INSIGHT: Despite recent gains, Fed lowers its US economic outlook

03 November 2011 17:03  [Source: ICIS news]

By Joe Kamalick

Not much blue sky in the US FedWASHINGTON (ICIS)--US Federal Reserve policymakers this week found little cheer in the improving US third quarter GDP results and instead looked uneasily toward the accelerating EU financial meltdown, warning that the crisis poses “a significant downside risk” to the US recovery.

Despite the clearly improving if modest US economic gains for the third quarter, the Fed went so far as to lower its forecasts for the nation’s economy for this year and through 2014.

The Fed also revised its outlook for US unemployment, indicating that it now expects the nation’s 9.1% jobless rate to hold for full-year 2011, with only modest declines in 2012 and 2013.

The White House also took note of the continuing sovereign debt crisis in Europe and new turmoil surrounding the Greek prime minister’s decision to put the EU bailout plan and related austerity measures in the hands of Greek voters in a referendum.

White House spokesman Jay Carney likened the unravelling EU debt resolution to the Japan earthquake in March this year that destabilised economies worldwide. “It’s just a reality that this country and every country has to deal with,” Carney said of the euro crisis.

In other words, as with a tsunami, not much can be done about it; you just have to watch it sweep ashore.

In its rather sombre evaluation, the Fed’s rate-setting federal open markets committee (FOMC) noted that the US economy had “strengthened somewhat” in the third quarter. But the central bank also cautioned that key sectors remain weak and the EU debt crisis continues to pose a significant danger for the US.

US GDP expanded at an annual rate of 2.5% in the third quarter ended 30 September, a solid improvement from the mediocre 1.3% growth rate seen in the second quarter and vastly better than the first quarter’s barely breathing 0.4% performance.

Having dismissed the third quarter gain as only "somewhat" of an improvement, the Fed instead emphasised that “recent indicators point to continuing weakness in overall labour market conditions, and the unemployment rate remains elevated” at 9.1%.

“Household spending has increased at a somewhat faster pace in recent months [and] business investment in equipment and software has continued to expand,” the central bank conceded, “but investment in non-residential structures is still weak, and the housing sector remains depressed.”

In its statement at the end of a two-day economic assessment, the FOMC said that it continues to expect only a moderate pace of economic growth over coming quarters and the years ahead.

But that moderate pace of growth also means that “the unemployment rate will decline only gradually toward levels that the committee judges to be consistent” with normal economic growth.

Even that anticipated moderate growth remains in some doubt, however. That’s where the euro crisis plunges into the Fed’s forecast.

The committee noted that “there are significant downside risks to the economic outlook, including strains in global financial markets”, the latter a reference to the continuing European financial crisis and the risk of Greece’s default on its sovereign debt.

As most observers - apparently including some among the Fed governors - see a Greek default as inevitable, the central bank sharply reduced its US economic outlook for this year and the three years to come.

That's pretty remarkable. 

As recently as June this year, the Fed said it expected full year 2011 US GDP growth would be within a whisker of 3% and certainly above 2.5%.

Now, however, the Fed greybeards project US GDP growth this year to be 1.6% to 1.7% at best - a forecast that is almost 50% lower than the estimate made just four months ago in June.

What has happened in the four months since June? Within those four months (basically the third quarter) the US economy performed at a pace almost double that of the previous three months, so it doesn’t seem likely that improvement triggered the cutback in the Fed’s outlook.

It has to be Greece and the likely financial and economic contagion that would flow from an expected Greek default.

For 2012, the Fed lowered its GDP growth forecast from June’s more rosy 3.3% to 3.7% pace to a sub-par 2.5% to 2.9% rate.

The Fed’s revised outlook does anticipate US GDP climbing to 3% to 3.5% in 2013, but even that forecast is down considerably from the central bank’s June prediction of 3.5% to 4.2% growth.

The Fed doesn’t see the US economy growing at a rate above 3.5% until 2014. 

That is significant because economists say the nation’s economy cannot make significant reductions in the persistently high 9% unemployment rate until GDP growth reaches a steady 3.5% pace or higher for an extended period, perhaps five or six quarters.

Since 3.5% growth doesn't seem to be in the Fed's Tarot cards for the next couple of years, the central bank also has revised upward its unemployment outlook for this year and through 2014.

The central bank’s economists now see the US jobless rate holding at 9% or the current 9.1% for full year 2011, compared to their June forecast of unemployment falling to as low as 8.6% for the year. 

Bear in mind that when Fed soothsayers said in June - unemployment then was 9.2% - that full year 2011 jobless rate would be 8.6%, they must have been expecting some really solid second-half employment gains. Clearly, those expectations have been stuck in a drawer.

The Fed said the jobless rate now is likely to hold around 8.6% for 2012 (June forecast was for 8%), and 2013 will still see an unemployment rate as high as 8.2% (rather than the June prediction of only 7.5%).

Peering all the way into 2014, the Fed expects unemployment still will be relatively high around 7% and possibly up to 7.7%. In June the Fed did not offer a 2014 employment forecast.

Unemployment at 7% or higher three years out is a remarkably dour forecast indeed. The Fed is predicting that in 2014 - five years after the June 2009 end of the Great Recession - US unemployment still will be at 7%. 

In normal economic times, the US would be expected to have a jobless rate of around 5%. In 1999 it was 4%.

Back at the White House, spokesman Carney said: “Now, it’s very important that the Europeans take the conclusive action that’s necessary to deal with this crisis.”

Obviously, he added, that is in the Europeans’ own self interest.

“But our interest is not entirely altruistic,” Carey said, adding: “It’s also because [they] are a very important part of the global economy, and it affects our economy.”

President Barack Obama was to be en route to France for the 3-4 November G-20 summit meeting in Cannes.

Carney said that the looming Greek default and the broader euro zone crisis “will certainly be a topic of discussion, I can pretty much predict that with great confidence”.

 ($1 = €0.72)

Paul Hodges studies key influences shaping the chemical industry in Chemicals and the Economy

By: Joe Kamalick
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