A Recovery in Output But Not in Jobs

An excerpt from the Weekly Economic & Financial Commentary from the Economics Group, Wells Fargo Securities LLC.

For this year and next we anticipate that overall economic growth will be a bit subpar compared to the long-run trend at 2.7%. Manufacturing output has rebounded and will continue to grow over the next two years, demonstrated by gains in industrial production of 9% and equipment and software spending of 17%. Yet two traditionally strong early cycle sectors, housing and consumer durables, remain below the pace of prior recoveries. To reemphasize our statement from the Annual Outlook, December 2009, we continue to anticipate that both the pace and composition of the expansion will be very different from what we are used to or we may wish. The expected pace of job gains, 110,000 per month over the next two years, is not enough to reduce the unemployment rate below 9%. Therefore the disconnect between the actual pace of this recovery and what voters expected continues to generate political tensions and, in effect, also prompt further policy change discussions.

Short-run Harmony, Long-run Dissonance

Yet, on the economic side, markets and voters appear to be very wary of the degree of policy ease in the short-run and its implications for the long-run pace of economic growth and competitiveness in the U.S. economy. If this recovery is sustainable, it is very unlikely to be accompanied by the low level of interest rates and the high level of fiscal debts that have given it life.

Both fiscal and monetary policies have been in harmony in supporting easy policy to promote growth—and growth we have. But over time, the Fed’s intention is to keep inflation in check. On the fiscal side, the challenge is to maintain the delicate balance of providing enough policy support to maintain growth and yet not so much ease as to lead to increased skepticism about the longer-run credit rating of U.S. Treasury debt and the risk of debt monetization leading to inflation. As we have mentioned before, for fiscal policy, the party is over and bills are coming due.

Non-market Prices: The Cost of Normalization

In recent weeks we have witnessed a rise in mortgage and Treasury rates as markets have begun the difficult process of returning to open-market pricing independent of the artificial support of Federal Reserve’s buying in both markets. Our outlook has both short-run and long-run interest rates rising despite 9%-plus unemployment and under-2% inflation. Moreover, President Hoenig of the Kansas City Fed is already gearing up for higher short-term interest rates in an effort to head off the inflation bandits at the pass.

Mortgage rates are rising while many homeowners see flat prices and rising foreclosures. Unemployment rates are high and yet both monetary and fiscal policies are gearing up for moves to tighten policy. The structural excesses of too many houses and too many goods relative to demand persist as many low-skilled and semi-skilled workers see very little in their future. Indeed a very strange brew for this very atypical economic recovery.