Is the US economy actually shrinking?

Remember the Disney movie “Honey, I Shrunk the Kids!”   Well, it’s happened to the U.S. economy – again…!

Remember the first estimate of 2014’s Q1?Economists and news reporters thought it was a typo: .1% GDP growth – that’s “point” 1%, as in 1/10th of one percent.   Now they’ve revised it – and it’s worse – the first-quarter contraction of the U.S. economy was 1%.   As in 1 whole percent contraction.   This is terrible news.   The economy actually shrunk.  Some may blame it all on the bad winter weather – I don’t, at least not entirely.   There are fundamental problems in the U.S.: too many new (bad) laws (Dodd-Frank, CFPB, Affordable Care Act, increase in regulations, etc.) creating too much un-certainty.  But I’m also optimistic: GDP growth in the second quarter should bounce back to a rate of 2% to 3%.   The economy will re-bound in the second half of the year: economic activity is likely to grow only 2.4% for the year as a whole, with a much stronger second half gaining at a pace of around 3%.

Also, there’s a decent chance of an upside surprise to 2014 growth – in other words, we might see growth above 3%...!   Consumer spending and confidence are still way below what would be considered normal levels by the standards of past economic expansions, so as job growth begins to return and consumers feel more secure, this virtuous cycle could be started whereby more spending begets more consumer income which in turn means more spending.    If this (finally) occurs, quarterly growth is likely to exceed an annualized pace of 3%.   If that doesn’t happen in 2014, then look for it in 2015.

Job growth improved to 288,000 in April which confirms a pickup in the economyafter a hard winter.   Monthly gains so far this year have averaged 214,000 a month, above earlier expectations of 200,000, indicating that a virtuous circle of rising incomes, output, and employment is gaining momentum.

By year-end, net job creation could be about 230,000 a month, with economic growth gaining strength in the second half of the year.   For the year, we now expect employers -- private and public -- to add about 2.6 million workers to payrolls.

Now, for the BIG news: if we do indeed have job growth of greater than 200,000, we will – for the first time since the recession ended in June 2009 – have finally gotten back all of the jobs lost due to the recession.   In other words, after five long years, we will be at break-even pre-recession levels of jobs.

As for the unemployment rate, don’t expect much more improvement.   The drop to 6.3% – the lowest since 2008 – is more of a result of would-be workers leaving the labor force than of them finding jobs.  The labor force participation rate dropped to 62.8 from 63.2 in March, with more than a third of those who stopped looking for work being long-termunemployed – out of work longer than six months.   Labor force participation has been volatile, with large numbers of people jumping into and out of the job market as the perceived difficulty or ease of finding a job changes.    The Federal Reserve estimates that perhaps a quarter of those not in the labor force is due to demographics (people aging, retiring, and dying).   But the causes for the rest of the labor force shrinking?   People are discouraged – there are not enough jobs being created.   Well, what do you expect with the economy only growing by 1.5% for the last five years?   The typical or historical growth is 3 ½ %.  And in fact, it’s likely that there will be a bump up in the reported unemployment rate (U3) in the next month or two, as an improving economy pulls more of those out-of-work into the labor force, causing a short-term pickup in the unemployment rate.

The Feds will be done with QE3 by October; this should allow interest rates to begin a gradual, incremental rise in rates.   In fact, everyone predicted that by this time (start of Q2) that interest rates would have risen.   It hasn’t happened.   Instead, interest rates have actually decreased a bit.   Why?   The bond market is at odds with the stock market: bond investors are telling us that the economy is weak, and equity investors are saying “no problem”…   Why the disconnect?   Perhaps too much easy money from the Fed for six years…   If you have an answer, please let 400-some economists know your reasoning…

Inflation will be 2%; the Feds would prefer it to be higher, like 2 ½%.   Although inflation seems tame when you look at the numbers, it doesn’t feel that way because food and gas are going up sharply.

The housing market in 2014, will be another good year – but perhaps not as good as last year.   Both building starts and new-home sales will show significant growth, but mostly due to tight inventory.   An improved housing market is its own enemy: rising home values, lack of inventory, and tighter mortgage lending rules take a toll on home sales.

The pace of existing-home sales should gradually rise to last year’s level (remember, the harsh winter depressed all sales: retail, cars, and housing), but the total will wind up about 1.7% lower this year than last: 2013 had a strong increase of 9.3%.   As prices rise and the inventory of foreclosures has dropped, fewer bargains are available, and many investors have pulled out of the market.   The recent declines in mortgage interest rates should help support sales, but this dip in rates can easily be reversed later in the year.

Sales of new single-family homes will climb by 8%, to just under 470,000, in 2014 -- strongly up, but significantly less than the past two years: 17% in 2013 and 20% in 2012.   Rising labor costs, scarcity of qualified labor, and difficulty accessing credit are hampering builders.  New homes are staying on the market for an average of just 3.4 months before being sold, still far below the 5.5-month average of the past 30 years.

2014 building starts are likely to total about 1.03 million this year -- an 11% jump from 2013 starts.   But historical 50 year average is 1.5 million units.   In April, starts climbed 13.2%, making up for quite a bit of March’s decline of 14.5%.   Growth will accelerate during the latter half of the year as the economy strengthens and building conditions become more favorable.

Home values will only show a 5% gain in 2014 due to slowing sales and increasing interest rates later this year.

Bottom line: 2014 – or more specifically the second and third quarters – could be the year that the economy begins that virtuous cycle of more jobs (think construction and oil & gas), which will allow for more spending (both consumer and for firms hiring), which means the economy grows.


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