United States – Down we go!

Juli 16, 2012

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GDP growth in 2012 should be 2.1%, with downside risks in H2 2012. In 2013-14, we expect GDP growth of around 1.7%…….

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The focal point of our outlook is harsher fiscal tightening, offset only in part by further monetary stimulus. Core inflation should decline in H2 2012, due to weak demand and to the limited pricing power of businesses. The FOMC is expected to introduce new monetary stimulus by its September meeting, outweighing only in part the restrictive effects of US fiscal policy and slower global demand.

– The US recovery is losing steam, affected by both domestic and global factors. The year 2012 should be followed by an extended period of weak growth, tied to the expected fiscal consolidation and to a local and global economic situation that is still feeling the impact of excessive debt levels. In 2012 GDP growth is forecast at 2.1%, before slowing to 1.7% in the 2013-14 period.

– The risks weighing on our US forecast are very broad, and slightly skewed to the upside for 2013. The main element of uncertainty is the evolution of fiscal policy, especially unpredictable ahead of the elections in the autumn. Current legislation includes “automatic” tightening measures worth around 600 billion dollars (4% of GDP) for fiscal year 2013: if enforced, they would trigger a contraction already as of 2013. What’s more, in November 2012 the statutory debt limit should again be reached.

– Our scenario includes a last-minute agreement in Congress that will block most of the measures, but not all of them, resulting in enhanced fiscal tightening, worth at least 200 billion dollars in 2013. The elections should result in a split government, generally associated with legislative deadlock.

– The Fed has pushed back in time the expiration of its portfolio maturity extension programme, with the reinvestment of agency and MBS coupons and principal until the end of 2012. The FOMC’s bias remains interventionist. In case of a further slowdown in growth and the labour market’s failure to reabsorb slack, the FOMC is ready to introduce new stimulus through a further increase in balance sheet assets. In light of existing risks to growth, and of data on the employment trend, we assign a probability of close to 70% to the announcement of QE3 worth around 400-600 billion by the end of September, with a substantial share of MBS purchases.

– In light of the minutes of its June meeting, the FOMC will probably push back (at least to mid- 2015) the expected date of its first interest rate hike. Between August and September it could also announce credit easing actions, may be through programs aimed at prompting more lending in specific markets.

In conclusion, in light of generally weak monthly economic data, both at the domestic and international levels, we continue to expect the announcement, by the September meeting, of a securities purchase package to include MBSs. The minutes let on that in addition to a new securities purchase package, the Fed may introduce other new measures at the next meetings:

1) postponement, at least until mid-2015, of the initial interest rate hike, and 2) opening of credit easing programmes to reap more significant and widespread effects on credit conditions.

Fiscal policy: tightening started in late 2011
The uncertainty surrounding 2013 fiscal policy is dominating the US scenario, while the emergency light on the economy has lit up again. Under existing legislation, tax rises and spending cuts totalling around USD 600Bn would be implemented in the 2013 tax year. For the calendar year, restrictive measures would be worth USD 770Bn (5.1% of GDP).

In the absence of a political agreement blocking all or at least some of the measures, the US economy would be in recession in early 2013. In our central scenario, an eleventh-hour agreement will be found that postpones many of the automatic measures. We forecast that growth will slow in 2013. Restrictive fiscal policies are also likely to continue in the following years, curbing US GDP growth by somewhere in the region of 2% over the long term.

According to the Bipartisan Policy Center, Congress leaders are discussing an agreement that could allow them to postpone all the restrictive measures envisaged by current legislation until March 2013. The agreement would also include an expenditure bill to finance the US Treasury until March. This agreement would mean that all tax and spending decisions could again be postponed until after the inauguration of the new president and the new Congress. In the event of such an agreement, we think that there would be further fiscal tightening in 2013, but it would be more limited than that incorporated in our current scenario (around USD 200Bn), partly because the restrictive measures would only apply for half the calendar year. Projected growth could therefore rise to 1.9% for 2013, from our current forecast of 1.7%, but restrictive measures would then be greater in 2014. At the moment however, there is no indication of a solution to the impasse taking place before the elections.

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