Economic Outlook

Weaker Growth, Later Exit

Economic Outlook

The Outlook in Brief

Following another month of weaker-than-expected data, we have revised down our forecast of growth in both 2011 and 2012. As a result, we have pushed back to mid-2012 the expected start of Fed tightening.

  • Our estimate of GDP growth in the second quarter declined steadily from 3.5% in our last forecast to just 2.6% in this round, in response to data that have been decidedly weaker than expected.1 To be sure, some is due (again) to temporary factors, and evolving estimates of the impact of the earthquake in Japan, but much is not.
  • Growth projected over 2011 has been revised down from 3.2% last month to 2.8%, and growth over 2012 has been revised down from 3.5% to 3.3%, with additional fiscal drag in 2012 a factor.
  • While not huge, the changes to the growth profile were large enough to raise the unemployment rate path (aided by May's uptick). We now expect the unemployment rate to average 8.8% in the fourth quarter of this year, up two-tenths from last month.

GDP growth is expected to rebound in the second half to a comfortably above-trend pace, but one slightly slower than in last month's forecast, despite factors that would otherwise lead us to expect stronger growth.

  • We revised down second-half growth to 3.5% from 3.8% last month, despite developments that should have boosted growth about 1/2 percentage point: the removal of our assumption of federal spending cuts in fiscal 2011, a bigger assumed rebound in auto production following the earthquake-induced drop in the second quarter, and a sharper decline in energy prices than expected last month.
  • On balance, therefore, the rebound in second-half growth is not nearly as impressive as it first appears, and the loss in underlying momentum is greater.
  • Reasons for weaker underlying momentum in this forecast include: a downward revision to real disposable personal income, significantly weaker-than-expected equities, much weaker capital goods orders, and weaker housing starts, to name a few!

Our forecast of core Personal Consumption Expenditures (PCE) inflation in 2011 has been revised up 1/2 percentage point over the past four months. The question is why?

  • One possibility is that we have underestimated the residual seasonality of inflation in the first few months of the year and, thus, we have allowed too much of the recent increase in inflation to persist over the remainder of the year.
  • The other more troubling possibility is that there has been more pass through from oil prices to core inflation than the small amount we would have expected. Nevertheless, we now project core PCE inflation of 1.4% this year and next, followed by a gradual rise to the Fed's 2% objective.

We now expect the Fed to begin tightening rates in mid-2012 rather than January 2012, as a result of the further weakening of the growth outlook and higher unemployment path.

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