slightly larger increases in the second 5:1 ratio, which approximates the traditional and half. In turn, this implies that the manufacturing remarkably stable relationship between sales of ISM index could dip in the near term and then existing and new homes; lately this ratio has risen fluctuate around 55, as shown in Exhibit 3. nearly to 15:1.) Thus, we expect new home sales to edge up only gradually, to an annual rate of3. Anemic recovery in housing. Although lower about 350,000 by mid-2010 and 400,000 by year- home prices and mortgage rates have made home end, while sales of existing homes recover toIssue No: 10/48 4 December 3, 2010
GS Global ECS US Research US Economics AnalystA Road Map for Transition to Above-Trend Growth Sector/Variable Mileposts for 11Q1/11Q2 Mileposts for 11Q3/11Q4Consumer spending and confidence: Real consumer spending (%ch/mo) Average +0.2%/mo Average +0.2%/mo Auto sales (millions of units, annualized) Average 12½ million in Q2 Average 13 million in Q4 Nonauto retail sales (%ch/mo) Average +0.45%/mo Average +0.5%/mo Reuters/Michigan sentiment (index, 1966=100) Increase to around 75 Increase further to around 80 Conf. Board confidence (index, 1985=100) Increase to around 60 Increase further to around 65Manufacturing: Durable goods orders -- total (%ch/mo) Average +0.6%/mo Average +0.7%/mo ISM manufacturing index (index) Dip to 55 or a bit less Fluctuate around 55 Industrial production, mfg. (%ch/mo) Average +0.25%/mo Average +0.3%/moHousing and construction: New home sales (annual rate, thousands) Rise to 350k in Q2 Rise to 400k in Q4 Existing home sales (annual rate, millions) Rise to 5.5 million in Q2 Rise to 6.25 million in Q4 Housing starts (annual rate, thousands) Rise to 610k in Q2 (500k 1-family) Rise to 680k in Q2 (550k 1-family) Construction outlays (%ch/mo) Total flat, residential +0.5%/mo Total 0.4%/mo, residential +1%/moLabor market: Initial jobless claims (thousands/week) Fluctuate in 400-425k range Fluctuate in 375-400k range Nonfarm payrolls (net change, thous/mo)** Rise 100k-125k/mo. Rise 150k-175k/mo. Unemployment rate (% of labor force) 9.5% at end of Q2 9.3% at end of Q4Inflation: Headline CPI (%ch/mo) Average +0.1%/mo Average +0.07%/mo Core CPI (%ch/mo) Average +0.06%/mo Average +0.03%/mo Core PCE (%ch/mo) Average +0.06%/mo Average +0.03%/moSource: Our calculations. about a 6-million-unit rate over the same period. 5. Persistently low core inflation. Even as growth Because housing starts follow new home sales, picks up during 2011, the huge amount of excess they are unlikely to break 700,000 (annual rate) capacity in the US economy should push core before 2012, and gains in residential construction inflation down a bit further over the next year outlays will likewise remain modest. and—more importantly in terms of understanding our view on monetary policy—keep it from rising4. More improvement in the labor market. While anytime soon. As shown in Exhibit 6, since the the jobs report for November was disappointing, late 1950s the core inflation rate has never risen in general US firms are hiring more workers. over a two-year period when the unemployment This is suggested by the decline in initial claims rate was 8% or higher at the beginning of that for jobless insurance—the most reliable leading period (shaded area of the exhibit). We expect indicator of labor market activity. Accordingly, core inflation by either measure (CPI or PCE) to we expect nonfarm payrolls to return to a range of settle at ½% annual rate over the next year. This 100,000 to 125,000 per month during the first half translates to average monthly changes of just of 2011 and to pick up to a 150,000-175,000 pace 0.06% in the first half of 2011 and 0.03% in the during the second half. Meanwhile, claims should second. But rising energy and food prices are apt settle into a 400,000-425,000 range in the first to keep the headline rate a bit higher—about 0.1% half and only break through 400,000 (on a per month. sustained basis) later in the year, as shown in Exhibit 5, on page 4. Ed McKelvey Sven Jari StehnIssue No: 10/48 5 December 3, 2010
GS Global ECS US Research US Economics AnalystII. Forecast Highlights1. Real GDP accelerates from the current 2½% scope of this forecast—we are also confident that thegrowth trend, reaching 4% by mid-2012. We FOMC will complete the $600bn in LSAPs to which itestimate that real GDP is tracking into the fourth is already committed. However, noticeable headwayquarter of 2010 at a 2½% annual rate despite a swing on the unemployment front could test Fed officials’toward fiscal restraint and reduced inventory building. willingness to extend these purchases, especiallyThis implies that the underlying trend of US economic given the backlash that has greeted this program.activity has picked up substantially, suggesting in turnthat some of the headwinds to growth that previously 5. Market rates move up as persistent inflationconcerned us have started to ease. We’re particularly worries feed expectations of Fed tightening. Asencouraged by evidence of the gradual if uneven strong growth in global economic activity keepsimprovement in labor market conditions and in credit commodity prices under upward pressure, manyquality. On an annual average basis, we expect real participants in the financial markets will anticipate anGDP to rise 2.7% in 2011 and 3.6% in 2012. These earlier pickup in US (core) inflation that is consistentfigures are slightly above the latest Blue Chip median with either our outlook or that of most Fed officials.for 2011, and—we think—more clearly above the This is especially likely if the dollar also depreciates,2012 median, to be published early next month. as we expect it will, or if bank loans start to grow. In turn, these inflation fears will feed expectations that2. Unemployment drifts down gradually, to 9¼% tightening in US monetary policy is just around theby year-end 2011 and 8½% by year-end 2012. This corner. While we disagree with that view, we expectpart of our forecast rests on a two fairly conservative market rates to rise in response, with increases tiltedassumptions: (a) potential growth is currently about toward the short end of the curve, where changes in2½%, lower than we previously have thought to allow market expectations of monetary policy matter more.for the likelihood that reductions in capital spendinghave put a short-term dent in the productivity trend, The Data Turn Slightly Squishyand (b) workers who have been discouraged from It had to be: in a week when we upgraded our forecast,active job search by the lack of openings will either the data have been somewhat soft. The two biggies—stay on the sidelines (our baseline assumption) or find the Institute for Supply Management’s (ISM’s) indexjobs quickly. If either of these assumptions is wrong,then the jobless rate could remain even stickier than of manufacturing and the employment report—were both weaker than expected in November. In the casewe now project. However, in the latter instance this of the ISM index, the devil was in the details; whilewould be “good news” in the sense that the reentry of the headline index was in line with the consensus anddiscouraged workers would presumably reflect a only a tad lower than we expected, the indexes of newperception of improved job availability. orders and production fell several points apiece. With3. Core inflation falls a bit further, to about ½%. the inventories index also up, the gap between this index and the one for new orders closed. Taken atMost measures of resource availability (the official face value, this suggests that growth in industrialjobless rate and its many cousins, capacity utilization output will weaken in coming months.in the factory sector, and residential and nonresidentialvacancy rates, to name a few) show an unusually large In the labor market, the warts were there for all to see,amount of excess productive capacity in the USeconomy. Accordingly, we continue to think that the and without much compensating good news under the surface. Nonfarm establishments added only 39,000bias in core inflation is to the low side, with workers to their payrolls (50,000 if you count just theexpectations the main bulwark against an outright private sector), and the jobless rate rose to 9.8%.decline. As long as the jobless rate exceeds 8%, wesee little, if any, prospect of a sustained pickup in core Forecasters dismiss data at their peril, but there areinflation over the succeeding two years. good reasons not to worry. Beyond the usual “one data point does not make a trend,” we note that some4. Monetary policy remains highly accommodative, weakening in industrial output is probably in order towith a probable extension of large-scale asset bring inventory accumulation under control. As forpurchases (LSAPs) and no rate hikes before 2013. the labor market, the disappointment follows a biggerWe are more confident of the latter expectation than upside surprise for October, and other data—claimsthe former, as our forecasts for unemployment andcore inflation still imply a negative “optimal” federal and the employment index from the ISM report for the nonmanufacturing sector—continue to improve. Sofunds rate under any realistic assumption about the not to worry—pay attention to the data, but don’t let astance of fiscal policy. Absent a major upside surprise report or two derail the forecast.in the data on economic activity—one well outside theIssue No: 10/48 6 December 3, 2010
US Calendar Focus for the Week Ahead ■ In a data-light week, the premier indicator is the trade balance. We expect further narrowing in the deficit as the correction in inventory accumulation now underway reduces imports (December 10). ■ Today’s disappointing report on labor market conditions in November adds importance to the weekly data on unemployment claims, which lately have shown a tendency to decline (December 9). Economic Releases and Other Events Time Estimate Date (EST) Indicator GS Consensus Last Report Sun Dec 5 19:00 Bernanke spks on economy on CBS 60 Minutes Mon Dec 6 13:00 Richmond Fed Pres Lacker spks at Chamber of Commerce Tue Dec 7 15:00 Consumer Credit (Oct) n.a. -$1.0bn +$2.1bn Thu Dec 9 8:30 Initial Jobless Claims n.a. 425,000 436,000 8:30 Continuing Claims n.a. 4,240,000 4,270,000 10:00 Wholesale Inventories (Oct) n.a. +0.9% +1.5% Fri Dec 10 8:30 Trade Balance (Oct) -$40.5bn -$43.8bn -$44.0bn 8:30 Import & Export Prices (Nov) n.a. +0.8% +0.9% 9:00 Fomr Fed Chairman Volcker spks on panel on history of Fed 9:55 Reuters/U. Mich Consumer Sentiment—Prel (Dec) n.a. 72.5 71.6 14:00 Federal Budget Balance (Nov) n.a. -$132.0bn -$120.3bnIssue No: 10/48 8 December 3, 2010