What's next for the US economy?

Most forecasters are revising their US GDP numbers higher after the economy grew at an annualised rate of 8.2% in Q3. Our full-year estimates of 3.1% for 2003 and 4.5% for 2004 are now only slightly above consensus. Indeed, something would have to go seriously wrong to prevent rapid growth next year. Geopolitical risks and terrorism are the obvious threat, but the economics at least looks good

Monetary and fiscal policy are both firmly expansionary and the currency is weakening. The Q3 data showed a broad-based recovery with investment accelerating and the inventory cycle starting to turn. Forward-looking numbers are strong, including the consumer and business confidence surveys, and investment indicators such as corporate profits and orders for capital goods. Even lagging indicators, such as the labour market, are showing clear signs of a pick up. Later this week we expect to see the first of a series of 200k monthly increases in non-farm payrolls.

The one negative is the broad monetary aggregates, such as M3. The money supply has been falling in recent months and could signal a potential liquidity problem. However this change largely reflects increased appetite for risk, which is encouraging flows out of money market funds and deposit accounts into assets such as equities and corporate bonds. On balance this development is unlikely to threaten the recovery.

In our view, therefore, the cyclical outlook for the US economy is excellent. The main worry now is structural weaknesses. The corporate sector is in great shape, with cashflow and balance sheets both strong. But there are valid concerns over the financial positions both of households and the public sector. The Federal deficit is likely to be nearly 5% of GDP in 2003, or 6% for the total public sector including state and local governments. These in turn explain the deterioration in the current account and the continued weakness of the US dollar. This is because the current account is the sum of the surpluses/deficits run by the household, corporate and public sectors.

These structural problems will inevitably result in a period of weaker growth at some point. Even at current low interest rates the debt service burden has risen to historic highs. Strong income growth and asset prices mean that consumers can both spend and save more. Hence we do not expect a recession soon, unless either equity markets or housing markets collapse. But fiscal policy will eventually have to be tightened, probably after the Presidential elections in November 2004. We have reflected these risks in our forecasts by assuming that US growth slows to around 2% in 2005.

These longer-term concerns are unlikely to influence the Fed's decisions in the coming months. The discussion at the December FOMC will focus on the improvement in recent data. Fed speakers have been emphasising that there is no need for rates to rise 'in the near future'. This suggests that the easing bias will be retained this month, even though the risk of deflation is now negligible. But the rest of the statement should be more upbeat on the economy. The burden on proof is firmly on the pessimists.


This is an extract from our recently published Global Interest Rate Strategy. Further information is available at www.standardchartered.com/globalmarkets