U.S. Review
A Huge Week for Policy Announcements
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The U.N. General Assembly, G-20 and FOMC meeting overshadowed this week’s economic news. Stimulus efforts remain in place but some programs are approaching expiration and plans were announced for an orderly winding down of the Fed’s quantitative easing.
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This week’s key economic news included reports on new and existing home sales. New home sales rose 0.7 percent, whereas existing home sales fell 2.7 percent.
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Weekly first-time unemployment claims fell more than expected, dropping 21,000 to 530,000
The Leading Economic Index may Hold Some Key Clues
The Leading Economic Index may be giving us some key clues on the answer to the often asked question about what the letter shape of the economic recovery will most closely resemble (V, W, U or L). The LEI fell for 20 consecutive months following its peak in July 2007, which marked its longest downtrend since the deep recession of the early to mid-1970s. The LEI bottomed in March and has risen for five consecutive months. The increase would be consistent with the recession ending this summer. If this proves to be correct, the downtrend in the LEI would be roughly consistent with the length of the recession. Moreover, the LEI would have provided a five-month lead on the start of the recession and four-month lead on the start of the recovery.
Discussions about the usefulness of the LEI usually focus on its accuracy at predicting turning points in the business cycle. The LEI has given a number of false signals of recessions in the past but has a slightly better record at predicting recoveries. The strength and breadth of the rebound in the LEI may also provide us with some indication about the shape of the recovery. The LEI came storming back in April and May, rising 1.0 percent in April and 1.3 percent in May. Seven of the 10 indicators increased in both months, with the stock market, interest rate spread and consumer expectations leading the way.
The pace of improvement in the LEI has lessened somewhat in recent months, rising 0.8 percent in June, 0.9 percent in July and 0.6 percent in August. Not only has the pace of improvement slowed but the breadth of improvement has also narrowed. Only six of the 10 components of the LEI rose in August, and much more of this past month’s increase came from the financial components, such as the stock market and interest rates spread, rather than the purely economic components, such as the average workweek and factory orders.
The letup in the pace of improvement of the LEI may lend some support to those looking for a W-shaped recovery. After a strong start, growth will likely to settle back down a bit. And that trend will likely be reinforced by the ending and winding down of key stimulus programs like the $8000 tax credit for first-time homebuyers and the Fed’s purchases of asset-backed securities and Treasury bonds. Just because we have a W, however, does not mean the second downward leg will result in a decline in GDP. Our current forecast has real GDP rebounding at a 3.7 percent pace this quarter, followed by 2.5 percent growth in the fourth quarter and 2.0 percent growth in the first quarter of next year. The LEI numbers are consistent with this outlook.
Most of this week’s other key economic reports were also consistent with at least some modest improvement in the broader economy. Sales of new homes rose 0.7 percent in August, following a downwardly-revised 6.5 percent gain in July. New home sales have risen for five consecutive months and appear to benefitting from the $8000 tax credit for first-time homebuyers. The benefit from that program now appears to be waning. Sales of existing homes fell 2.7 percent in August.
Global Review
G-20 Summit: Coordinated Policies Ahead?
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When the leaders of the G-20 countries gathered in London in April, the global economy was in its worst recession in decades. As they met in Pittsburgh this week, a tentative global recovery appears to be taking hold.
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Promises of continued macroeconomic stimulation may be difficult to achieve in practice. Although many advanced economies will probably need accommodative policies for some time, many developing economies will most likely need to withdraw some stimulus in the months ahead to ward off another inflationary outbreak.
What a Difference Five Months Make
When the leaders of the G-20 countries gathered in London in early April, the global economy was in the midst of its worst recession in decades. As they met in Pittsburgh this week, the outlook had certainly improved. Stock markets worldwide have rallied since their March lows as signs of global recovery have become more widespread (see graph on front page).
Should credit for the incipient global recovery go to the summit meeting held in London in April? Probably not. Most G-20 countries implemented expansionary monetary and fiscal policies late last year and early this year, and these policies have helped to stabilize the global economy. In that regard, the leaders deserve credit for the policies their countries undertook individually. However, the decisions that the G-20 leaders made as a group in London in early April likely have had little effect, at least so far, on the global economy.
President Obama, who hosted the summit meeting this week, was keen to get his counterparts to agree not to withdraw macroeconomic stimulus until a global recovery is truly self-sustaining. Although the communiqué, which had not yet been released as of this writing, likely will make some reference to ensuring recovery, it will be interesting to see what individual countries do in the months ahead. Now that priorities may be starting to diverge, continued coordination may be more difficult to achieve.
Consider the OECD countries, the 30 most advanced economies in the world. Although industrial production has come up off the bottom, the upturn so far has been rather muted (see top chart). Many of these countries went on a credit binge during the past few years, and growth in the quarters ahead will likely prove to be frustratingly slow as banks and consumers in these countries continue to delever. For them, continued macroeconomic stimulus is probably necessary. On the other hand, many developing economies are well on their way to self-sustaining economic recoveries. For example, Chinese industrial production growth has trended higher since the beginning of the year (middle chart). Most developing economies outside of Eastern Europe were not overly leveraged coming into the crisis, and they have been able to recover fairly quickly. For them, it is not as readily apparent that continued stimulus is needed.
CPI inflation rates in most developing economies have declined in recent months, but deflation is generally not much of a concern in the developing world at present (see Russian CPI in bottom chart). As economic growth strengthens, inflationary pressures may start to rise again in many emerging economies. Indeed, we project that CPI inflation rates in most of the developing countries that we follow will pick up somewhat over the course of the next year or so. Will these governments really want to continue stimulating their economies if inflation is becoming a problem again? When inflation starts to rise, will governments of developing countries stand by the promises made in Pittsburgh or will they start to tighten policies? Our bet would be that they follow the latter course of action.
