Time for a reality check on the US

Standard Life Investments economist Douglas Roberts discusses the outlook for the US economy in the second half of the year.

Amid the bullish euphoria that followed the US tax deal struck at the end of 2010, many forecasters began to pencil in some rather optimistic numbers for 2011 growth. With the consumer coming on strong in Q4, QE2 on tap until June and the tax deal done, the more excitable forecasters could envisage growth of 4%, if not more. This always seemed a rather extravagant expectation – a best, best case scenario that would require all assumptions to be met, and no unforeseen disappointments along the way.

Indeed, the US economy has struggled so far this year, and forecasters have been busily revising their numbers downwards. We already know that both private investment and consumption spending disappointed in Q1, and that the balance of payments deficit was wider than expected.

Most forecasters are now looking at a 2.5% annualised rate of growth in Q1, compared to the 3.5% they had been expecting, and compared to the 3.1% in Q4 2010. There has also been a shaving of forecasts for Q2 to take account of the more elevated level of gasoline prices. However, the bulls are still clinging to expectations for an accelerated expansion in the second half of the year – so full year forecasts, generally, still top 3%.

Reasons for slow growth

What went wrong? Well, the consumer was never likely to reprise the 4% spending surge of Q4. That had been financed by the mortgage refinancing blitz between July and October last year. Since then, refinancing applications have collapsed back to the low levels seen in the middle of last year.

Nevertheless, it was reasoned that the 2% cut in the payroll tax, that was part of the tax deal, should give a boost to disposable incomes and to spending. That seemed an optimistic assumption given that consumers are still highly indebted and were just as likely to pay off debt as to increase their spending.

In the event, real disposable incomes were only up 0.4% over the first two months of the year, and real spending is only running at a 1.25% annualised rate – a far cry from the 4% Q4 advance. This is the main reason that forecasters have to re-estimate their numbers.

The problem for consumers is not just that they now have limited recourse to their housing ATM as they did last year, but they face a faster pace of price increases at the same time that wages are stagnant, with no gain in average earnings in four of the last six months. WalMart recently announced that “US consumers face ‘serious’ broad-based inflation in the months ahead for clothing, food and other products.”

The upward pressure is due to rising commodity prices and higher fuel costs for transportation.

It is true payroll growth eventually seems to be picking up, with private sector monthly job growth averaging in excess of 200,000 over the past two months. Although that is a welcome development, it has to be tempered somewhat by the very large numbers who have left the workforce, disillusioned by job prospects – without these departures, the unemployment rate would have been closer to 11%.

The most recent meeting of the Federal Open Market Committee mentioned this development as a good reason for being cautious about accepting the recent fall in the unemployment rate, to 8.8%, as an indication of the health of the labour market. Fed chief, Ben Bernanke, has regularly stressed that it would be premature to declare an established recovery until job gains became more substantial.