The Week In The US: A Matter Of Confidence

The US economy apparently held up better than expected to the fiscal uncertainty that plagued year-end 2012. The first statistics for 2013 are generally upbeat.

Uncertainty over the fiscal cliff and how to avoid it, which prevailed right into the first days of 2013, may have weighed solely on corporate decision making. Investment spending marked a pause, with an annualised quarterly decline of 2.3% in Q3, while monthly statistics on durable goods new orders do not allow expecting a marked rebound in Q4. Purchasing manager surveys in the manufacturing sector also revealed a downturn in confidence towards the end of the year: the ISM was down from 51.5 in September to 49.5 in December.

In contrast, fiscal uncertainty does not seem to have affected consumers much. Consumer spending remained relatively buoyant. Retail sales rose at an annualised quarterly rate of 5.8% in Q4 compared to 5.3% in Q3. Excluding building materials (which are not part of private consumption as in NIPA accounts), growth accelerated to the same extent. At the same time, inflation was mild (+0.6% annualised rate after +3.1% in Q3 for CPI commodities), leading to expect real household consumption to have increased by 2.5% in Q4, vs. 1.6% in Q3: Clearly, American consumers did not cut back on spending.

The construction sector does not seem to have suffered either. The number of homes authorised increased again in December (by almost 29% year-on-year) to reach the highest level since summer 2008. Other indicators also confirm the sector rebound. In January, the NAHB confidence index for real estate agents recorded an eighth consecutive monthly improvement, reaching the highest level since early 2006.

The construction sector created 58k jobs between May and December 2012, a 1% increase in payrolls. Home sales were also buoyant, with existing home sales up 12.4% and new home sales up 15.3% year-onyear in November. Real estate prices finally began rising again: the S&P/Case-Shiller national index was up 3.6% in the year to Q3 2012.

Although orders and confidence faltered, manufacturing production actually showed signs of revival. It rose at an annualised quarterly rate of 0.7% in Q4, correcting the 0.7% slump over the previous quarter.

Based on these figures alone, it is easy to conclude that economists overestimated the potentially negative impact of fiscal uncertainty on activity. We must admit that households’ spending resilience surprised us. Yet it is impossible to deny the drop off in confidence indexes at the end of the year, the decline in new orders for capital goods and the relatively sluggish pace of job creations.

The Beige Book, the economic report compiled by the 12 regional Federal Reserve banks in preparation for each FOMC meeting, also highlighted the effects of uncertainty on activity. Our A2F index (the balance of references in the Beige Book to the terms strong/strength, weak and mixed) has fallen by 18.5 points between June and November 2012. Over the same period, references to fiscal uncertainties increased from 6 before the summer, to 14-15 at year-end before jumping to 38 in the latest release.

The Fiscal Fix (the name given to the law that avoided the fiscal cliff) provides only a partial solution that does not address the automatic spending cuts or the need to raise the debt ceiling as quickly as possible. At least it clarifies the fiscal horizon: the burden of increased federal revenues will only fall on households, allowing the US business sector to spend part of the cash accumulated over the last couple of years on investment.

It may sound optimistic, but latest data are comforting our view. The latest issue of the Beige Book drove our A2F index up by more than 10 points. The release of manufacturing surveys by the New York and Philadelphia Feds were less supportive of our optimism, but at first sight only. Admittedly, our NEM index (a PMI-like weighted-sum of indices for activity, new orders, employment, delivery times and inventories from the two surveys) lost 0.9 point in January, remaining below the 50-threshold for the fifth month in a row.

However, while the component for employment confirmed the rebound initiated in December, the 6-month forward-looking data highlight better prospects. The NEM index for manufacturing expectations reached 56.6 in January, with both production and new orders sub-indices bouncing back above 60.

In itself, a rebound in confidence and investment in the business sector is not sufficient to support strong GDP growth. However, if it comes with growing employment, it will soften the negative impact of increased taxes on households’ income, and could allow them to keep on spending despite the end of the payroll-tax holiday.

As always with the US economy, everything will depend on the trend in the labour market. To that matter, the drop in weekly initial claims last week to 335k, the lowest reading since January 2008, was particularly good news.

By Alexandra ESTIOT