I’ve been meaning to put together an update for America’s economy for a week or two now, but I’m glad that I’ve waited. Earlier this month, there was evidence that we might be headed for a very strong fourth quarter and 2012. From what I remember, we were seeing numbers from the Fed at around 2.9% and numbers from the big banks sitting around 3-4%. Now that’s a little more like a recovery.
Unfortunately, the latter part of this month has not been very encouraging for those hoping for strong US growth in 2012. First, we see US growth in the third quarter, which originally was listed at 2.5%, revised downward to only 2.0%. You can read the article for some of the more specific specs, but what is most important beyond the downward revision is the 393,000 jobless claims this month, which was above the 390,000 expected. This number is below the 400,000 mark that is generally regarded as the turning point for an improving economy but it is not much lower. Along with that, there were some upward revisions of last weeks jobless claims to 391,000.
Consumer sentiment, income, and savings rate were all up on the month, though income and savings edged up only a few tenths of a percentage point. This all points to a continued recovery at a slightly weaker level that we all would have expected.
What can we blame for these weaker numbers? Well, I think we can look either East or West for our answer. In Europe, bond woes continue and contagion is apparently spreading beyond the Southern economies despite the attempts of Merkel and Sarkozy to contain it. Now Belgian yields are beginning to spread from their German counterparts, even as the Germans fail to meet their auction target at the somewhat overly-hopeful rate of 1.98%. Italian 10-years now sit above 7%. I doubt that had Berlusconi resigned earlier in the crisis, if this would have had any effect on today’s bond performance. Italy currently has a debt ratio of 120%. The problem with Italy’s situation is that despite running only modest deficits (circa 4% of GDP), it’s political system is considered sclerotic enough as to prevent effective measures to turn that deficit into a surplus or to encourage growth that might shrink the debt versus GDP. Italy hasn’t manage a single annual growth rate above 2% since the crisis ended and we’ve seen Italian inflation slowly creep up despite worries about the strength of the European recovery. The current eurozone inflation rate, for reference sake, is almost 3%. This is a rather grim set of statistics that will make any attempt to either reverse the deficit or kick-start growth quite difficult.
I’m putting a together a more comprehensive update on Europe’s situation for the coming week, but it’s worth paying close attention to the Italy situation along with any new plans that “Merkozy” may provide to help Greece from defaulting. Both of these provide quite substantial obstacles to a strong US recovery and I think we can place plenty of the responsibility for weakening prospects here on the situation on the ground in Europe.
Looking East, we notice China. Luckily for those of us worrying about an impending hard landing in the world’s second largest economy, Chinese inflation (which can be seen as a barometer for how likely any loosening of policy by the PBoC might be) eased from it’s highs of over 6% to around 5.5% this last month. This will certainly make it easier for the Chinese authorities to adjust any of the increasingly tight price controls on property markets or the high reserve ratios on banks. However, factory index data from China has weakened to “the lowest level in 32 months” to 48. The number 50 indicates the split between expansion and contraction in factory output. This could simply be a lagging influence of higher interest rates and lower loan quotas (China has a nominal cap on the amount of new loans that can be made in a year) pushing marginal borrowers into the shadow banking industry where interest rates can top 30%. For those of you who aren’t familiar with lending conditions in China, the state-owned enterprises (SOE’s) typically command the lion’s share of the loan market from their preferred status as government controlled entities. The small and medium enterprises (SME’s), who are often times manufacturers, and left to fend for themselves in the informal banking industry. Keep your eye on any changes to monetary policy by the PBoC might enact given the lower inflation data.
Overall, I predict the US economic recovery could remain below its optimal level as long as there is sufficient turbulence in the global economy that would push private sector investment into safe-haven treasuries (US 10 year bonds still sit around lows below 2.0%). Either an instability in the Euro-area, or a potentially harder landing in China (who would have thought more than a few months ago that China would be threatening US growth and not the other way around?) could fit the bill.