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U.S. economic growth continues, but uncertainties linger

IHS Global Insight August Economic Forecast Flash

Most incoming evidence points to continued growth, albeit at a modest pace. The best news recently was the July employment report, showing 163,000 jobs created, suggesting that second-quarter job creation averaging just 73,000 per month had undershot the economy's underlying trend, just as the first quarter's 226,000 average had overshot it. The key manufacturing signal from the ISM survey remains fractionally below the breakeven 50-mark, but well above the low-40s level that would point to recession. The survey still shows production growing, but heavily reliant on an earlier backlog of orders that is now being worked off. It shows new orders falling in both June and July, especially for exports. We need to see orders picking up soon, or production will follow orders down. The most upbeat news is coming from housing, with prices now beginning to turn up, and home sales and housing starts trending higher.

Second-Half Growth Will Probably Be Restrained by Inventory Caution. We expect second-half 2012 GDP growth, averaging 1.4%, to be little different from the second quarter's 1.5% pace. That's slower than the 2.0% second-half pace that we assumed last month, in large part because of reduced expectations for consumption growth. We think that final sales growth will achieve a 2.1% average pace, but that inventory accumulation will be a drag on growth, as inventory-to-sales ratios have recently begun to creep higher. GDP growth for calendar year 2012 now comes in at 2.1%, up from 2.0% in last month's forecast, only because an upward revision to growth in the fourth quarter of 2011 has given the economy a stronger starting point as it entered 2012. But our 2013 growth projection has been lowered to 1.8%, from 2.0%, partly because of the weaker momentum exiting 2012. In addition, the higher food inflation resulting from this year's drought adds a slight drag (we expect consumer food prices to rise about 3% in 2013).

Key Uncertainties Unlikely to Be Resolved Soon (1): Europe. Unfortunately, key uncertainties casting shadows over the recovery are unlikely to be resolved soon. Despite the initial euphoria over ECB president Draghi's commitment to do "whatever it takes" to save the euro, the Eurozone crisis is dragging on with no end in sight, and the (as yet unofficial) Eurozone recession is deepening. We continue to assume that it will take a dramatic event – Greek exit from the euro, which we assume for mid-2013 – for policymakers to finally deliver on "whatever it takes" to save the rest of the Eurozone.

Key Uncertainties Unlikely to Be Resolved Soon (2): Fiscal Cliff. We do not expect the economy to go off the "fiscal cliff." But the uncertainties over the cliff – and more broadly over the direction of federal tax and spending policy – are unlikely to be resolved quickly unless November's elections deliver an extremely decisive result. Our assumption is that the lame-duck Congress will punt the problem down the road with a "stay of execution" that will postpone the tax hikes and spending cuts for a few months. That will remove the immediate risk but delay a final resolution. As a result, extreme uncertainty over fiscal policy is likely to remain a fact of life – and a deterrent to risk-taking – well into 2013. The fact that the debt ceiling will need to be raised some time in the first few months of 2013 adds an unwelcome extra complication.

The Fed: Quantitative Easing Expected in September. The Federal Reserve has signaled that it is ready to do more to help the economy. The improved July employment report eased the pressure for action slightly, but we believe that the Fed's published growth projections remain too optimistic, and that it will downgrade its outlook and take more action in September. We assume it will announce another round of quantitative easing worth $600 billion, concentrated on mortgage-backed securities. We still see growth picking up sufficiently in 2014, led by a housing revival, for the Fed to start raising interest rates at the end of that year, consistent with its present guidance.