Sunday, March 14, 2010

Economic Outlook: Review of Possible Upside Surprises to Forecast

by Calculated Risk on 3/14/2010 05:09:00 PM

My general outlook for 2010 is for sluggish and choppy growth. Usually the deeper the recession, the steeper the recovery - however recoveries following economic crisis tend to be sluggish (see: "The Aftermath of Financial Crises", Reinhart and Rogoff, 2009):

An examination of the aftermath of severe financial crises shows deep and lasting effects on asset prices, output and employment. ... Even recessions sparked by financial crises do eventually end, albeit almost invariably accompanied by massive increases in government debt.
Also the two usual engines of recovery, consumer spending and residential investment, both remain constrained as households rebuild their balance sheets (constraining consumption), and serious problems remain in the housing market including significant excess inventory and high levels of distressed properties.

Last November I listed a few possible upside surprises and downside risks to the above forecast. Here is an update on the possible upside surprises:

On consumer spending, I wrote:
  • Consumer spending. One of the key reasons I think growth will be sluggish in 2010 is because I expect the personal saving rate to increase as households rebuild their balance sheets and reduce their debt burden. But you never know. As San Francisco Fed President Dr. Yellen said yesterday: "Consumers have surprised us in the past with their free-spending ways and it’s not out of the question that they will do so again." Still, it is hard to imagine much of a spending boom with high unemployment (putting pressure on wages), and limited credit (so some people can spend beyond their income).
  • My expectation has been that the saving rate would rise to around 8% over the next couple of years. The saving rate rose sharply in 2009, however the most recent report from the BEA: Personal Income and Outlays, January 2010 showed the saving rate fell to 3.3% in January.

    PCEClick on graph for large image.

    This graph shows the saving rate starting in 1959 (using a three month trailing average for smoothing) through the January Personal Income report.

    Although I still expect the saving rate to rise, it is possible that it will not rise as far - or as fast - as I expected. That would mean consumption could grow closer to income growth in 2010.

    My comments last year on exports:
  • Exports. Perhaps we are seeing a shift from a U.S. consumption driven world economy, to a more balanced global economy. An increase in consumption in other countries, combined with the weaker dollar should lead to more U.S. exports. And if China revalued that might lead to a boom in U.S. exports. ... Please don't hold your breath waiting for China!
  • Based on the comments of Chinese Premier Wen last night, "don't hold your breath" was probably good advice (although I do expect China to revalue this year). U.S. exports have increased over the last year, but it appears the growth of exports has slowed.

    On Residential Investment:
  • Residential Investment. Those expecting a "V-shaped" or immaculate recovery - with unemployment falling sharply in 2010 - are expecting single family housing starts to rebound quickly to a rate significantly above 1 million units per year. That won't happen. But it is possible for single family starts to rebound to 700 thousand SAAR, even with the large overhang of existing housing inventory.
  • This has been as weak as expected ...

    And on another stimulus:
    With unemployment above 10%, there will be significant political pressure for another stimulus package - especially if the economy starts to slow in the first half of 2010. This next package could be several hundred billion (maybe $500 billion) and could increase GDP growth in 2010 above my forecast.
    It now appears the additional stimulus will be in the $100 billion range, mostly for additional unemployment benefits.

    The most likely upside surprise appears to be coming from consumer spending and the lack of an increase in the saving rate. I still think the saving rate will continue to rise - although maybe not as fast as I originally expected.

    Also - I still think the recovery will be choppy and sluggish. I'll review the downside risks soon ...