Looking for Traction on the Edge of the Fiscal Cliff

  • With the election behind us and hurricane season brought to a dramatic conclusion by Hurricane Sandy, the U.S. economy lurches, stumbles or fades at the end of 2012. The three verbs all imply a transition from the deceptively solid 2.7 percent rate of real GDP growth in Q3, to something less solid, and perhaps less deceptive, too, in late 2012 through early 2013. That there is a transition is evident. The quality of the transition is not entirely evident. A lurching economy may recover its balance. It has elements pushing it in a positive direction, such as housing and consumer spending, and elements pulling it back to recession, such as the Fiscal Cliff. A stumbling economy has fewer positives; perhaps consumers have leaned out too far over their skis and will pull back in early 2013. Business investment freezes even more than it did in Q3. A fading economy simply loses momentum. The run-up in inventories and government spending that supported the 2.7 percent growth rate of Q3 real GDP now fades, and there is nothing there to take up the slack. The three verbs also imply a heightened probability of recession for the first half of 2013, subjectively now placed at 40 percent.
  • The December forecast calls for weak real GDP growth of about 1.5 percent for the three quarters from 2012Q4 through 2013Q2. This forecast is meant to reflect a partial strength Fiscal Cliff where some, but not all, of the now-scheduled federal tax increases take place, and some, but not all, of the now-scheduled federal spending cuts take place. It is unlikely that the actual numbers will line up this way. They will most likely show either a mild acceleration from weak growth in the current quarter, or a deceleration into recession. The U.S. economy has not had, since modern data collection began in 1947, three consecutive quarters of sub-2 percent real GDP growth without soon falling into recession. Only one period comes close: 2002Q3 though 2003Q1, the jobless recovery.
  • The U.S. economy generated a moderate 146,000 payroll jobs in November beating consensus expectations that assumed more of a wash-out from Hurricane Sandy.  The unemployment rate fell to 7.7 percent as the labor force shrank by 350,000. According to the Bureau of Labor Statistics, “Hurricane Sandy did not substantively impact the national employment and unemployment statistics for November.” Downward revisions should not be a surprise.
  • The Federal Open Market Committee will issue another monetary policy announcement on Wednesday afternoon, December 12. They are expected to confirm that “Operation Twist” will end this month. Operation Twist is the program of selling short term Treasury bonds and buying longer term bonds to extend the duration of the Fed’s balance sheet and put downward pressure on long-term interest rates. The Fed is expected to roll some, but not all, of the long bond purchases into QE3, and continue them well into 2013 if not longer. There has been much discussion by Fed officials about a so-called “Evans Rule” that would tie the duration of QE3 to an unemployment rate target of, say, 6.5 percent. That would essentially marry monetary policy to fiscal policy, making the duration of QE3 contingent on the resolution, or lack thereof, of the Fiscal Cliff, and so a firm Evans Rule is unlikely.

Click here for the complete December 2012 U.S. Monthly Update, including charts, special commentary and an updated forecast worksheet: USEconomicUpdate1212.

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