Monthly US Outlook

All Eyes on the Fed's Push for a Stronger Recovery

Macroeconomic data have remained mixed, with weak employment growth but a rebound in consumer spending. More concerning is that manufacturing indicators continue to suggest decelerating activity and increasing uncertainty related to future demand conditions. On a brighter note, the second estimate for real GDP growth in 2Q12 came in at 1.7% on a QoQ seasonally-adjusted annualized basis, slightly higher than the initial figure of 1.5% released last month. Improvements in the underlying data mostly reflected upward revisions to personal consumption expenditures (PCE) and net exports. Offsetting these gains were downward revisions to private inventory investment and nonresidential fixed investment. The revised data are mostly positive and keep us on track to reach our baseline scenario of 2.1% growth for the year, even with the slowing momentum in 2H12. The upward revision to net exports was mostly due to reduced imports, a sign that businesses remain highly uncertain regarding future demand conditions. However, exports continue to grow despite expected slowing in demand from Europe and China. Real personal consumption increased 0.4% in July, higher than the average monthly rate in 2Q12, signaling that PCE growth could be slightly stronger in 3Q12. Looking forward, we need to see real GDP growth near 1.4%, on average, for the third and fourth quarters in order to reach 2.1% growth for the year.

The employment report for August reflected a decline in the unemployment rate despite weak job growth. Total nonfarm payrolls increased by 96K, with private sector hiring stronger than the public sector. On the other hand, the unemployment rate declined unexpectedly to 8.1% from 8.3% in July but reflected another drop in the participation rate for the month. Ultimately, the report continues to point to ongoing weaknesses and structural problems in the labor market. For instance, the number of long term unemployed (27+weeks) was almost unchanged at 5 million, accounting for 40% of the total unemployed. The number of discouraged workers and persons employed part-time for economic reasons were also little changed from the previous month.

Inflationary concerns remain modest, although we do see some pressure building for the headline figure. Energy prices are being driven by a rebound in oil prices, while the Midwest drought has put upward pressure on food inflation. However, neither of these components have affected core prices. Average hourly earnings were flat in August and suggest little inflationary pressures from labor costs. Stabilization in core inflation is consistent with slow economic activity and large economic slack.

Given the latest data and communications from the Fed, we expect that the FOMC is more likely to announce an extension of policy guidance rather than additional quantitative easing. The latest FOMC minutes from the August 1st meeting underscored the prolonged internal debate among committee members regarding the appropriate response to slow economic activity. Members discussed various options on the table, including additional quantitative easing, extension of the policy guidance, and lowering the interest rate paid on reserves. In his Jackson Hole speech, Chairman Ben Bernanke discussed in depth the Fed's actions since the recession and the costs and benefits of additional accommodation, but his conclusions were not a dead giveaway for what the FOMC is likely to announce in the September meeting. He mentioned, as in previous speeches and communications, that the fiscal cliff is a potential risk to growth in the short-term and Congress should "avoid a sharp near - term fiscal contraction" while solving medium - - and long-term fiscal issues. Bernanke mentioned again that the Fed "will provide additional policy accommodation as needed", but he hinted at no commitment to taking action in September. We believe that the August employment report and latest macroeconomic indicators are not weak enough to drive FOMC members to announce QE3 but could be sufficient to change the policy guidance this week