This will likely be the last analysis roundup of 2012. The first edition next year will be posted on or before January 4th.
No Hope for Good Yields from Treasuries
Bloomberg posted this chart this morning, showing how yields on 10-year US Treasuries have remained bottomed out at below 0 for two consecutive yields, remaining far below even the most modest measures of inflation. For municipal governments dependent on Treasury-based investment funds to generate at least a little off their savings, as well as the elderly managing their retirement cash, this trend, facilitated in large part by the continuation of quantitative easing, is not a positive harbinger for the future.
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Our 2013 forecast remains cautious to say the least. Real GDP growth appears to have slowed to around a 1 percent annualized rate during the final quarter of 2012, as businesses have put expansion and hiring plans on hold ahead of the fiscal cliff negotiations. We expect growth to get off to a slow start in 2013, as higher taxes hit households at all income levels. Federal government spending will also contract modestly. We expect growth to rebound modestly by the middle of the year, as the economy moves further away from the fiscal cliff and homebuilding gains momentum.
Propelled by an improving housing market, continued employment gains, and a better household financial balance sheet, the economy will expand again in 2013. The national economy will grow between 2.25% and 2.5% (Gross Domestic Product), add 2 million jobs, and reach a 7% unemployment rate by the end of 2013. Buoyed by reductions in their debt/income ratio and gains in their net worth, consumer spending will lead the way with the best growth rate in four years.
Better numbers are also predicted for the North Carolina economy. Both output (Gross State Product) and employment growth are expected to exceed national rates in 2013, resulting in a payroll employment gain of 68,000 jobs and an unemployment rate falling by 1.1 percentage points (compared to a 0.8 percentage point decline for the nation). The state’s economic growth will be driven by its high labor productivity, competitive business costs, and location in the expanding Southeast. Anticipated economic growth resulting from the opening of the larger Panama Canal will also be a positive element for the state economy. Raleigh-Cary, Durham-Chapel Hill, and Asheville will have the lowest unemployment rates in the state at the end of 2013, with Raleigh-Cary’s rate falling to under 6%. The strongest job growth by sector will be in professional and business services.
Upper-end projections for GDP growth in 2013 remain at 3%, with national unemployment expected to remain in the upper-7% range.
The Fed Establishes Benchmarks for QE
On Wednesday, the FOMC announced more quantitative easing at a rate of $85 billion a month for an extended period of time. The Bernanke Fed has also modified its guidance, noting its ultra-accommodative stance will remain in place until the unemployment rate falls below 6.5% and inflation projections remain no more than half a percentage point above 2% two years out.
QE4 is here. Only a few months after announcing what had been dubbed QE3, an open-ended $40 billion a month program to buy up mortgage backed securities (MBS), the FOMC decided to extend its asset purchases in 2013 as Operation Twist expires.
The Fed will therefore accelerate its rate of balance sheet expansion, easing monetary conditions further. While Operation Twist had been sterilized, which means the Fed sold assets at the same rate as it was gobbling them up, the new program will consist purely of Treasury purchases. Combined with QE3, the Fed will be taking $85 billion in bonds, both Treasuries and MBS, out of the market. The FOMC also decided to begin rolling over its maturing Treasuries as of January.
Bernanke’s biggest surprise came in terms of the Fed’s forward guidance. The FOMC moved from a calendar-based guidance to one tied to economic factors, specifically, inflation and unemployment (which constitute the Federal Reserve’s dual mandate)…
Once again, the Richmond District President, Jeffrey Lacker, was the sole member of the FOMC to vote against the policy continuation and changes.
“I disagreed with the Committee’s decision to continue purchasing additional assets to stimulate the economy. With economic activity growing at a modest pace and inflation fluctuating close to 2 percent — the Committee’s inflation goal — further monetary stimulus runs the risk of raising inflation and destabilizing inflation expectations.
“I also objected to the continuing purchase of agency mortgage-backed securities. If asset purchases are appropriate, the FOMC should confine its purchases to U.S. Treasury securities. Purchasing agency mortgage-backed securities can be expected to reduce borrowing rates for conforming home mortgages by more than it reduces borrowing rates for nonconforming mortgages or for other borrowing sectors, such as small business, autos or unsecured consumer loans. Deliberately tilting the flow of credit to one particular economic sector is an inappropriate role for the Federal Reserve…
“I agree that it’s useful for the Committee to describe how its future actions are likely to depend on the evolving state of the economy. However, monetary policy has only a limited ability to reduce unemployment, and such effects are transitory and generally short-lived. Moreover, a single indicator cannot provide a complete picture of labor market conditions. Therefore, I do not believe that tying the federal funds rate to a specific numerical threshold for unemployment is an appropriate and balanced approach to the FOMC’s price stability and maximum employment mandates. I would prefer to describe in qualitative terms the economic conditions under which our monetary policy stance is likely to change.
The National Federation of Independent Business’ (NFIB) Small Business Optimism Index declined 5.6 points to 87.5. According to the NFIB, November’s drop was one of the largest on record and is the largest singlemonth drop dating back to 1987. The fall in small business optimism is consistent with our own quarterly small business survey, which posted its largest drop in four years during the fourth quarter. Small businesses are concerned about the future course of public policy, particularly as it relates to taxes and regulation. Business owners also seem to be more concerned about future economic conditions. Small businesses are more susceptible to changes in the tax code and part of the most recent decline likely reflects uneasiness about the fiscal cliff negotiations.
Big Business Sentiment Mixed, Manufacturing Lagging
Manufacturing activity cooled slightly during November, with the composite index sliding 2.2 points to 49.5. With the drop, the ISM manufacturing index has been below the key 50 breakeven level during four of the past six months. A reading below 50 signals that more manufacturers see conditions worsening in their business than see them improving…
…While it is always difficult to draw too many conclusions from one month’s survey results, November’s data suggest that manufacturers have turned more cautious following the presidential election and increased focus on the fiscal cliff. Fewer manufacturers report increased orders and more manufacturers report that their customers are reducing their inventories.
Business activity shot up 5.8 points to a stellar 61.2, marking its highest level since February. Thirty-one percent of businesses surveyed said that business activity improved in November, while just 14 percent reported that it decreased… The supplier delivery index fell 2.5 points, which indicates that more firms noted that delivery times shortened during the month…The employment component fell 4.6 points to 50.3 in November, with the most significant declines occurring in arts and entertainment, mining, management of companies and support services, professional and technical services, and hotels and restaurants. By contrast, hiring rose in agriculture, forestry, construction, retail trade and other services…While the overall index rose in November, the service sector appears to have slowed, particularly in the largest employment categories, such as business and professional services. Much of this past month’s gain appears to be tied to the budding recovery in housing and late harvest in the farm sector.
What Does the Fiscal Cliff mean for the Tar Heel State?
Generally speaking, not too many people are excited about the prospect of Congress and the President failing to reach a solution in order to avoid tax increases and budget sequestrations scheduled to take effect at the first of 2013. We have outlined the impact of the “fiscal cliff” situation before, so here are what some are now saying as it begins to approach us.
In 2011, North Carolinians collected roughly $69.1 billion in government assistance. Payments stem from a list of programs, including Medicaid, Medicare, unemployment, disability, veterans assistance and food stamps.
Nationwide, government programs awarded $2.2 trillion to residents last year, according to estimates from the U.S. Bureau of Economic Analysis. The monies make up a large chunk of some people’s income.
“It’s really quite simple: People who get the spending like to keep getting it,” veteran Washington budget analyst Stan Collender said. “Almost any spending that’s still in the budget has substantial political support.”
Numerous polls show widespread enthusiasm for cutting spending in general, but there’s resistance to specific trims, Collender said.
“With the possible exception of foreign aid, and every once in a while NASA, almost nothing has a majority of support for cutting,” Collender said. “If you read the public opinion polls, Americans don’t want their government to do less; they just want it to cost less.”
We have heard that the fiscal cliff is really a slope, that tax increases and spending cuts could be administratively delayed or retroactively reversed, that kicking the can into 2013 makes sense to intensify the pressure for a deal. That thought process is reckless and naïve.
As North Carolina State Treasurer, I am concerned about potential impacts on our pension fund, our bond rating and the state budget.
With time running out before year-end, investors get nervous, causing market volatility and accompanying unpredictable pension returns. If returns are low, North Carolina’s taxpayers will need to make up the difference.
Punting on the fiscal cliff would send rating agencies the wrong message – that our federal government is truly dysfunctional. As Alan Krueger, Chairman of the Council of Economic Advisors, put it, the message would be that government cannot solve the problems it is there to solve. If the federal rating is downgraded another notch, North Carolina’s AAA bond rating will be automatically knocked down a rung on the ladder making it harder to fund roads, schools and other capital improvements.
In a worst case situation where Congress does nothing, experts suggest America’s GDP would be cut by 4 percent, sending our economy back into a recession and putting 2 million individuals out of work. Here in North Carolina, if no deal is reached, an estimated 100,000 people could lose unemployment benefits and the typical middle-class family earning an income of $63,700 could see their income taxes rise by $2,200, according to a White House report. Going over the cliff also means a 6.3 percent cut in state revenue from the loss of federal money. North Carolina’s military bases and research universities will feel the impact in particular.
As the steward of our public pension system, I am responsible for the retirement security of 875,000 police, firefighters, teachers, health care workers and other state and local employees.
Their pension investment returns depend on the economic growth of the United States if we cannot solve our long term structural deficit.
Over time, the rising level of America’s debt squeezes out priorities that keep us competitive. We lose the opportunity to invest in things that really matter to North Carolinians − education, technology, job training, research, and infrastructure.
Business Owners Selling in Anticipation of 2013 Tax Increases
A November 1st Wall Street Journal article profiled several business owners across the country who were selling their businesses this year in order to avoid paying higher taxes on investment income, as well as to liquidate built up equity for retirement purposes.
“It just made more sense for me to take my chips off the table and go do something else,” said Bert Wolf, 60, who has an agreement to sell his compress-gas business, Acetylene Oxygen Co., of Harlingen, TX, before year’s end.
Mr. Wolf added that if he waited until after the tax increase to sell, he would have to expand the business at its current rate “for 3 or 4 more years to achieve the same after-tax dollar.”
“There’s a kind of a panic on to get things done,” said Beatrice Mitchell, co-founder of Sperry, Mitchell & Co., Inc., a New York investment bank advising Mr. Wolf on the sale.
The trend is also happening in North Carolina. Earlier this year, Rocky Mount-based Meadowbrook Meat Company, a family-owned business and one of the nation’s largest food distribution operations, sold out to McLane, a global trucking company that is part of Berkshire Hathaway.
Smart investors, CEOs, and entrepreneurs are already bracing for impact. As Triangle Business Journal recently reported, “large numbers of business owners are scrambling to sell their companies before January” because “for many, the currently lower tax rate translates into tens or even hundreds of thousands of dollars.”
This is what happens in the real world when politicians indulge the prejudices they harbor in their fantasy world. Taxes affect the prices of labor, resources, and capital. They push people into making decisions they wouldn’t otherwise have made, with largely deleterious consequences for the economy as a whole.
Economic conditions in the Fifth Federal Reserve District generally improved in recent months with moderate improvement in labor markets, housing markets, and among area businesses…Reports on the North Carolina economy suggested moderate improvement in employment conditions and mixed conditions in the housing market.
While data this week showed that the economy is nowhere near falling off a cliff, it is lacking much to be cheerful about. With negotiations surrounding the fiscal cliff still up in the air, small businesses are beginning to show concern about the near-term path of the economy… Consumers are proceeding with caution as we head into the final weeks of the year. Retail sales disappointed in November by rising 0.3 percent, which was just enough to offset October’s decline. Core sales, which excludes autos, gasoline and building materials, looked a little stronger with an increase of 0.5 percent, and suggest that consumers have not gone completely into hiding for the holiday season (see top chart on page 1). Sales picked up across a broad range of stores, led by non-store retailers where sales rose 3.0 percent and are up 12.4 percent over the past year