The best-laid plans don’t always work out exactly as anticipated. The tax cut Congress approved last year is a case in point. The Obama Administration had expected the $66.3 billion reduction in payroll taxes to fuel an increase in consumer spending, providing an additional boost to an economy that has been improving steadily, but too slowly to make much of a dent in the unemployment rate.
But rising food and energy costs have absorbed most of what was supposed to be excess cash and inflationary concerns have encouraged consumers to save more and spend less than they might have.
Unrest in the Middle East has pushed gasoline prices up by more than 3 percent – to average of $3.19 per gallon -- in the past month alone, leading many economists to scale back their growth projections for this year. With crude oil prices topping $100/barrel the first week in March, energy costs are making just about everyone nervous.
Some analysts say the price would have to get much higher - $125 to $150 – to damage the economy; others think the price is already high enough to curb consumer spending and take a significant bite out of economic growth.
"When oil prices were ratcheting up to record levels a few years ago, unemployment was at 5 percent, not 9 percent,” David Rosenberg, chief economist with Guskin Sheff, told Bloomberg News. "The Fed had ammunition left. There was still appetite for fiscal stimulus. But there's nothing in the cookie jar today as an offset [against the impact of higher energy costs],” he warned.
Not How High – How Long
Other analysts say the issue isn’t how high oil prices rise but how long they remain elevated and, at least for now, most appear to be betting against a sustained increase that would fuel an inflationary spiral. Consumers, however, appear to be hedging those bets.
Although personal incomes increased by 1 percent in January, consumer spending increased by a scant 0.2 percent ¾ the smallest gain since June ¾ according to a Commerce Department report. Factoring in the increase in energy costs, consumer spending actually declined by .1 percent for the month, while household savings rates increased, indicating that consumers are not ready to relax the tight grip they have maintained on their wallets. At close to 6 percent of after-tax income, the January savings rate was nearly double the rate at which consumers were saving in 2007, before the economy crashed and burned.
"Overall we expect consumption to be fairly strong in the first half of the year,” Paul Dales, senior economist at Capital Economics, told USAToday. “But the way things are going at the moment, all the payroll tax cut will do is offset the rise in gasoline and food prices, rather than provide a boost to real spending.”
Before political protests erupted in the Middle East, analysts had been predicting that the U.S. economy would grow at an annual rate of more than 3 percent this year, up from the 2.6 percent consensus forecast at the end of last year, and improving on last year’s 2.8 percent growth rate, which was the strongest performance in five years. Excluding concerns about the risk of an oil price shock, economic fundamentals still look generally favorable.
Positive Indicators
“Pretty much across the board there has been a better view with regard to the economic recovery,” Bill Strauss, a senior economist at the Federal Reserve Bank of Chicago told Bloomberg News, commenting on the upbeat responses to a recent survey conducted by the National Association for Business Economics.
About 40 percent of respondents said they expect the recovery to continue at a “moderate” pace and 30 percent said they are more optimistic about growth prospects now than they were a year ago. Only 11 percent said the recovery is “sub-par,” compared with 40 percent who held that view a year ago.
An array of key indicators supports this more upbeat view:
- The Institute for Supply Management’s (ISM’s) factory index in February increased at the fastest pace since May 2004 as factories added workers and boosted production.
- The ISM’s measure of new orders also increased from 67.8 in December to 68, reaching its highest level since 2004.
- Retailers reported stronger sales in February than most had expected.
- Factory orders jumped by 3.1 percent in January, the strongest gain in more than four years.
- Consumer confidence levels, as measured by several indexes, have been increasing. The Conference Board’s index of sentiment increased to 70.4 in February, compared with 64.8 in January, posting its highest reading in three years. The Thomson Reuters/University of Michigan preliminary index of consumer sentiment also rose, as did Bloomberg’s Consumer Comfort Index, as consumers responded to recent signs of improvement in the labor market.
Employment Gains
The employment market, which has been generating an alternating mix of positive and negative signals, turned encouragingly positive in February, as an impressive (192,000) increase in private sector payrolls offset the loss of 30,000 government jobs. Particularly encouraging – small businesses were responsible for much of the increase. The unemployment rate, meanwhile, declined to 8.9 percent, despite an influx of newly optimistic job-seekers into the market.
“The economy has been clawing its way back up the side of the mountain for the better part of a year and these numbers are consistent with that,” Paul O’Neill, a special advisor to the Blackstone Group LP and a former Treasury Secretary, told Bloomberg Television. “Where we are is the process of natural healing of our economy,” he added.
The strong hiring report, while welcome, did not entirely erase other negative labor market indicators, however. Announced firings jumped by 20 percent compared with February of last year, according to statistics compiled by Challenger, Gray & Christmas, and “more job cuts at the federal level are expected in the months ahead as pressure mounts to cut costs and rein in the soaring national debt,” John Challenger, the company’s chief executive officer, said in a press statement. Those reductions, combined with the $4-per-gallon gasoline prices some analysts are predicting, “could be an extremely damaging setback at this stage of the recovery,” Challenger said.
Although no one is pooh-poohing the positive February employment numbers, some analysts say there may be less to those statistics than meets the eye. The jobs many previously unemployed workers are finding don’t often match the pay or benefits of the jobs they lost, according to these analysts, who point out that the new jobs being created, by and large, are not the high-paying positions needed to boost the economy.
“In the last recovery, we were adding management jobs at this point, and this time it’s disappointing,” observed Paul Ashworth, chief U.S. economist for Toronto-based Capital Economics. “The very best jobs, we’re still losing those,” Ashworth told Bloomberg.
Housing Pain
The housing market also continues to struggle, denying the economy the additional momentum it sorely needs.
The new home market remains in tatters; purchases fell another 13 percent to an annual rate of 274,000 in January – a record low, according to a Commerce Department report. Home starts increased by 15 percent, but that was largely on the strength of a multi-family resurgence; single-family construction fell by 1 percent, to the lowest level in two years and building permits – an indicator of future starts – fell by 14 percent, indicating that homebuilding activity isn’t likely to pick up any time soon.
“I don’t see anything that’s going to make 2011 better than 2010,” Donald Tomnitz, chief executive officer of the homebuilding giant, D.R. Horton, told reporters in a conference call. “We need job growth, we need consumer confidence and we still have issues with qualifying people with tighter mortgage underwriting [standards],” he added.
The existing home market fared somewhat better as the year began, posting a surprising 2.7 percent year-over-year January gain. But pending sales, measured by a National Association of Realtors (NAR) index, declined by 3 percent, suggesting that the January gain isn’t likely to be repeated in February or March. Distressed sales, meanwhile, accounted for nearly 40 percent of the January total, according to the NAR, 23 percent of the buyers were investors and 32 percent of the purchases were all-cash transactions – the highest level since the NAR began tracking that statistic.
A Foreclosure-driven Market
While you can view these statistics positively, as a sign of growing confidence in the housing market, they also reflect the extent to which investors are taking advantage of fire-sale foreclosure prices, which is not a particularly positive indicator.
“It is really a foreclosure-driven market,” Ethan Harris, an analyst at Bank of America Lynch Global Research, told Bloomberg News. “I don’t think it is a sign of the market returning to health.”
The continued decline in home prices suggests that ‘health’ continues to elude the housing market. The S&P/Case-Shiller index of home values took its sharpest dive in two years in December, falling 2.4 percent, as 19 of 20 cities in the data base reported year-over-year declines. The index is now 31 percent below its peak in July 2006 and only 2.3 percent above its April 2009 low point.
An increasing number of analysts, including Robert Shiller, a co-founder of the index, are predicting that prices will continue to fall this year, as foreclosures continue to inflate housing inventories, while slow job growth and economic uncertainty depress buyer demand.
“My intuition rates the probability of another 15, 20, even 25 percent real-home price decline as substantial,” Shiller told reporters in a conference call.
Economist Karl Case – the other half of the Case-Shiller index – is less pessimistic, seeing at least a “chance” that the market has hit bottom. “It looks like even the pessimistic indicators are flat,” he suggested during the conference call.
Consumers appear to be more upbeat about the housing outlook. Nearly 80 percent of the respondents to Fannie Mae’s annual housing survey said they think home prices will remain stable or increase over the next 12 months – this even though nearly two-thirds of them think the economy is on the wrong track.
Perceptions of housing and home ownership appear to be changing, however. The percentage who think buying a home is a safe investment fell to 64 percent in the January survey, down from 70 percent a year ago; eight years ago, 83 percent of Americans responded positively to this question.
Younger Americans remain relatively bullish on homeownership, with 59 percent of those between 18 and 34 still viewing it as a good investment. Minorities also continue to hold fast to the ownership dream; 34 percent of Hispanics and 35 percent of African Americans say they expect to purchase a home in the next 3 years, compared with only 23 percent of all other Americans.
