Economic Outlook 2011, Inching Our Way Toward Recovery

Location: New York
Author: Milton Ezrati
Date: Tuesday, January 4, 2011

Following are five easy pieces on the likely macroenvironment in the coming year:

1. Economic activity. As measured by the real gross domestic product (GDP) and other gauges, the economy should continue to expand, though at a still-subdued rate of about 2.5%, far slower than in past recoveries and also slower than the long-term trend growth of about 3.2%. Still, the gains should produce healthy, double-digit earnings growth, largely because of foreign exposure and the impact of operating leverage. Behind this overall growth picture is the expectation that the consumer will increase spending moderately. While a continued concern about the debt overhang will prevent a return to the free-spending ways of the past, enough de-leveraging has occurred to permit households to increase spending at least in tandem with income growth. Capital spending should outpace the consumer, as it has all this past year, as business strives for further efficiencies. Exports should provide the greatest growth advantage, because the dollar remains fundamentally cheaper than it’s been in years. Though housing will offer no growth, and government spending likely will remain restrained, the balance of these influences should prove sufficient to generate the expected moderate overall growth.
2. Labor market. Slow growth will bring only marginal improvement in the unemployment rate over the course of the new year. Actually, new hiring will likely surprise on the high side, because the wholesale layoffs of 2008–2009 will force firms to call back at least some staff full time. The last 12 months have begun to see some of this improvement, as full-time payrolls have expanded by some 950,000, or at a monthly rate of 79,000. That hiring pace should accelerate to an average of 200,000 a month in 2011. Because any uptick in hiring will bring discouraged workers back into the search for employment, the recorded unemployment rate likely will tick up before it starts to fall in earnest. It is entirely possible that it will again rise above 10% during the early months of this year before the rehiring eventually brings it down—probably closer to 8% by late 2011, early 2012. That is still very high by historical standards, but better than at present.
3. Prices. Inflation should remain contained in 2011. To be sure, commodity prices have risen and will likely continue to rise going forward, albeit at a more moderate pace. But the effect of commodity prices on overall inflation measures of finished goods and especially services is usually slight. In the meantime, the slack labor market will hold back any wage inflation for the coming year, and low rates of capacity utilization will also limit business’ ability to make price increases stick. Core consumer prices will likely rise in the range of 1.5–2.0%, and the GDP deflator will probably rise even more slowly. Longer-term inflation could become a problem, though markets will react to such fears sooner if Washington fails to manage fiscal and monetary policy well. This is not an actual inflation issue for 2011, but it could be by 2012.
4. Monetary policy. In this less-than-robust economic environment, especially with no immediate inflationary pressure, the Federal Reserve likely will hold down interest rates for some months yet. Fed chairman Ben Bernanke and his colleagues are well aware that in time they will have to change policy in order to absorb the excess liquidity they have used to promote economic recovery, but they are understandably wary of moving too soon. Bernanke has made clear that he will continue the present, easy monetary policy until the employment rate begins to fall and banks return to lending. Since these events are expected to occur convincingly only in the latter part of 2011, the Fed should begin to alter its policy only late in the year or early in 2012. According to the Fed’s own description, the policy turn should occur in stages, first with a cessation of any new quantitative easing, then a decision to allow its balance sheet to shrink as issues on it mature, and only then will the Fed begin to raise interest rates, undoubtedly in a very gradual way, first by raising the rates paid on bank reserves held at the Fed and then by raising federal funds rates.
5. Budget deficits. The outlook for fiscal policy, particularly deficit reduction, is more problematic. Despite the election reversal last November, the politics of deficit reduction will render it very difficult to make progress, especially against the market’s concerns over deficits of more than $1.0 trillion a year out into the more distant future. Of course, investors are realistic. They have no expectation that Washington can turn around this situation quickly. What they need is a credible plan to get a handle on deficits over that long-term horizon. The longer Washington fails to deliver such a plan, the stronger headwind it will create for markets and the economy. Over the next 12–24 months, these concerns likely will remain insufficient to turn plus to minus, but they will gain force over the longer term.

The outlook carries much risk in addition to these five key references. The world faces considerable trade and currency tension, especially between the United States and China. Europe’s sovereign debt problems threaten a financial crisis seemingly on an ongoing basis. China faces a potential real estate bubble. And these are just three of the more prominent concerns. Still the underlying macro environment offers more security and potential for improvement than in the past few years, even if it pales next to previous recoveries.

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