Liz Ann Sonders on the US Economic Recovery
There is a key release of unemployment data coming this week, which will be known by the time we publish this. I believe youve said that you expect approximately 200,000 jobs to be created. [Ed. Note: On April 2, the BLS announced that non-farm payrolls increased by 162,000.]
I dont publish forecast job forecasts. If I mentioned a number, it was the consensus.
The consensus is around 200,000 but the range around that is huge. There are estimates as high as 400,000 with most economists believing the risk to the consensus being to the upside not the downside.
The whisper numbers are going higher, which is not necessarily a good thing, because then the bar gets set higher and higher.
We had the ADP numbers out today, which were weaker than what people were hoping for. Sometimes it tends to be a fairly good indicator of what the BLS jobs report will be; other times it totally misses. I dont generally put a lot of weight on that number as a guidepost for what this Fridays numbers are going to be.
Bigger picture, do you expect this to be a jobless or a jobful recovery?
Somewhere in between. If you look at the decline in initial unemployment claims, which is the key leading indicator for jobs growth, and if you take the four-week average, which is the common way it is measured, claims are down about 200,000 from the peak. If you compare that pace and that decline to the last two recoveries, which were the so-called jobless recoveries, after the 1991 and 2001 recessions; and you also compare it to the recovery prior to that, which was the 1983 recovery that came after the back-to-back recessions in the early 1980s, the current path is tracking much closer to the 1983 experience. There we saw a very strong jobs recovery.
That gives some hope that this is something better than those jobless recoveries. If you draw a regression line that compares past recessions to past payroll losses and you look at the peak-to-through decline in GDP for all of the past recessions alongside the peak-to-trough drop in payrolls during those same periods, there is obviously a very tight fit on the regression line. The bigger the drop in the economy, the bigger the drop in payrolls. No big shock there.
If you take what we know to be the drop in the economy during this recession, which was a 3.8% decline in GDP, and put that dot right on the regression line, it suggests that we should have seen payrolls drop by 4.3%. Instead they dropped by 6.1%. That is a 36% greater loss of jobs that what was justified by the drop in the economy.
We have a catch-up phase to look forward to, hopefully. It was much more severe this time because during the period when monthly job losses were the greatest (700,000 or more) in the fourth quarter of 2008 and the first quarter of 2009 business sentiment at the time was expecting true Armageddon. Businesses anticipated Great Depression II. We know in hindsight we didnt get that. Thats not to suggest this wasnt an awful recession. It just wasnt quite as severe as what the worst case scenario was viewed to be at that time. We have a catch-up phase coming, even if were not off to the races.
The sense that this is another jobless recovery may be a little bit too pessimistic.
With major sectors of the economy like housing, finance and automobiles permanently crippled relative to what they were three or four years ago, what sectors of the economy are going to contribute to job growth?
Its funny that you mention that, because some financial and most manufacturing industries, including autos, are actually rehiring. Its another example of coiled springs and flies against conventional wisdom that the most troubled industries have no hope to be participants in the recovery.
As is the case in almost every recovery, there will be a set of industries that represent some of the brightest lights in the next phase of the economy. Those industries wont necessarily the ones that led in the past. To me, it is not all that difficult to figure out where some of those areas are going to be: maybe biotechnology or energy technology. You can easily find some sectors and industries where there is employment growth potential. With those aforementioned hard-hit industries, because the layoffs were so severe, with any kind of pickup in demand you get the coiled spring of needing to replace inventories which feeds into production, which feeds into jobs.
Youve said that inflation in the US will not occur as long as velocity of money, wage pressures and unit labor costs remains depressed, and excess capacity remains elevated. Over the longer term say three, five or even ten years from now do you view inflation as a much more serious threat, particularly because of rising budget deficits?
It depends on the aforementioned conditions. Inflation is not an automatic threat by virtue of budget deficits. Youve listed the things that would have to fall into place to suggest the risk of inflation was increasing. I dont have this dig my heels in the sand view on inflation in either direction. Right now the conditions are not in place for any kind of meaningful core inflation to erupt. That doesnt mean, That is my view as far as the eye can see, and damn the statistics Im going to stick with it.
I just know the various things I will look at to get a sense of when inflation will be a threat.
A debt crisis that arguably we have been in for some time isnt guaranteed to be inflationary, even though unfortunately we havent gotten ourselves out of that crisis because all weve done is shifted the debt from the private sector to the public sector. For evidence, we have no further to look than to Japan, which has been in a deflationary spiral, even in the face of what appears to be insurmountable debt and a brutal economy.
That is just one example. If you look at the Reinhart and Rogoff work on past financial and debt crises, they found that those are inherently deflationary, not inflationary.
There is this misguided view that one equals another: rising debt means we are guaranteed to get inflation. We may, but I am not dogmatic in thinking that it is automatically going to come. I know that a combination of the money multiplier, wage pressures, unit labor costs, excess capacity, TIPS spreads all those things that you mentioned are the things we are looking at to judge inflationary pressures to come.
You have to understand the way the math works and understand that there are different deflator rates for each of the components of GDP. Clearly residential investment has had a huge negative deflator, whereas in commodity prices there has been a lot of inflation. Its a question of what ultimately filters into core inflation. We know that 38% of core CPI is something called owners equivalent rent and there continues to be downward pressure on that.
A lot more analysis needs to be done to develop a concrete view on inflation. Too many people are making very simplistic assumptions of why it is necessarily coming.
Id like to talk about your interest rate forecast. Youve also said there are clues that the Fed may begin raising interest rates. Do you foresee problems in a supply/demand imbalance with projected issuance US Treasury bonds that could also force rates higher? Can you foresee a scenario, potentially over the near term, with sharply rising real interest rates?
There is certainly a huge risk that we could run into trouble financing our deficit. That is one reason, but not the only reason, that were starting to see upward pressure on the long end of the yield curve.
There are other reasons, and some of those may not necessarily be bad reasons, why you will see some upward pressure on yields, not the least of which is if we get some downward traction in the unemployment rate and there is more adherence to the view that this is indeed a self-sustaining recovery. Thats a good reason why yields would go higher not because of some massive inflation scare or need to ramp rates by bond vigilantes because of the budget deficit. Its going to be a combination of forces, some good and some bad, that will keep pushing rates upward.
There is a natural resistance when you get to about a 400 basis-point spread between the Fed Funds Rate and the 10-year yield. Just about any time that has happened in the last 10 years, youve gotten a little bit of a reprieve and a rally in the bond market. Yields have come down a little bit. I dont ever attempt to give advice to someone who trades the bond market. This is not to suggest that my view should be reacted to with a trade. There will be a bit of a trading range for yields. The bond market reacts to extremes of sentiment just like the stock market.
Often times that 400 basis point spread doesnt resolve itself by the long end coming down. Sometimes it resolves itself by the short end going up.
I dont think the Fed is imminently going to raise rates, but I wouldnt be surprised to see the key extended period language change at the April meeting. Does that suggest the next meeting will result in a rate hike? Who knows?
I also think its silly that so many people have this view that the Fed already knows what it is going to do and when, and that its just a question of when they are going to start hinting to us. They are in the same boat as all market watchers. They are judging the data as it comes in.
They will be really pushing it, come the end of April, assuming we dont have a collapse in a variety of economic numbers, to continue to press that extended period language. The dissents are increasing.
Frankly, I think it would be a good thing if we were actually in an environment that suggested short rates had to start to go up. I shudder to think of an environment that justifies zero Fed Funds Rate through this year and into next. There are folks out there who think the Fed shouldnt raise rates until 2012. Zero percent is an emergency level of rates. I think an environment where the Fed is justified in normalizing rates is a good thing. It may not protect the market from having a little indigestion, but thats normal as you approach a rate hike cycle.
Youve criticized Paul Krugmans proposal for a 25% tariff on Chinese goods. Isnt Chinas currency manipulation just another form of trade protectionism? How should the US respond?
I dont want to get into recommending policy. My comment there was based on what we know the damage was from Smoot-Hawley back in the 1930s. Im generally against overt protectionism. The thought is that China has every reason due to its own budding inflation problem to consider currency revaluation. Id rather see that be the impetus.
I would be remiss if I didnt ask about your assessment of the health care bill.
We dont comment on that. We stay out of the political second-guessing.
Clearly there are companies that are taking some write-downs. That is going to be the next big issue. Companies that have announced accounting hits are going to be brought in to testify. We are starting to see some of the implications. But we dont take a hard political stand on this.
Aside from the politics, do you believe it will be stimulative or inhibitive of economic growth, particularly over the long term?
Well see. The early read from companies is that its hurting companies as they have to take immediate write-downs for future healthcare liabilities
What worries you the most about your forecast? What are the key risks that could, for example, bring about much slower growth or higher inflation?
I dont consider what I do forecasting. I dont forecast GDP or employment, and I dont put year-end targets on the S&P 500. We are not market timers. Its more about a general view that I have on the market and the economy, as opposed to an explicit forecast. We are staunch believers that specific prediction is not an appropriate thing to do. It doesnt help individual investors, in particular. I would shudder to think that there is anyone swinging their money around in the short term based on my or anyone elses forecast.
After being pessimistic about both the economy and stock market since mid-2007, I became decidedly more optimistic about both in the spring of 2009. Entering 2010 however, I felt it would be a choppier year than it was since March of 2009. I dont think that we have that kind of trajectory in front of us.
In terms of my economic view, debt is at the top of my list of concerns. We are about to cross a very important threshold where public debt becomes greater than 90% of GDP. That will happen this year. Reinhart and Rogoff have shown very clearly that, over the last several hundred years, that is an important threshold for the ability of economy to grow. As debt is growing as a percentage of GDP, up until the 90% threshold, it doesnt tend to have a big impact on GDP. But because of the crowding out effect and the potential for rates to rise in order to stimulate demand by the debts financiers, 90% tends to be the tipping point, not only for developed economies but for emerging economies too. As we cross that point this year, you cant help but have that as a niggling concern.
Is it inevitable that the government will have no choice but to inflate its way out its debt problem?
Not necessarily. What I hope is inevitable is that the government realizes that the only long-term way to solve a deficit problem as large as we have is to establish the conditions to grow the economy as fast as possible without runaway inflation. Thats really the only way to solve a real deficit problem.
Youve got three pillars of deficit reduction: tax increases, spending control, and economic growth. The tax increase part we are getting, whether you like it or not. That pillar is in the bag. The various rates and the expiration of the Bush tax cuts are still to be decided, but rising tax rates are coming, no question about it.
At the national level, the focus seems to be controlling the rate of growth of spending. Whats interesting is that you are starting to seeing more actual spending cuts at the state and local level, because in some cases their budget deficits are at more dangerous levels than at the national level. Politicians and policy makers are starting to realize it's not just the rate of spending that should be cut, you actually have to cut spending outright from the prior year. New Jersey is one of the newest examples of a state, with a new governor, that has announced very deep spending cuts.
If you look at the various surveys and polls, even when the deficit or debt as a percentage of GDP was elevated, it doesnt tend to be a huge issue for the public for voters. It is a much bigger issue now. There is more attention on this, and it is higher up on the priority spectrum for the public. Politicians on both sides of the aisle are going to realize that.
Although debt was not as elevated in the early 1990s as it is now, it was uncomfortably high and had been growing rapidly. We were also coming out of a financial crisis the S&L crisis. You couldnt have gotten anybody to believe then that there would be a budget surplus at the end of the decade. But a very strong economy did just that.
It can (and needs to) be a combination of boosting tax revenues, reining in spending and establishing the conditions for above-average economic growth that brings down deficits to a more manageable level.
Do you favor allowing the Bush tax cuts to expire at the end of next year?
I was an advisor to the Bush Administration on the tax cuts at that time. Im not a fan of double-taxation of income, period. Id be happier to see those extended rather than to allow them expire, unless we see some significant upside momentum to the economy.
We are still in recovery, but I would not deny at this stage it is fairly shaky. Piling up another set of tax increases on top of that will have some unintended consequences.