Business Barometer: The Economy Will Continue to Disappoint
October 11, 2013
FOR IMMEDIATE RELEASE
For More Information Contact:
Brandon Wright, Director of Communications
The Economy Will Continue to Disappoint
Harry M. Davis Ph.D
NCBA Economist and Professor of Banking
Appalachian State University
RALEIGH, N.C. – The U.S. economy is stuck in a rut and will continue to disappoint for several more quarters. GDP growth is having a hard time even growing 2% a year which leaves the unemployment rate well above 7 percent. This article will examine the potential impact of several positive and negative factors on economic growth and future bank profitability.
The stock market continues to do extremely well. The indexes and the Dow Jones Industrial Average are all at near record highs. How is it possible for the financial markets to be doing so well when the economy is experiencing only slow growth? Stock prices are largely driven by business profits. Companies continue to find ways to cut costs and operate more efficiently. More and more part time employees are being used which keeps medical and other costs down. As a result, employment growth is weak by post WWII standards. Another factor is the ”new normal” of international trade. U.S. companies can generate profits in Asia or other parts of the world even though the U.S. economy is experiencing slow growth. This systemic change in world trade makes economic forecasting even more difficult than usual.
The housing sector has been improving and is a major growth sector for the economy. New and existing home sales have been rising for three years and have reached annualized rates of nearly 500,000 and 5 million, respectively. Both numbers are driving the inventory of unsold homes to a record low level and are leading to double digit increases in home prices. Sales are also causing home construction to increase to about 900,000 units on an annualized basis. Higher interest rates hurt the July new home sales figure but the August existing home sale figure reached a 6 year high. Housing will continue to be one of the strongest sectors of the economy.
Consumer confidence started rising in February and reached a 5 year high in July and August. Since consumer spending makes up 70% of the economy, consumer confidence is critical for growth. Unfortunately, consumer spending remains in the doldrums with annual growth of only about 2.5 percent. Salary and wage increases are anemic and median family income is actually lower today than when the recovery started in 2009. The lack of job and income growth, along with higher gas prices are cutting consumer’s ability to spend.
The employment picture continues to confuse and frustrate. The average number of jobs created per month in the 1st quarter came to 172,000 but declined to only 148,000 per month in the 2nd quarter. In order to absorb people entering the labor force that number needs to be north of 200,000 per month. The unemployment rate is 7.3% after 4 years of economic growth. In August 312,000 individuals left the labor force and are now not counted as unemployed. The labor force participation rate fell to 63.2% in August which is the lowest rate in 35 years. Finally, many of the jobs being created are in the hospitality and tourism area which are relatively low paying jobs. Growth for high paying professional jobs continues to disappoint.
The high unemployment rate and low inflation rate will allow the FED to continue to buy securities keeping interest rates low for the rest of this year and into 2014. The rate of inflation is only running about 1.6% which is below the linchpin level of 2% that the FED uses for policy changes. Even though the rate on the 10-year Treasury bond has risen about 1.25% in recent months, the rate is still historically low. Chairman Ben Bernanke does not want interest rates to increase much for the rest of his term which ends at the beginning of next year.
The manufacturing sector continues to sputter. The sector needs strong economic growth in China and all of Asia. Unfortunately, economic growth in China is slowing and is likely to disappoint into 2014. On the bright side, falling and low natural gas prices are reducing costs and the large investment in the energy sector is increasing demand for numerous manufactured products. Another bright spot is auto sales which are running at around 16 million units which is the best rate since 2007.
The state unemployment rate for August decreased to 8.7% and remains one of the highest in the nation. The rate has only declined .9% in the last 12 months. Total nonfarm jobs added came to 66,700 over the last year. Leisure and Hospitality Services, Professional and Business Services, and Trade, Transportation, and Utilities are the three strongest sectors for job growth. Job creation for the state should increase next year due to tax and regulatory changes. Hopefully the unemployment rate will approach 8% by year end 2014.
Bank profitability in the 2nd quarter set a new record but further progress will depend on stronger economic growth. Net interest margins are down to the lowest level since the 4th quarter of 2006 and net interest income has fallen four out of the last five quarters. Banks have cut operating costs but additional cuts will be difficult due to additional regulatory expenses. Capital requirements will continue to increase making it more difficult to provide adequate returns to shareholders. While the yield curve has steepened slightly, only stronger economic growth (lending) can generate greater interest income which is essential for sustained bank profitability.
GDP growth for 2013 and 2014 will only be in the range of 2-2.5 percent which is the “new normal”. That rate will only lower the national unemployment rate to about 7 percent. Housing, autos, and energy will be the bright spots for the economy. Consumer spending and income growth will continue to disappoint. Washington must cut regulations and find ways to stimulate business investment in order to energize the economy.