Definitive statements about the future are always suspect in finance and economics, but it’s reasonable to assume that the threat of deflation as a clear and present danger has passed. But we can’t say for sure. To the extent that a double-dip recession remains a possibility, so too will does hazard of a fresh round of deflationary pressures.
Yet those concerns look minimal at this point. The primary challenge, as we’ve discussed routinely this year, is tied to the headwinds of growth. The risk of another of follow-up cataclysm to last year’s drama, by contrast, fades with each passing month. In short, the central issue is one of managing the chronic problems that await rather than the acute ones that recently passed.
Yet we shouldn’t underestimate the complications and potential fallout that are likely to accompany what we expect will be a subpar economic recovery, in large part because of what’s likely to be a sluggish rebound in the labor market. (For some background on our thinking about the job market, take a look at this post from earlier this month and our analysis here, for example.)
Even before the debacle of 2008, the recovery momentum in the labor market in post-recession periods was waning in the U.S. in both relative and absolute terms. There are many reasons for this troubling trend, none of which are easily resolved. Given the current environment, the “solutions” are even less likely to yield results.
We’re hardly alone in worrying about the U.S. employment trend. “A sharp rise in unemployment, coupled with the recognition that it will stay high for a while, changes the behavior of the employed, and it changes government behavior,” Pimco’s Mohamed El-Erian told Investment News this week. “I guarantee you that within six months’ time, there will be talk of another stimulus plan related to unemployment.”
As challenging as the job market’s future will be, it’s even more complicated because of what we might think of the coming disconnect, however temporary, between headline changes in the economy and a struggling labor market. On the one hand, the near term outlook seems set to deliver relatively favorable comparisons in such metrics as retail sales and GDP vs. the declines of the recent past. Looking out beyond the next 6-12 months, however, may be more problematic.
Paul Zemsky, head of multi-asset strategies at ING Investment Management in New York, makes a distinction between the optimism for the near-term trend vs. a more cautious view on the longer-term. It’s the cyclical vs. the secular, he explained yesterday at a press briefing at the firm’s office in Manhattan. The odds for a double-dip recession are quite low, he said. Meantime, retail sales need only tread water to generate encouraging year-over-year comparisons in the quarters ahead, courtesy of the sharply lower absolute levels in consumption in the recent past.
Overall, Zemsky projects a “mild recovery” in 2010 that will fuel additional increases in the prices of risky assets, starting with the stock market. He also expects that consumer consumption will average 2.5% for much of next year. That’s a welcome change from the past 12 months, of course, although he notes that a 2.5% rate of consumption for Americans will be well below the 3.5% pace for the past generation or so. Nonetheless, he opines that “financial markets respond to the change, not the level” in key economic comparisons such as retail sales, which leads him to call for a rising stock market for at least the near term. Supporting this optimism is Zemsky’s call for the U.S. economy to expand by 2.4%-2.8%, comfortably above the consensus forecast.
If so, one might expect that inflation will continue to bubble higher, if only marginally. Once again, the year-over-year comparisons are likely to climb, in part because the recent past witnessed such sharp declines, i.e., a brief flirtation with falling prices. In today’s consumer price report for October, the government advised that CPI rose 0.3% last month, up slightly from September’s 0.2% increase. For the past 12 months, CPI has fallen, but as we move beyond the data from the months of last year’s financial crisis, the inflation comparisons are likely to turn positive on an annual basis.
Indeed, if we look at so-called core inflation (less food and energy), consumer prices climbed 1.7% over the past year through October. That’s still modest, but the trend of late suggests that pricing pressures are likely to rise, if only modestly. But what’s troubling for the goose is likely to be a headache for the gander. If year-over-year comparisons in retail sales, GDP and other metrics offer some reason for optimism, the shifting trend in inflation is likely to deliver the opposite. No, we don’t expect inflation to suddenly take wing. But let’s consider the big picture.
First, the Federal Reserve continues to flood the economy with liquidity, and for the moment there are no plans to change this state of money printing. The central bank wants higher inflation. If it’s going to err, it’s going to err on the side of higher prices. Meantime, the prospects for favorable year-over-year comparisons in several economic yardsticks look encouraging, albeit relative to depressed absolute levels of the recent past. But waiting in the wings is the sobering outlook for job growth.
All of which suggests that near-term events will tempt the crowd to think that all’s well. But the biggest challenges are yet to come. Transitioning between the snapback in progress and the longer-term reality awaits. There’s always a reason to worry, of course. Meantime, markets have been known to climb a wall of worry. Somewhere between these two extremes lies a reasonable outlook for strategic-minded investors. But no one should expect the answer will come easy. As always, finding a happy medium between the tactical and the strategic is the goal, but finding the optimal mix isn’t likely to get any easier.