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Weak Worldwide Growth Spooks Markets

Bad news from around the world could mean bad news for the U.S., too.

It was a very bad week for worldwide equities and commodities while bonds and conservative investments did quite well. Setting off this week's free fall was more bad economic news out of Germany combined with a report from the IMF that again reduced its forecasts for worldwide growth. While the report wasn't exactly new information, it was a catalyst for investors that had already grown a bit weary of high valuations. That generally bad news for the economy turned into good news for some on Wednesday when the Federal Reserve minutes mentioned worries about the world economy. Some investors surmised that those worries might lead the Fed to raise rates later rather than earlier. Then reality set in again on Thursday when everyone decided slowing growth wasn't such a good deal after all. Falling oil prices didn't help that very important sector of the market, either. While I generally like falling oil prices because of the positive effects on the consumer, prices have now fallen enough to potentially slow the U.S. oil boom if this week's prices are sustained. Worse, falling oil prices could begin to really squeeze Russia, which could cause them to make even more provocative maneuvers on the world stage.

There wasn't much economic news in the U.S. to speak of. The U.S. budget deficit came in better than expected after a swell of tax collections in September. The number of job openings surged in August, confirming the strong data from the September employment report. Initial unemployment claims fell to near recovery lows yet again, also affirming the health of the labor market. However, the consumer still seemed cautious with no major breakout in spending this week and consumer loan growth slowing yet again. The caution comes despite the fact that gasoline prices continued their free fall, now standing at $3.24 per gallon, perilously close to its lowest price since 2011. Falling oil prices this week may keep those gasoline prices going down for another few weeks, too. There was more good news for the consumer, too, as Freddie Mac mortgage rates dropped from 4.19% to 4.12% week to week and down from 4.53% at the beginning of the year. That indeed has helped halt the slide in housing affordability.

The IMF Reduces its World Growth Forecast for 2014 and 2015
The IMF releases one of the more comprehensive forecasts of global economic growth several times a year. Markets seemed to take the new report as some kind of shocking revelation. Instead, I think the report still looks a little too optimistic, especially relative to China and Europe.

Overall, the report the report now predicts just 3.3% growth in 2014 and 3.8% for 2015, down 0.1% and 0.2%, respectively, compared with the IMF's July forecast. The new forecast means that the world growth rate has been basically unchanged in each of the latest three years. Each year usually began with hopes of an improving situation, only to see those hopes dashed by the time the final numbers were reported. This same October report, produced a year ago, was forecasting 3.6% growth for 2014 (now 3.3%). Keeping with IMF tradition, things will be better next year and growth will accelerate to 3.8%.

That new lower number still looks a little high to me, and the numbers for Europe and especially China look a bit high to me, too. Below is a table showing the changes between the July report and this week's report.

The news for 2014 would have been even worse if there hadn't been such a sharp increase in the numbers for the U.S., increasing to 1.7% from 2.2%. Europe, Japan, and Brazil were the primary causes for the 2014 growth forecast decrease. Europe, Brazil, and Russia were the primary culprits of the decreases in 2015. The Russian situation could get considerably worse if oil prices continue to decline. And a weaker Russia will not be good for a European economy that is already stumbling. With China's growth rate slowing, and mix of growth shifting to the consumer (which means less use of natural resources and basic commodities) I am surprised that emerging-market growth rates did not take an even bigger hit in this round of forecasting.

The U.S. Will Not Be Entirely Immune to Slowing World Growth
I have generally had a pretty sanguine view of slowing world growth and its impact on the U.S. economy. With just 13% of U.S. growth dependent on exports (and the bulk of that from Mexico and Canada) we are much less exposed to slowing world GDP growth than most other countries that typically get a third or so of their GDP from exports. In fact, falling commodity prices that slowing growth rates engender could be a net positive for U.S. consumers. However, the slowdown is also hurting oil prices, which would potentially put the brakes on the U.S. oil boom. At $80 a barrel or less, many fracking projects lose their economic feasibility. I am not so sure that this week's drop in oil prices to the mid-80s will prove to be sustainable, but prices are now getting a little too close for comfort.

Too, my optimism relative to the world economy and the U.S. assumes that things abroad don't collapse. A bank failure in Europe would indeed affect the United States. A collapsing Russia would not be a great thing either, especially if it were to lash out militarily. Those types of things would affect the relatively well-protected U.S. economy. Let's hope that things don't get that bad.

Job Openings Continue to Increase
The job openings report contained both good news and bad news for economists. On the bright side, job openings surged in August, indicating a stronger desire to hire employees in the future and therefore a stronger economy. The bad news is that despite months of improvement in openings, hiring fell, indicating the employers are having a hard time finding workers because of inadequate worker skills, unwillingness to pay market-acceptable wages, or the lack of mobility of the workforce (unwilling to move to take a job). Perhaps most troubling, the quits rate fell, which is generally an indicator of falling worker confidence.

The number of job openings jumped from 4.6 million to 4.8 million in a single month. The number of openings is now higher than at any time since 2001. That is probably a little Pollyannish though, because of population growth since then. More meaningfully, the ratio of the number of unemployed to the number of job openings, has fallen to 1.98, the best (lowest) ratio since 2008. It is also way down from the recession high of near 7. This would seem to indicate that employees are about to gain the upper hand in pay discussions somewhere in the very near future.

As we noted in our discussion of the August payroll report last month, August was not a great month for hiring, although some of that may be because of statistical and seasonal adjustment factors for the month. Hiring fell from 4.9 million to 4.6 million in August, according to this week's report. The September employment reports suggest that there will be a surge in hiring in the JOLT report for September, which won't be released until November. It will be interesting to see if the burst in September hiring finally makes a dent in the surging openings data.

The quits data is harder to explain. With unemployment claims remaining uniformly low if not falling, and the headline unemployment figures dropping, it's hard to explain why so few workers are quitting their jobs. I am not sure if it is some statistical fluke or if Ebola fears and ISIS headlines spooked workers.

U.S. Budget Deficit for Fiscal Year 2014 Comes in Smaller Than Recent Forecasts
As I suspected last week, the U.S. budget deficit for fiscal year 2014, ended on Sept. 30, fell to $486 billion, better than the Congressional Budget Office forecast of $506 billion. The results bettered the CBO estimates primarily because of a last-minute surge in tax receipts in September. There was a $195 billion reduction in the deficit from $680 billion in fiscal year 2013. The 2014 deficit level is just 2.8% of GDP that is below the average of the past 40 years. It is the fifth year of deficit reduction progress, and is greatly improved from the 9.8% deficit level reached in 2009.

The deficit progress was primarily a result of increased tax collections due to a stronger economy, higher tax rates, and a small positive improvement from an increase in the payroll tax. Spending, ex a few special factors, increased 0.3%. Adjusted for inflation, government spending would have been down.

Spending Restraint Remains Remarkable and Unprecedented
The key reasons spending was so constrained was falling defense spending and declines in unemployment insurance payments. I suspect that both of those factors will continue to benefit the deficit in 2015, though perhaps by not as dramatically as in 2014. The biggest increase was due to Social Security, which saw increased benefit payments thanks to inflation as well as a greater number of retirees, a trend that may worsen next year. Medicaid also showed some very healthy increases because of provisions of the Affordable Care Act that broadened eligibility in certain states. Payments from Fannie Mae and Freddie Mac (government sponsored enterprises, or GSE) were still elevated though considerably smaller than in 2013. Those contributions should shrink even more in 2015, and new legislation/restructuring will potentially eliminate these payments, though probably in subsequent years and not in 2015.

Budget Data Should Be Under Good Control Through 2020
Wrapping all the data together, the CBO believes that the deficit will fall further in 2015 to $469 billion. That would put the deficit at 2.7% of GDP. That is likely to be the best result for this economic cycle, though the deficit isn't projected to move over 3% again until 2020, before accelerating again with more baby boomer retirements. Unfortunately, though falling in size, the deficits are projected to continue each year, meaning there will still be more debt outstanding than today and interest rates are likely to be meaningfully higher than today. That could mean that interest payments will be a big part of the worsening deficit picture in 2020 and beyond.

All in all, the budget situation is far better than anyone imagined just a couple of years ago. New taxes, which no one believed possible, spending limits, unemployment rates that fell precipitously as well as a new lower trend line in health care inflation have brought about this very favorable state of affairs. One set of projections from CBO from early 2012 suggested the fiscal year 2014 deficit could have been as high as 6% of GDP instead of the actual 2.7% rate that was just released.

Consumers Holding Their own, but not Accelerating
My version of consumer confidence is doing OK, but not great. There was a brief surge in weekly chain store sales, which has subsequently fallen back a little. Last week, auto sales missed the mark but still looked better than a year ago. Even consumer borrowing has backed off again. And anything related to housing has clearly paused.

I don't have a great reason for why the pause now. The jobs numbers looked very good, gasoline prices are down to their lowest levels of the recovery, interest rates and mortgage rates are back down, yet consumers seem to be as cautious as ever. Normally, any one of these factors would have been enough to kick off a consumer spending spree. I am still betting the consumers will close out the year on a high note and it is just taking awhile for all the recent good news to work its way through the system.

Retail Sales, Industrial Production, and Housing Data on Tap for Next Week
Retail sales had a very robust 0.6% growth rate last month but that is set to drop back in September because of already reported falling auto sales and a drop in gasoline prices. Weekly shopping center sales have been good, but not as good as they were earlier this summer. That would suggest a slowing in retail sales growth even when throwing out autos and gasoline. The consensus is for headline retail sales to fall 0.3% and to increase 0.3% when excluding autos. That type of growth should keep third-quarter consumption rates close to 2%.

Industrial Production Data Due for an Auto-Related Bounce, Plus More
Industrial production had an unusual off month in August as shifting auto summer shutdowns drove down industrial production by 0.1% in August. More favorable seasonal factors and various purchasing manager surveys point to a much better September. Higher manufacturing hiring and a greater number of hours worked, as featured in last week's employment report, also suggest a better IP report on Thursday. Indeed, I believe the consensus forecast for a 0.4% increase could prove to be low, perhaps by a lot. Unfortunately, a worsening of export data due to a stronger dollar could begin to cut into production by the end of the year.

Housing Starts: At Last a Rebound?
Housing starts have been relatively trendless this year, averaging just over 1.0 million units. Economists are expecting more of the same with starts expected to increase to 1.015 million units on an annualized basis for the month of September. That compares with 0.96 million units the previous month, which seems likely to be revised, to me. Home sales and builder sentiment were both better in August but housing starts looked quite a bit worse. So either August starts are likely to get revised up or the September spurt will be better than analysts are currently anticipating. With mortgage rates falling and jobs growing I am hoping that housing can pull out of its doldrums in the very near future, even if September doesn't look wonderful.

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