Michelle Girard is a managing director and chief economist at Royal Bank of Scotland.
Harlan Levy: What do you take away from the Federal Reserve's comments on the economy and outlook on lessening its monthly buying of Treasuries and mortgage-backed securities?
Michelle Girard: Recent comments suggest the Fed is encouraged by recent data and the resilience of the economy, even in the face of the government shutdown. But it seems they want more evidence that the pace of growth can be sustained and perhaps have some upward momentum. Our best guess continues to be that tapering will not occur until March. That will be presumably new Fed Chair Janet Yellen's first meeting, and, in addition to tapering, we think the Fed will emphasize the fact that rates will remain low by strengthening its forward guidance on interest rates in some way. We think that lowering the unemployment rate threshold is less likely than simply indicating more explicitly that interest rates will not be raised as soon as the 6.5 percent jobless rate is reached.
HL: What do you think of the Philly Fed report?
MG: We had mixed information on manufacturing activity. The broader national measure, the Institute of supply management has been surprisingly strong in recent months, and the Philly Fed was sending a similar signal. It seemed to me that these gauges suggested more strength in manufacturing than would be consistent with an economy just growing 2 percent, so I would not be surprised to see the manufacturing gauges showing some loss of momentum in the months ahead, and that may be what the Philly Fed survey represented.
HL: What's happening on the jobs front?
MG: The October jobs report was very encouraging, with a strong gain in payrolls. We had been suspicious of some of the weaker readings that were reported in the late summer and early fall. At the same time, the trend payroll growth of more than 204,000 jobs feels stronger that what I expect the economy growing at 2 percent can sustain. That said, our early read for November is only slightly softer than the 204,000 job gain in October. On balance, our feeling is that the labor market hasn't changed much over the last year. It's neither weakening noticeably nor strengthening sustainably. It's just moving sideways at a pace that will continue to bring the unemployment rate down very gradually.
HL: Is the housing recovery slowing?
MG: The backup in mortgage rates over the summer has certainly led to some loss of momentum in the housing recovery, but we don't think the housing recovery is likely to be derailed. The supply and demand conditions remain very favorable, in particular the lack of inventory has been a factor that has held back sales. Sales would be higher if there were more inventory to buy. While demand for housing may have been temporarily undermined by the rising mortgage rates, that may have more of an impact on the pace of home price appreciation than the pace of sales. We think sales can hold up not far from the levels we've seen so far this year. However, home price gains may moderate a bit from the blistering increases seen over the last year.
HL: What are the implications of the 10-year bond rate activity?
MG: The 10-year yields are in the middle of the range which we expect to persist through the end of the year, with the Federal Reserve making clear that interest rates will not be raised any time soon. And also with inflation remaining very well contained, currently holding well below 2 percent, we see the odds of a sharp move toward much higher 10-year yields as limited in the near term.
HL: Where do you see the economy going?
MG: Our expectation is that the economy in 2014 isn't going to look much different from the economy in 2013. We continue to see a gradual improvement in the pace of growth. And in fact we think 2014 will be slightly better than 2013. On a Q4-over-Q4 basis, we look for growth in the coming year to be 2.3 percent, versus 1.9 percent in 2013. The problem continues to be while some headwinds have diminished others persist. That prevents a more noticeable acceleration in the pace of Gross Domestic Product growth.
HL: What headwinds are persisting?
MG: In particular, ongoing fiscal drag from budget cuts and higher taxes will restrain growth in 2014, albeit to a smaller degree than in 2013. In addition, general uncertainty over fiscal policy and the outlook for the economy continues to keep businesses in a cautious mode. They are unwilling to hire and invest more aggressively in an uncertain environment. The other problem is the regulatory burden. Companies are having to comply with much tougher regulations. There's the Dodd-Frank Act, the Affordable Care Act, and all of that is requiring time, attention, and money that could otherwise be put to more productive uses.
HL: Some say continuing with the sequester and an emphasis on cutting spending is retarding the recovery rather than increasing spending to employ more workers who can improve our aging infrastructure. What do you think?
MG: we're long past the point of increasing government spending to boost the economy. We're not focused on cutting spending and getting the deficit down. I don't think that that poses as much drag as some others do, but I absolutely think there is some drag associated with. That's one of the headwinds that will continue to restrain growth in coming years.
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