EYE ON AMERICA
Happy holidays ahead
By Peter Morici
In a nutshell, US economic growth should reignite as we move through the
holiday season and into 2007 - if gasoline prices do not significantly rebound
and the adjustment in housing prices does not cause a large, abrupt increase in
consumer savings. The prospects for both seem low at this time.
Growth accelerating from 3.1% to 3.3% over the next four quarters seems likely;
however, this will not be enough to lower unemployment. Productivity growth
remains good; however, the
economy and labor markets will continue to underperform their potential, thanks
to large trade deficits and inappropriate exchange-rate and energy policies.
The second and third quarters may well prove the low point of the current
economic cycle. Second-quarter growth was 2.6%, and third-quarter growth is
likely to be less than 3% too. (See projections below)
3Q
2006
4Q
2006
1Q
2007
2Q
2007
3Q
2007
4Q
2007
Ann
2006
Av
2007
Real GDP
2.8
3.1
3.2
3.2
3.3
3.3
3.5
3.2
Unemployment rate
4.7
4.6
4.7
4.7
4.8
4.8
4.7
4.7
Consumer price index
(Y-on-Y)
3.3
2.8
2.8
2.2
2.0
2.4
3.4
2.4
In the third quarter, the housing sector slowed, and higher prices for imported
petroleum in July and August took a big bite out of demand for domestic goods
and services. Consumer spending continued to grow but at a slower pace. The
flagging housing market and higher gasoline prices in July and August dampened
consumer confidence considerably.
Signs of recovery in consumer sentiments emerged after the North American Labor
Day (September 4), as large retail chains were surprised by robust apparel
sales.
Gasoline prices peaked in August, and falling prices are putting more spendable
income in consumer pockets. Moreover, housing values are still up about 50%
over the past five years. Even with a moderate pullback in the housing market,
Americans are much wealthier than they were two and five years ago.
The key question is: Will Americans focus on the recent modest decline in home
prices and save more, or will they focus on the longer-term gains they have
enjoyed and are likely to sustain?
If consumers focus on the recent decline in home prices, savings performance
will improve and economic growth could slow to 2% or less. If consumers focus
on their longer-term housing gains, holiday sales will prove stronger than
retailers have predicted.
My bet is that falling gasoline, heating-oil and natural-gas prices will be
enough to ignite shopper enthusiasm, and holiday sales will be robust and beat
conservative early-September forecasts.
Although housing construction will stay below boom levels through 2007,
non-residential construction looks to be strong, and industrial capacity
utilization levels have reached levels that require significant new investments
in plant, equipment and software.
Overall, falling gasoline prices will give new life to the aging economic
expansion, and growth will recover to about 3.2% in 2007. At that pace, labor
markets will exhibit enough slack that wages will not threaten to reignite
inflation.
Along with lower gasoline and natural-gas prices, modest wage pressures will
keep prices in check, and the Federal Reserve Bank will have no cause to raise
interest rates any time soon. No change in the Fed's interest-rate policy
should be expected until well into 2007.
Modest growth, constrained wages, steady interest rates, and falling energy
prices will be good for corporate profits and stock prices. The stock-market
rally should continue, and recent big-cap stock gains should spread into the
broader market.
In 2007, the adjustment in the housing market should further benefit the stock
market. In recent years, Americans have been pouring more and more of their
disposable income into house payments to purchase ever more expensive houses,
and saving less as a byproduct. When housing prices pull back, Americans tend
to shift from investing in housing to investing in paper assets, and that
includes stocks.
Disposable income continues to grow month after month, and if Americans are not
taking on ever larger mortgage debt, they can afford both to spend more at the
mall and invest in equities. The simple calculus of supply and demand would
indicate that stock prices should rise.
Peter Morici is a professor at the University of Maryland school of
business and former chief economist at the US International Trade Commission.
