Saturday, June 30, 2007

U.S. Economic Picture Mixed

As I've said before, it seems likely that second quarter growth in the U.S. was higher than the sligtly upwardly revised 0.7% of the first quarter. This is despite the fact that the most important component of personal consumption expenditure will grow far slower than the slightly downwardly revised 4.2% of the first quarter, probably as low as 1.5% as blogger "Calculated Risk" argues on the basis of the personal income and spending release for May.

But on the other hand, business investments (particularly nonresidential construction) will probably grow faster than in the first quarter. Residential investments will probably be a much smaller drag than in the first quarter. And inventories will likely add rather than significantly subtract from growth as in the first quarter. Net exports is the big wild card and I will not try to forecast second quarter growth in any more specific terms than "higher than in the first quarter but probably not dramatically higher" before the May trade balance number is released.

Anyway though, the most interesting question is not really second quarter growth, but the outlook for the third and fouth quarter.

There are two (or in one sense three) conflicting forces in the U.S. economy. On the one hand, the housing sector remains a mess and will probably continue to be a drag for the rest of the year. Househould finances are certainly not in great shape, with the household savings rate at -1.4%. Moreover, rising interest rates, rising oil prices and falling house prices will further worsen household finances. Partially offsetting this is rising stock prices. But nevertheless, consumer spending will likely rise only very slowly at best.

Against this is the great shape of corporate America, where profits remain high, although earnings growth is stagnant in the domestic nonfinancial sector. Are the "stagnant but still very high" earnings enough to keep business investment growing significantly? There have been conflicting signals about this lately. The answer to this question is arguably the single most important factor in determining whether America will fall into a recession or continue with merely slow growth. Other factors, most notably various market signals such as bond yields, stock prices and oil prices is also important, but business leader assessment of whether it is profitable for the to increase investments is arguably the most important factor.


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