Surprisingly Brisk U.S. Growth This Quarter

December 15, 2009

The dollar’s upturn began with improving market technical support but is now getting fed by economic data, which are highlighting a comparatively stronger U.S. recovery after a recession that, despite being harsh in absolute terms, was not as severe as other regions experienced.  In U.S. data released this morning, industrial production registered an advance of 0.8% in November, more than analysts were projecting.  In the five months since mid-2009, output increased at a 9.3% annualized pace, and the gain in manufacturing was even brisker at 11.0% annualized.  By comparison, Euroland industrial production fell 0.6% in October, the latest reported month, and grew 3.0% annualized between June and October.  U.S. industrial production showed an on-year drop of 5.1% in the year to November, whereas October versus October 2008 declines were recorded of 15.1% in Japan and 11.1% in Euroland.  Since midyear, U.S. capacity usage has risen 3 percentage points to 71.3%.

It takes an improved inventory situation or better real final sales to drive industrial production, and the U.S. economy is getting help from upside surprises from each of these sources.  In spite of the end of government auto incentives, retail sales posted back-to-back gains of 1.1% and 1.3% in October and 2.8% and 2.6% in exports in September and October.  Consumer confidence has improved by more than one would expect in the face of double-digit unemployment.  Chain store sales this holiday season seem to be performing better than feared.  Forecasts of at least 4% annualized U.S. economic growth this quarter are becoming more commonplace, and some pundits are even penciling in 5%.  In the third quarter, U.S. GDP expanded 2.8% annualized, a little more than one percentage point faster than growth of 1.3% in Japan and 1.5% in the euro area.  The differential between U.S. growth and GDP growth in those other economies during the present fourth quarter will be substantially wider than last quarter.

To be sure, the United States still has “substantial” resource slack as as FOMC statements since June have claimed.  U.S. real GDP has expanded just 1.7% per annum this decade, down from a pace of 3.3% in the 1990s, 3.0% in the 1980s, 3.3% in the 1970s, 4.3% in the 1960s and 4.2% in the 1950s.  Because of under-utilized labor and capital, monetary officials have repeatedly predicted subdued inflation for some time.  When the Committee met in November, however, they hedged the likelihood of exceptionally low central bank rates for an extended period, implying this depended on the persistence of low resource utilization, subdued inflation, and stable expected inflation.  A much bigger-than-expected 1.8% increase reported today in U.S. producer prices last month swung the 12-month PPI comparison from minus 1.9% in October to +2.4%, its first on-year gain in a year.  Energy was responsible for about three-fourths of the month’s rise in producer prices, but core PPI inflation (+0.5%) also jumped more than twice as much as had been expected.  Fears are ebbing of a Japanese-like chronic deflation in the United States and being replaced by worries about future inflation.  Runaway budget deficits have already created an atmosphere where expected inflation cannot be automatically assumed to remained anchored.

The stage is set for some modifications in tomorrow’s FOMC statement. Comments by officials have not prepared markets for a meaningful change in the phrase “exceptionally low levels of the federal funds rate for an extended period,” but language about the assumptions underlying that forecast may be stated with greater emphasis.  The assessment of production and demand will have to be upgraded — that’s of course expected.  The forecast that “inflation will remain subdued for some time” might be massaged a bit, and that’s not generally anticipated.  The statement will be combed for clarifying details about how quantitatively provided liquidity will be reabsorbed.  Bigger news would be made if anything is hinted about the timing of an initial rate hike.  I do not look for that last change to happen now, not in the middle of the holiday shopping season.  As a general rule, the Fed has made greater fireworks at its first meeting of a new calendar year in late January than its final one in December.  After a deep recession, one would not think that tradition would be changed.

FOMC statements do not deal with the dollar, but its erosion until recently is a huge reason why the U.S. economy has been showing a little more spark than other regions.  One of the big lessons of the Great Depression was that conditions were comparatively better where currency weakness was allowed first, namely in Britain.  The better tone of the dollar lately will not upset this source of economic support.  For one thing, it’s very recent. International capital flows in October reported by the Treasury this morning highlighted the dollar’s poor capital flow underpinning as recently as then.  The data provide three different measures of net flows.  The narrowest of these produced a $20.7 billion inflow, about half as much as September’s and smaller than the 3Q monthly average of $31.5 billion.  A somewhat more inclusive aggregated net inflow fell to just $8.3 billion from $26.7 billion in September, and the broadest gauge posted a net outflow of $13.6 billion versus an average monthly inflow in 3Q09 of $19.4 billion.

To put the dollar’s firmer tone this month in perspective, moreover, spot euro is currently quoted at $1.4537, which coincidentally translates to DEM 1.3454, virtually on a par with the strongest D-mark level against the dollar of 1.3450 attained on March 8, 1995.  The yen at 89.74 per dollar is also more elevated than Japan’s economy can reasonably handle, although 12.4% greater than its all-time peak of 79.85 on April 19, 1995.  With inflation and growth starting to perk up, Fed officials likely welcome the dollar’s rally.  To preserve confidence in the dollar as the lynchpin of the international monetary system, it’s important to remind markets that the dollar has upside as well as downside risk, and dollar appreciation represents a passive tightening of monetary conditions that requires no announcements from the central bank, where unwanted magnified market responses are always a possibility.

Copyright Larry Greenberg 2009.  All rights reserved.  No secondary distribution without express permission.

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