Mild Acceleration in Economy Dampened by Fiscal Cliff, Hurricane Sandy

  • The U.S. economy accelerated mildly from a weak 1.3 percent real GDP growth rate in Q2 to 2.0 percent in Q3.  Consumer spending increased, and so did federal government spending. The fly in the ointment came in the form of declining business fixed investment. Normally in a recovery cycle business investment would be an accelerator for GDP. However, in Q3 it was a brake as real (inflation adjusted) investment in equipment and software flat-lined and real investment in structures declined. The decline in business fixed investment, at a 1.3 percent annual rate, is coincident with growing cash stockpiles at many corporations. This suggests that businesses have adopted a defensive posture as 2012 comes to a close, perhaps in anticipation of the Fiscal Cliff. This has three sets of implications worth considering. First, is that the Fiscal Cliff is already exerting a drag on the economy, whether or not we actually go over it. Second, is that the dynamics of the Fiscal Cliff may be more complex than previously thought, and could result in a deeper drag than originally thought. Third, if the Fiscal Cliff is reduced or eliminated, there may be Fiscal Cliff “bounce” in the form of increased business investment as cash stockpiles are deployed.
  • Hurricane Sandy delivered a devastating blow to communities along the Mid-Atlantic coast. Damage totals are expected to be in the range of $50 billion, making it one of the most costly storms in U.S. history, but well shy of Hurricane Katrina. A consensus appears to be forming that Sandy has shaved about 0.5 percentage points off of  GDP growth in Q4 as purchases are delayed and businesses are disrupted. The first visible sign of drag came in the form of declining auto sales for October, down to a 14.2 million unit rate. Payroll employment numbers will likely be only slightly reduced as the data is collected during the week of the month that contains the 12th of the month. So October was not impacted, and November labor data will have two weeks to normalize after the storm.  Typically, there is a GDP bounce for a quarter or two after a hurricane strike as rebuilding efforts and new construction are mobilized. While the net result of the hurricane may actually prove to be a small economic positive at the national level, at the local level there will be long lingering negatives.
  • Labor data for October was mixed, but generally positive. The key positive was the moderate gain of 171,000 payroll jobs in October and the upward revision to September, now showing an increase of 148,000 jobs.  The trend in job creation now appears to be increasing after a weak summer. The negative came from  another counter-intuitive move in the unemployment rate, this time up, to 7.9 percent.
  • The Federal Open Market Committee’s policy announcement from October 24 delivered little new news. Operation Twist is expected to wind down by year end. QE3 is expected to march on, well into 2013 if not longer. Boston Fed President Eric Rosengren offered a “threshold” of a 7.25 percent unemployment rate as a requirement for ending QE3, which makes the end point dependent on the contours of the Fiscal Cliff. According to the New York Times, FOMC Chairman Bernanke may not seek reappointment even if President Obama is re-elected.

Click here for the complete November U.S. Economic Update, including charts of economic activity and an updated forecast worksheet: USEconomicUpdate1112.

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