US Treasury Issues Cautiously Bullish Outlook For TBAC

WASHINGTON – The recovery continued to firm in the The recovery continued to firm in the final quarter of last year, and labor market conditions improved. According to the advance GDP report released last week, the economy grew by 2.8 percent at an annual rate in the fourth quarter, the tenth straight quarter of growth since the recession ended in mid-2009. Job growth accelerated in the final months of 2011, and the unemployment rate declined sharply, although at 8.5 percent, it still remains too high. The unwinding of the effects of temporary shocks sustained earlier last year helped boost growth in the second half of the year. Private forecasters anticipate a more moderate but stable path of expansion going forward. Even so, further progress this year in reducing unemployment from current levels may be limited. The economy continues to face a number of challenges, including the slowdown in growth overseas, particularly in Europe, and the threat of further fiscal contraction at all levels of government. The Administration remains committed to fostering stronger near-term growth and a more rapid pace of job creation and to redressing the country’s longer-term fiscal situation.

During 2011, real GDP expanded by 1.6 percent. Growth slowed sharply in the first half of the year, to just 0.8 percent, as temporary shocks including surging energy prices and supply chain disruptions related to the disaster in Japan restrained output. According to the advance report on fourth-quarter GDP, growth accelerated at the end of 2011 to a 2.8 percent annual rate from a 1.8 percent pace in the third quarter. Since the recovery began in mid-2009, the economy has grown by 6.2 percent, lifting real GDP 0.7 percent above its level at the end of 2007, when the recession began.

The fourth-quarter pickup in growth was due mainly to a marked acceleration in private inventory accumulation, which contributed nearly 2 percentage points to real GDP growth after subtracting more than half that amount in the previous quarter. Faster growth of personal consumption expenditures and a notably stronger pace of residential investment also contributed to the improved pace of activity in the fourth quarter. Consumer spending rose 2.0 percent at an annual rate, up from a 1.7 percent pace in the third quarter, and added roughly 1.5 percentage points to growth. Residential investment advanced nearly 11 percent, the most since the spring of 2010, when the home buyer tax credit was a factor. Residential investment added ¼ percentage point to fourth-quarter GDP growth after contributing little in the previous four quarters. Private domestic final purchases – the sum of consumption, business fixed investment, and residential investment – grew at a solid 2¼ percent annual rate in the fourth quarter, and by 2¾ percent in the second half of 2011. This measure excludes government spending, exports, and imports, focusing on the strength in underlying private demand. The acceleration from the first half’s pace of just under 2 percent is a welcome sign that the recovery is regaining forward momentum. At the same time, however, government spending was a large drag on growth in the fourth quarter, falling by 4.6 percent at an annual rate and subtracting 0.9 percentage point from GDP growth.

Some of the strength in the final quarter of last year reflected a reversal of the temporary factors that held down growth earlier in 2011, including supply-chain disruptions in the auto industry stemming from the natural disaster in Japan last March. Consumer spending on motor vehicles was particularly strong in Q4, surging by nearly 38 percent at an annual rate. Earlier in the year, consumption of motor vehicles was held back in part by dealership shortages of popular models due to supply chain disruptions. Consumer spending on motor vehicles plunged by 25.5 percent at an annual rate in Q2 and rose just 1.6 percent in Q3. The fallback in energy prices from peak levels reached last spring likely contributed to the recent stronger performance of the economy as well. Although oil prices have moved higher over the past few months, they remain below the peak level of $110 per barrel recorded last spring, and dipped below $100 per barrel late last week. Similarly, the retail price of regular gasoline, at roughly $3.40 per gallon, is substantially below the nearly $4.00 per gallon price tag of last May.

In the labor market, hiring continues to pick up, and the unemployment rate has recently moved lower. The private sector created an average 160,000 jobs per month in 2011, up from 98,000 per month in 2010. Job growth picked up towards the end of 2011 following a slowdown during the summer. On average, private employers added 172,000 jobs per month in the last four months of the year, compared to just 107,000 per month from June through August. Nearly 2 million private sector jobs were added last year – more than in any year since 2005 – and since the employment low of February 2010, businesses have added 3.2 million jobs to their payrolls. At 8.5 percent in December, the nation’s unemployment rate is the lowest since February 2009. It is encouraging to note that the 0.5 percentage point drop in the jobless rate during the fourth quarter was due mainly to increased employment. Other positive trends include upticks in labor force participation, the length of the average workweek, and average hourly earnings. Moreover, there are signs that job losses have slowed at the state and local government level.

Although the housing market remains very weak, recent housing data have been more favorable, suggesting that conditions are starting to improve. Single-family housing starts, permits, and home sales picked up in the last three months of 2011. The inventory of homes for sale is falling, and home builder confidence, though still very low, has improved notably over the past several months. Mortgage rates are at record low levels, and housing affordability is at an all-time high. Overall, home prices appear to be stabilizing, and the latest monthly report shows the Federal Housing Financing Agency’s House Price Index posting its largest percentage gain in nearly seven years. Of concern, though, is the potential for further declines, given the large stock of homes still in the foreclosure pipeline.

Improving economic and financial conditions contributed to a better-than-expected fiscal picture in the fiscal year just ended, FY2011. The federal budget deficit was little changed at $1.299 trillion but as a share of the economy declined to 8.7 percent of GDP from 9.0 percent in FY2010. Estimates published early last year, in the President’s FY2012 budget, projected a much larger deficit of $1.645 trillion (11.0 percent of GDP) for FY2011. The Budget Control Act enacted last August guarantees that we will trim the deficit by at least an additional $2.1 trillion over the next decade.

Set against the variety of positive signs for the future are a handful of significant downside risks, however. Although exports have provided significant support for growth since the recovery began, a slowdown in the global economy and the likelihood of recession in Europe is expected to cut into foreign demand for U.S. goods and services going forward. In real terms, exports of goods and services have increased nearly 25 percent since the trough of the recession. Growth has moderated recently, however, and in the fourth quarter imports rose faster than exports, causing the trade deficit to widen slightly. As a result, net exports (exports less imports) made a small negative contribution to real GDP growth. We also remain concerned about the possibility of financial spill-overs from the Eurozone crisis. At the state and local government level, finances remain constrained, suggesting additional fiscal drag on top of planned consolidation at the federal level.

In sum, the economy has recovered from the many setbacks it faced early last year and is clearly starting to firm. While we are cautiously optimistic about the near-term outlook, we remain cognizant of the many challenges our economy still faces, including the high level of unemployment, the threat of further fiscal contraction at all levels of government, and our vulnerability to global economic conditions. These risks underscore the importance of enacting policies that put the economy on a firmer footing. The President’s initiatives to extend the payroll tax cut and unemployment benefits for the full year should remain a high priority given the amount of fiscal drag already evident in the latest GDP data. At this critical juncture, we need to remain consistent in our support for the recovery.

Janice Eberly, Assistant Secretary for Economic Policy

Statement for the Treasury Borrowing Advisory Committee of the Secuirities Industry and Financial Markets Association

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