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Economics: United States Economics – Markets – Strategy Higher oil prices are a burden but it is paid for in real time. Oil prices are not a hammer waiting to fall on future growth everyday nuts and bolts of total expenditure, most of which has to be spent in good times and bad – is what attenuates, or drags an economy out of recession when it has fallen into one for some other reason. It is not what pulls an economy into recession. The solid straight line of services consumption growth shown in the picture on the previous page is a good indication of what we’re talking about. Investment may fall, jobs may fall and, eventually, total consumption may fall. But core consumption, 60% of GDP, grinds forward. It’s not fast, it’s not sexy but it is big and reliable and for these reasons it tends to keep growth on track. Oil Total consumption is certainly facing some headwinds of late but that has more to do oil prices and the price of gasoline than anything else. Oil prices have tripled since January 2005 and vehicle sales have been falling since July of the same year. The surge in crude (50%) and pump (35%) prices since January has thrown even more cold water on sales. Higher oil prices are a burden but they appear compellingly to have been driven by strong global demand and income growth over the past 5-6 years (see Economic Overview, “On a clear day”, above). On this time frame, oil prices have grown fivefold. Growth in most parts of the world ‘survived’ the high oil prices because it drove the high oil prices. In this light, US growth faces headwinds from oil prices no greater or less than it has faced for the past five years. Further rises in oil prices would have further impacts on things like vehicle sales but it would not lower GDP growth later this year any more than it already has over the past five years. To be sure, US growth is not sterling at the moment. And foreign growth is driving oil prices more than growth in the US, Japan or Europe, where oil consumption has fallen for the past three years if not the past 12 (see “On a clear day”). Is the US suffering weak growth because foreigners are pushing up the price of oil? No. US growth is weak because of the US subprime crisis and the collapse in the housing market. Foreign demand, as we discussed earlier, is the only thing keeping US growth alive right now. So if foreigners are pushing up the price of oil, that is the price of their keeping US growth afloat at the same time. Global growth ‘survived’ higher oil prices because it drove higher oil prices US - core inflation % YoY, core PCE and core CPI 3.0 core CPI 2.8 2.6 2.4 2.2 2.0 Actuals thru April 1.8 core PCE 1.6 Sep06 Aug07 Apr08 Aug08 1.4 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 140
Economics – Markets – Strategy Economics: United States United States Economic Indicators 2007 --- 2008 --- -- 2009 -- 2007 2008(f) 2009(f) Q4 Q1 Q2 (f) Q3 (f) Q4 (f) Q1 (f) Q2 (f) Output & Demand Real GDP* 2.2 2.0 2.6 0.6 0.9 1.6 2.5 2.7 2.8 2.8 Private consumption 2.9 1.7 2.1 2.3 1.0 1.0 2.0 2.2 2.2 2.2 Business investment 4.7 4.8 5.9 6.0 -0.3 3.5 7.0 7.0 5.0 6.0 Residential construction -17.0 -20.1 -2.7 -25.2 -25.5 -20.0 -10.0 -5.0 1.0 2.0 Government spending 2.0 2.4 2.3 1.9 2.0 2.3 2.3 2.3 2.3 2.3 Exports (G&S) 8.1 6.4 5.6 6.5 2.8 5.5 4.7 3.3 6.6 6.5 Imports (G&S) 1.9 0.3 4.0 -1.4 -2.6 2.0 2.5 2.5 5.0 5.0 Net exports ($bn, 00P, ar) -556 -470 -465 -503 -480 -470 -465 -465 -465 -465 Stocks (chg, $bn, 00P, ar) 5 -4 5 -18 -14 0 0 0 5 5 Contribution to GDP (pct pts) Domestic final sales (C+FI+G) 2.1 1.4 2.5 1.5 0.0 0.8 2.3 2.7 2.6 2.8 Net exports 0.6 0.7 0.0 1.0 0.8 0.3 0.2 0.0 0.0 0.0 Inventories -0.3 -0.1 0.1 -1.7 0.1 0.5 0.0 0.0 0.2 0.0 Inflation GDP deflator (% YoY, pd avg) 2.0 1.9 2.3 CPI (% YoY, pd avg) 2.9 3.8 2.6 4.0 4.2 3.9 3.9 3.4 3.0 2.5 CPI core (% YoY, pd avg) 2.3 2.5 2.3 2.3 2.4 2.6 2.5 2.5 2.3 2.3 PCE core (% YoY, pd avg) 2.1 2.4 2.1 2.1 2.0 2.4 2.5 2.4 2.2 2.2 External accounts Current acct balance ($bn) -739 -734 -785 Current account (% of GDP) -5.3 -5.1 -5.2 Other Nominal GDP (US$ trn) 13.8 14.4 15.1 Federal budget bal (% of GDP) -0.9 -1.5 -2.5 Nonfarm payroll** 115 -2 126 80 -82 -35 25 85 120 125 Unemployment rate (%, pd avg) 4.6 5.2 5.1 4.8 4.9 5.3 5.3 5.2 5.2 5.2 * % period on period at seas adj annualized rate, unless otherwise specified ** Change, x1000, month avg Fed We revised our Fed forecast in mid-May, bringing forward our expectations for the first round of Fed hikes to 4Q08 from 1Q09. We look for 50bps of hikes then, mainly on the view that growth will be running between 2.5% and 2.75%. Interest rates simply do not belong at 2.00% with growth of this sort, especially in an environment of relatively high and perhaps still rising inflation at yearend. Oil prices, currently at USD135/bbl (Brent & WTIC), will continue to drive headline and core inflation higher through the summer months. We expect core CPI and PCE inflation to rise to 2.6% YoY by August – well outside the Fed’s comfort zone of 1% to 2% – and, if oil prices continue to rise, inflation would not stop there as we currently anticipate. In the event, we look for another 75bps of Fed hikes in each of 1Q09 and 2Q09. That would leave Fed funds at 4.00% by July09. With neutral Fed funds at about 4.75%, the expectation must be for further hikes in 3Q09. We expect 50bps of hikes in 4Q08, followed by 75bps of hikes in each of 1Q09 and 2Q09. That would put Fed funds at 4.00% by Jul09 Sources: Sources for all charts and tables are CEIC and Bloomberg . 141
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