United States

Oxford Economic Country Briefings, Sep 15, 2008

Highlights and Key Issues

* The economic headwinds have intensified and caused us to downgrade the forecast for the next several quarters. The impact of the tax rebates has faded more quickly than expected and, with confidence at recession levels, consumers have begun to retrench.

* The decline in payroll employment has now extended to eight consecutive months and is expected to continue into 2009, constraining personal income and therefore consumer spending. In August, the unemployment rate jumped 0.4 percentage point to 6.1%, a five-year high. This will weigh on confidence, which despite a slight recovery in August remains at a very depressed level.

* Good news had not been entirely absent, however. Recently there have been signs of possible stabilization in the housing sector, declines in oil and other commodity prices and moderate improvement in the business sector. Along with continued strength in exports, these will probably prevent GDP from actually declining.

* Although inflation, both headline and core, is higher than the Fed would like, we do not expect a tightening until well into 2009. But falling commodity prices have provided some breathing room for the Fed, allowing it to wait to see if weak demand will bring inflation down in coming months.

Overview

The headwinds blow harder

* Consumer spending fell unexpectedly sharply in July, by 0.4%, after a 0.1% decline in June. These declines occurred despite the federal tax rebates, which were distributed mostly from May to mid-July. The spike in gasoline prices, to over $4 a gallon in early-July was a factor, depressing confidence and causing consumers to curtail other spending.

* In addition, payrolls have continued to shrink. The lastest report showed an 84,000 decline in August, with downward revisions to the previous couple of months' figures. So far this year, 605,000 jobs have been lost. And the unemployment rate is on the rise, jumping 0.4 percentage points in August to a five-year high of 6.1%. Both the decline in payrolls and the rise in the unemployment rate are expected to continue. This will constrain income growth, and consequently consumption, and it will put further downward pressure on confidence.

* The crisis in the housing sector continues, though there are some tentative signs of stabilization. Home sales have pretty much levelled off in recent months, but the overhang of unsold homes remains very high. That is maintaining pressure on house prices, and a recovery in home building remains elusive. Residential construction will continue to be a drag on growth, though that drag should gradually abate.

* And two sectors that have been supportive of growth may slow. Private nonresidential construction was rising at about a 20% annual rate in mid-2007 but has slowed significantly since then, though growth in Q2 was still very strong at 13%. However, the closest monthly data to this quarterly GDP component fell 0.7% in July, suggesting a further slowing in Q3. And real net trade is expected to contribute less to growth in Q3 than in Q2, and possibly exert a mild drag on growth in subsequent quarters. This will reflect both increases in imports after three consecutive quarterly declines and slower exports - US goods are still very competitive, but the economies of some of the key trading partners of the US are slowing and that will constrain demand.

* Finally, financial conditions remain very difficult, with high volatility in equity prices and widening interest rate spreads. This constrains borrowing, and thus business investment and consumer spending.

But not all the news is bad

* The economy has a couple of things in its favor, in addition to the possible stabilization in housing. The ISM indexes remain near neutral levels, which are well above recessionary readings. And new orders have been rising recently, suggesting growth in industrial production. The sharp decline in oil and other commodity prices since early-July will also support real disposable income growth, countering some of the impact of the declining payrolls.

* Finally, the federal seizure of Fannie Mae and Freddie Mac may lead to some improvement in financial conditions. Mortgage rates fell in the immediate wake of the announcement, and it is expected that the decline in house prices, which had already been slowing, will moderate further.

* Growth is expected to be very weak at an annual rate of 0.3% in Q3 and 0.6% in Q4. Obviously, it would not take much additional weakness for either of these to turn out to be actual declines. And even if growth stays positive, it will be slow enough to feel like a recession. We continue to expect growth to strengthen gradually over the course of 2009, reflecting a pick up in consumer spending and the beginning of a recovery in the housing sector. We expect annual growth of 1.8% this year and 1.5% in 2009. The slight upward revision to 2008 growth versus our last forecast is the result of the revision to growth in Q2, from 1.9% to 3.3%, which was due to stronger net exports and less stockbuilding than initially reported.