Written by Jeff Thredgold, President, Thredgold Economic Associates
May 3, 2011
U.S. economic growth slowed during 2011’s first quarter, impacted by higher energy prices and poor weather. Such growth is likely to pick up speed in coming quarters.
The American economy grew at a 1.8% real (after inflation) annual rate during the January–March 2011 quarter, the weakest performance since 2010’s second quarter. The meager 1.8% growth pace was in line with the view of forecasting economists.
Growth during 2010’s final quarter was at a 3.1% growth pace, with real growth during 2010 at 2.9%, the best in five years. In contrast, the U.S. economy nosedived at a 2.6% real rate in 2009.
Gas & Snow
Higher gasoline costs (and soft consumer confidence) led overall consumer spending to rise at a 2.7% real annual rate, down from the more robust 4.0% real annual pace of the prior quarter. Consumer spending accounts for nearly 70% of all spending within the U.S. economy, one of the highest levels in the world.
Fierce winter storms closed businesses and delayed building projects in much of the U.S. during the first quarter. Blizzards led nonresidential construction activity to decline at a 21.7% annual rate during the quarter, following a modest increase in 2010’s final quarter.
In addition, severe pressures on state and local government spending and a sharp decline in military outlays led total government spending to decline at the fastest rate since 1983 (bloomberg.com). Federal government spending, when compared to the prior quarter, declined the most in 11 years.
Inflation pressures rose. The price index for personal consumption expenditures (PCE, a favorite of the Federal Reserve) rose at a 3.8% annual rate during the first quarter. The PCE core rate—excluding food and energy costs—rose at a 1.5% annual rate, in line with the Fed’s presumed 1.5%-2.0% target range.
Most forecasters see first quarter economic weakness as an aberration, rather than the norm. Forecasting economists see growth returning to a 3.0%-3.5% real annual rate in coming quarters, with some forecasts even stronger. The Federal Reserve reduced its own forecast of 2011 U.S. economic growth to a 3.1%-3.3% real rate, down from the 3.4%-3.9% forecast range announced last January.
The major unknown still involves oil price volatility tied to political & military conflicts in Northern Africa and the Middle East. Other major issues of Euro-zone sovereign debt anxiety and what may or may not happen in coming weeks relative to future U.S. government spending and the debt ceiling also makes forecasting more than a bit “iffy.”
Always keep in mind, economists make forecasts of the future not because we know what is going to happen. We make forecasts because we are asked to…a big difference!
Federal Reserve Chairman Ben Bernanke held the Fed’s first ever press conference last week, a big deal to the media—much less of a big deal to financial markets. This news conference followed the Fed’s regularly scheduled Open Market Committee (FOMC) meeting, a group that meets roughly every 45 days.
The Fed Chairman did what he was supposed to do…provide a somewhat complex explanation of what the Fed has been doing in recent years without saying something that he would regret…or that bond market players would take wrong.
Mr. Bernanke indicated that the Fed would complete its second round of additional monetary stimulus, affectionately known as quantitative easing two…or “QE2.” This program of purchasing $600,000,000,000 of additional U.S. Treasury securities—all done with newly created money—will conclude in June.
Of more importance to the majority of economists and financial market players, the Chairman indicated that the Fed would not currently schedule “QE3.” I have argued that any additional monetary stimulus (QE3) could do more harm than good as it would trigger even greater inflation anxiety, and even greater U.S. dollar weakness.
Without doubt, members of the FOMC discussed in detail variations of an “exit strategy” from unprecedented monetary stimulus that must be implemented during the next two years. The FOMC statement again noted that the current federal funds target range of 0.00%-0.25% would continue for “an extended period.” The range has remained unchanged for the past 29 months.
In coming months, financial market players will look for the elimination of this phrase as an early indication of a higher federal funds rate to follow, perhaps two meetings later. Based on the Chairman’s comments and the FOMC statement, most forecasters expect the federal funds rate to begin to move higher later this year, or early in 2012.
Monetizing the Debt?
I get the question often…“Won’t the Federal Reserve just keep buying U.S. Treasury securities with money created out of thin air and let inflation move sharply higher, thereby making it easier for America to repay its enormous national debt with less valuable dollars?” I make the case that of all the things I can worry about in “the dismal science of economics,” that is not one of them.
I was a bond portfolio manager as far back as the late 1970s. A few years before that, the Federal Reserve took some irresponsible steps that, in part, contributed to the double-digit inflation during 1979-1981.
As inflation went sharply higher, medium and long-term interest rates also moved sharply higher, pushing bond prices down severely. The steps taken during late 1979 and in 1980 by then-new Fed Chairman Paul Volcker to break the back of inflation decimated our portfolios even further.
A federal funds rate as high as 19.5% at that time, with double-digit long-term interest rates also the norm, contributed to a painful recession before inflation fell to the 3.0%-4.0% range. Mortgage rates around 15%-17%, if you could get one or even qualify, decimated the housing market.
The point I am trying to make? Bond portfolio managers collectively said “never again”…we will not let the Fed destroy our portfolios again by letting inflation get out of control.
As noted in prior writings, the Fed is playing with fire in regard to the amount and duration of unprecedented monetary stimulus. However, the bond market is holding a loud and shrill whistle to be used when and if the Fed loses its credibility. The Fed must act responsibly in 2012 and 2013 to rein in excess money creation.
The Fed has an overseer…the American bond market.