Economic Outlook

Things are looking up, although you wouldn't know it listening to the politicians as the 2004 presidential race begins to warm. A recent (May-June 2003) edition of The Pocket Chartroom, the excellent economic newsletter published by the economic research unit of Goldman Sachs, adopts a cautiously optimistic outlook. On the positive side of the ledger, equity prices have been rising, as has consumer confidence that conditions are improving. Bond yields have continued to drop, driving down mortgage rates low and helping to sustain consumer spending as well as encourage business investment. There is a big chunk of fiscal stimulus being injected into the economy in the form of a rapidly-passed tax cut package, as well as planned increases in federal spending on defense, homeland security and rebuilding/stabilizing Iraq.

But not all the tea leaves are positive. Household balance sheets have still not adjusted to the big declines in equity prices of the past three years, and even after recent gains in the equity markets most households have net worth well below where it was 3 years ago. Nor does the rapid upward trend in stock prices of late seem sustainable. The bottom line is that households will feel compelled to save more—perhaps as much 6-10 percent of disposable income according to the Goldman Sachs econometric models, way above the April 2003 savings rate of 3.7 percent. This trend will continue to impose a drag on spending. The offsetting boost to household budgets associated with declining mortgage interest rates and refinancings will eventually play out, and the impact will be felt directly on consumer spending.

In addition, Goldman Sachs estimates that the fiscal squeeze in which most state and local governments find themselves will offset about one half of the federal fiscal stimulus on the economy. Plus, they point out an interesting and often overlooked disadvantage to corporations of the sustained low-rate environment that has been characterizing U.S. interest rates. Those companies with large defined benefit pension programs will have to increase cash contributions to offset lower-than-expected investment returns.

In describing the U.S. economic situation, Goldman Sachs economist William Dudley writes that he sees "light, but not yet at the end of the tunnel." He expects positive growth, but at a rate that is at or below its potential through the end of 2004. Unemployment will gradually rise through the remainder of this year and into 2004 to a level around 6.5%. Disinflation will continue to characterize core consumer prices. Corporate profits will remain weak through the balance of 2003 but rebound in 2004. Writing before the Fed's late June downward nudge in short term interest rates (25 basis points), Dudley expected a downward move of 25-50 basis points, with no remaining movement until the end of 2004. Importantly, this last point means that with no inflation in sight, the Fed will leave in place a very accommodative monetary policy for the next 18 months.