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Sunday, June 16, 2013

Mid-year Review: Ten Economic Questions for 2013

by Calculated Risk on 6/16/2013 05:22:00 PM

At the end of last year, I posted Ten Economic Questions for 2013. I followed up with a brief post on each question. The goal was to provide an overview of what I expected in 2013 (I don't have a crystal ball, but I think it helps to outline what I think will happen - and understand why I was wrong).

By request, here is a mid-year review (a little before mid-year).   I've linked to my posts from the beginning of the year, with a brief excerpt and a few comments:

10) Question #10 for 2013: Europe and the Euro

Even though I've been pessimistic on Europe (In 2011, I argued that the eurozone was heading into recession), I was less pessimistic than many others. Each of the last two years, I argued the eurozone would stay together ... My guess is the eurozone makes it through another year without losing any countries or a serious collapse. Obviously several countries are near the edge, and the key will be to return to expansion soon.

Note: unless the eurozone "implodes", I don't think Europe poses a large downside risk to the US. If there is a breakup of the euro (something I do not expect in 2013), then the impact on the US could be significant due to financial tightening.
Half way through the year, it looks like the Eurozone will stay together through 2013. Of course the news in Europe remains grim. However it is now obvious to everyone that "austerity" alone has failed, and I expect less fiscal tightening after German Chancellor Angela Merkel is reelected in a few months.

9) Question #9 for 2013: How much will Residential Investment increase?
New home sales will still be competing with distressed sales (short sales and foreclosures) in many areas in 2013 - and probably even more foreclosures in some judicial states. Also I've heard some builders might be land constrained in 2013 (not enough finished lots in the pipeline). Both of these factors could slow the growth of residential investment, but I expect another solid year of growth.

... I expect growth for new home sales and housing starts in the 20% to 25% range in 2013 compared to 2012.
We only have four months of data (starts for May will be released this week), but starts in the January through April 2013 period were up about 29% compared to the same period in 2012. New home sales are up 26% during the first four months of 2013 compared to the same period in 2012. So far so good ...

8) Question #8 for 2013: Will Housing inventory bottom in 2013?
If prices increase enough then some of the potential sellers will come off the fence, and some of these underwater homeowners will be able to sell. It might be enough for inventory to bottom in 2013.

Right now my guess is active inventory will bottom in 2013, probably in January. At the least, the rate of year-over-year inventory decline will slow sharply.
I track inventory weekly, and there is no question that the year-over-year rate of decline has slowed sharply. My mid-year guess is that inventory did bottom in January 2013 (this should be a huge focus right now, since rising inventory will slow price increases).

7) Question #7 for 2013: What will happen with house prices in 2013?
Calling the bottom for house prices in 2012 now appears correct.

[E]ven though I expect inventories to be low this year, I think we will see more inventory come on the market in 2013 than 2012, as sellers who were waiting for a better market list their homes, and as some "underwater" homeowner (those who owe more than their homes are worth) finally can sell without taking a loss.

Also I expect more foreclosure in some judicial states, and I think the price momentum in Phoenix and other "bounce back" areas will slow.

All of these factors suggest further prices increases in 2013, but at a slower rate than in 2012.
The Case-Shiller Comp 20 and National indexes both increased about 7% in 2012. We only have Q1 price data, but house prices increased about 3.5% in Q1. I expect price increases to slow, but my initial prediction for house prices this year might have been low.

6) Question #6 for 2013: What will happen with Monetary Policy and QE3?
I expect the FOMC will review their purchases at each meeting just like they used to review the Fed Funds rate. We might see some adjustments during the year, but currently I expect the Fed to purchase securities at about the same level all year.
There has been some discussion of "tapering" asset purchases later this year, but I still think the Fed will wait longer than many people expect to start tapering.

5) Question #5 for 2013: Will the inflation rate rise or fall in 2013?
I still expect inflation to be near the Fed's target. With high unemployment and low resource utilization, I don't see inflation as a threat in 2013.
Inflation has been falling and is now below the Fed's target. This is a significant issue for the Fed, and it appears my inflation forecast was a little high (at least mid-year).

4) Question #4 for 2013: What will the unemployment rate be in December 2013?
My guess is the participation rate will remain around 63.6% in 2013, and with sluggish employment growth, the unemployment rate will be in the mid-to-high 7% range in December 2013 (little changed from the current rate).
In May, the participation rate was at 63.4% (I still expect it to mostly move sideways this year), and the unemployment rate was at 7.6%. This forecast still seems about right.

3) Question #3 for 2013: How many payroll jobs will be added in 2013?
Both state and local government and construction hiring should improve in 2013. Unfortunately there are other employment categories that will be hit by the austerity (especially the increase in payroll taxes). I expect that will offset any gain from construction and local governments. So my forecast is close to the previous two years, a gain of about 150,000 to 200,000 payroll jobs per month in 2013.
Through the first five months of 2013, the economy has added an average of 189 thousand jobs per month - about as expected.

2) Question #2 for 2013: Will the U.S. economy grow in 2013?
[R]ight now it appears the drag from austerity will probably offset the pickup in the private sector - and we can expect another year of sluggish growth in 2013 probably in the 2% range again.
The economy grew at a 2.4% annualized real rate in Q1, and forecasts are for around 1.8% in Q2. About as expected so far, however there was more austerity than I expected - and I also expect some pickup later this year.

1) Question #1 for 2013: US Fiscal Policy
[T]the House will fold their losing hand [on the debt ceiling] soon. ...

Although the negotiations on the "sequester" will be tough, I suspect something will be worked out (remember the goal is to limit the amount of austerity in 2013). The issue that might blow up is the “continuing resolution", and that might mean a partial shut down of the government. This wouldn't be catastrophic (like the "debt ceiling"), but it would still cause problems for the economy and is a key downside risk.

And a final prediction: If we just stay on the current path - and the "debt ceiling" is raised, and a reasonable agreement is reached on the "sequester", and the “continuing resolution" is passed - I think the deficit will decline faster than most people expect over the next few years. Eventually the deficit will start to increase again due to rising health care costs (this needs further attention), but that isn't a short term emergency.
I wrote the post linked above just after the fiscal cliff agreement was reached. I was correct about the debt ceiling (the House folded - the debt ceiling is absurd). But unfortunately I was wrong about the sequester (bad policy).

Another point I was correct about was that the deficit is decreasing faster than most people expected - probably too fast. Fiscal policy (specifically the U.S. House) remains the key downside risk for the U.S. economy this year.

Overall 2013 is unfolding about as expected - at least so far. Longer term, the future's so bright ...