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International Investing

Weekly Economic Commentary
Northern Trust
By Carl Tannenbaum, Asha Bangalore, Victoria Marklew
November 9, 2012

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  • Hurricane Sandy will impact the pattern of upcoming data, but is not likely to have a lasting economic impact.
  • Our updated forecast anticipates some movement on the “fiscal cliff.”
  • France may be part of Europe’s problem, not a source of Europe’s solutions.

The human and physical costs of superstorm Sandy are enormous, with New York and New Jersey taking the biggest hit. According to estimates of the private sector (Equecat), Sandy is running up a tab of between $30 billion and $50 billion. Based on the high end of this estimate, Hurricane Sandy places third in the National Hurricane Center’s list of the costliest US storms in the post-war period. Hurricane Katrina is at the top of the list (2005, $108 billion damage and 0.86% of GDP), with Hurricane Andrew (1992, $26.5 billion and 0.42% of GDP) second.

The economic impact of natural disasters is the net of lost short-term business activity and the eventual rebuilding of damaged areas. The immediate impact will be visible and large in high frequency economic data such as jobless claims, payroll employment, retail sales, and industrial production. The behavior of these economic indicators after Hurricane Katrina and Hurricane Rita is a handy guide to the likely nature of these reports this time around.

Weekly Economic Commentary 11/09/12 Chart 1

Payroll employment plunged and jobless claims shot up in September 2005, while industrial production and retail sales also reflected the adverse impact of the hurricanes. Given the late-October occurrence of Hurricane Sandy, a large part of the setbacks will be in visible in economic reports of November.

Traces of Sandy will be small in the fourth quarter GDP numbers because GDP captures current production of goods and services and loss of equipment and structures built previously are not included. Having said that, loss of business activity in terms of a reduction in retail sales, construction activity, and industrial production will be reflected as a small reduction to fourth quarter growth from the projections made prior to the storm.

Rebuilding activity will be captured in economic data over an extended period of time. The pace of economic activity in the first quarter should be slightly better than previously predicted, but a massive pickup in economic activity is not likely. Also, it should be noted that the public budgets which will be asked to meet the demands of reconstruction do not have a lot of slack. Some rearrangement of spending, as opposed to an increase of existing budgets, is the likely course.

Finally, the storm highlighted the vulnerability of our nation’s infrastructure. The loss of power caused a two-day closure of the New York Stock Exchange and significant hardship for scores of families. It underscored our dependence on automated platforms for a host of basic services; these platforms are vulnerable to natural threats like Sandy and man-made threats like a computer virus. Even in a challenging budgetary environment, investing in our infrastructure could produce important returns.

Factoring in the Fiscal Cliff

Post elections, financial markets are on the watch for a resolution of fiscal cliff. Early remarks from leaders on both sides suggest a conciliatory tone and a willingness to negotiate in order to prevent a large reduction in government spending and a significant tax hike. The pressure they face is substantial, as nervous post-election trading suggests high anxiety on the part of investors. Our pre-election comment of November 1 outlines the issues that are at stake.

Our expectation remains that the worst case will not come to pass, and that the cliff will be softened to a slope sometime in the next six to eight weeks. Still, it is unlikely that all of the spending cuts and tax increases will be reversed, and we’ve reflected that in a forecast for a somewhat softer first quarter of 2013.

We have tweaked our forecast of fourth quarter GDP to account for Sandy and to reverse some non-recurring increases seen in the third quarter. As a result of these changes, we expect fourth quarter real GDP to advance at a 1.5% annual pace, representing a slowing from the third quarter.

US Economic Outlook

Weekly Economic Commentary 11/09/12 Chart 2

Key elements of the current forecast include:

  • Consumer spending is projected to have grown only 1.5% in the final three months of the year, a slowing that is partly related to the storm. Incoming household sector data on employment, sales, housing starts, and home prices point to improvements that will make a positive contribution to fourth quarter real GDP growth.
  • Business spending is estimated to have advanced at a tepid pace, as firms continue to hold back as fiscal policy discussions continue.
  • Net exports should post a small widening as exports are held back by soft economic conditions abroad.
  • The Federal Reserve will not waiver from its current course. The President’s re-election makes it much less likely that a change in philosophy is at hand.

Economic developments in Europe and China will have an important bearing on the growth path of the US economy. We continue to assume orderly resolutions of present challenges in both markets, but the risk of disorder remains.

Is French “exceptionalism” getting old?

Earlier this week the European Commission released its economic outlook for the 17-member Euro-zone. Most of the forecasts were in line with expectations but the analysis on France was notable for the extent to which it took issue with that government’s own predictions. Successive French administrations have argued for their country’s “exceptionalism” but in the new global climate of anxiety about jobs and deficits, the argument is losing its luster.

President François Hollande was elected in May on a platform of growth and job creation. On November 6 his government unveiled a series of measures designed to boost competitiveness. The key was the introduction of corporate tax credits indexed to a company’s total wage bill. The government says that this is a first step in reducing France’s infamously-high labor costs and will amount to a €20 billion “reward” for companies that keep jobs in France. The scheme will be paid for by a small hike in the value-added-tax (VAT) rate and by unspecified public spending cuts – both delayed until 2014.

Critics have derided the tax credit plan as overly-complicated compared with the direct payroll tax cuts sought the main business lobby. The plan does, however, mark a milestone in that the government has acknowledged that France has a competitiveness problem and that labor costs are too high.

The government’s 2013 budget, unveiled back in September, called for tax hikes on the wealthy and a freeze on public spending to reduce the general budget deficit from the 4.5% of GDP expected this year to 3.0%. This week, the European Commission forecast that not only will the deficit forecast be missed – predicting a shortfall nearer 3.5% next year – but also that the budget will undermine economic growth. The EU’s executive arm predicted that real GDP in the Euro-zone’s second-largest economy will come in at just 0.4% in 2013, not the 0.8% forecast by the government, held back by tax hikes that will weigh on consumer spending and on employment.

Job creation is a key issue for the French electorate but without the kinds of structural reforms that voters oppose, the various schemes unveiled by successive governments are just tinkering around the edges of the problem. France suffers from a rigid two-tier labor market. On the one hand, an elite of protected workers is covered by a complex and restrictive Labor Code that includes heavy wage regulation and high social security costs for employers. On the other, there are very high levels of structural unemployment among the young and ethnic minorities. Even during years of relatively-strong GDP growth, the unemployment rate remained among the highest in the EU – on the EU-harmonized ILO-based definition, the (seasonally-adjusted) jobless rate has been above 7% since 1983. Although it dropped markedly in the first half of 2008, this was more the result of an increase in government-subsidized labor schemes than a reflection of an actual increase in jobs in the private sector.

Weekly Economic Commentary 11/09/12 Chart 3


This debate about policy is particularly important not just because France is the second-largest economy in the Euro-zone, but also because analysts are starting to wonder how much longer the sovereign’s borrowing costs will remain at record lows. Aside from a brief spike upward in mid-2011, French ten-year bond yields in the secondary market have moved more-or-less in lock step with Germany’s over the past year. Any decoupling could prove very damaging to the French national budget.

The French economy stalled in the first half of 2012 and will likely contract in the second half and into 2013. Consumers are increasingly uneasy, and unemployment is at its highest since the first quarter of 1999. Ministers are openly disagreeing with their government and with each other about the best way forward. None of this sounds like a recipe for record-low bond yields.

European policy makers are already fighting problems on a number of fronts. Up until this point, France has not been one of them. But if France goes from being part of the solution to part of the problem, the quest for stability in Europe will become even more challenging.

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.


(c) Northern Trust


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