Economic Optimists See Bernanke Leaving Fed on a High Note

Monday, 03 Jun 2013 08:29 PM

 

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Federal Reserve Chairman Ben S. Bernanke will leave behind an economy poised to record its biggest advance in almost a decade when he makes his anticipated departure from the central bank early next year, if forecasts come true.

Growth will accelerate to 3 percent or more in 2014 after averaging an annualized 2.1 percent during the first four years of the recovery, according to projections by forecasting firms Moody's Analytics Inc. and Macroeconomic Advisers in St. Louis. That would be the fastest rate of expansion since at least 2005, the year before Bernanke became central bank chief.

He has "navigated the economy and the financial system through one of the darkest periods," said Mark Zandi, chief economist for Moody's in West Chester, Pennsylvania. "Now we’re starting to see some sunshine breaking through."

As the Fed celebrates the 100th anniversary of its founding this year, confidence in the sustainability of the expansion is mounting. The stock market is surging, with the Standard & Poor’s 500 Index up 15 percent. Consumer optimism is hovering near a five-year high, according to the Bloomberg Consumer Comfort Index, and April was the fifth consecutive month that home values advanced more than 10 percent year over year, based on data from the National Association of Realtors.

Fiscal fears are fading. The Congressional Budget Office estimated on May 14 that the federal budget deficit will shrink to $642 billion in the year ending Sept. 30, the smallest shortfall in five years.

Departure Anticipated

While the 59-year-old Bernanke hasn't said whether he wants to remain as Fed chief when his current term expires in January, a majority of investors believe he will depart, according to the latest Bloomberg Global Poll. A third of those surveyed expect he'll be succeeded by Fed Vice Chairman Janet Yellen, 66, the biggest vote getter in the May 14 poll of investors, analysts and traders who are Bloomberg subscribers.

A step-up to a 3 percent growth "channel" from 2 percent will make it much easier for the U.S. to tackle longer-term issues facing the country, said Vincent Reinhart, a former director of monetary affairs at the central bank.

"Are equity prices fairly valued right now? Can the Fed exit gracefully from quantitative easing? Is the fiscal position of the U.S. sustainable?" asked Reinhart, now chief U.S. economist for Morgan Stanley in New York. "If growth is picking up and we're on a 3 percent trend for a while, those things all work out. If we're not, then those things are much harder."

Dropping Joblessness

The strengthening expansion will push unemployment down and stock prices up. Zandi sees the jobless rate dropping to 6.7 percent at the end of 2014 from 7.5 percent now. At the same time, the S&P 500 will rise to 1,900, David Kostin, chief U.S. equity strategist for Goldman Sachs Group Inc. in New York, said in a research report last month. The stock gauge stood at 1,640.42 at Monday's close.

"You are seeing a recovery firing on more cylinders: housing, bank lending, the job market, confidence," said James Paulsen, the Minneapolis-based chief investment strategist at Wells Capital Management, which oversees more than $340 billion. While this doesn't mean the growth rate will get a lot faster, it does signal "the recovery has gotten broader" and people "are more confident" it will last.

Cyclical stocks, those that particularly benefit from an expanding economy, probably will outpace the S&P 500 in the second half of this year, he said. These include "industrials, materials, technology and financials."

Deserve Credit

Bernanke and his Fed colleagues deserve a lot of credit for the upswing, said Robert Shapiro, chairman of Sonecon LLC, an economic advisory firm in Washington.

"Uneven as it is, we are seeing a recovery in the U.S. which draws largely on correct policy, particularly monetary policy, and on the underlying strengths of the economy," said Shapiro, a former undersecretary in the Commerce Department.

The Fed's 2009 stress tests of commercial-bank balance sheets were critical in restoring faith in the financial industry and helping clear the way for growth, according to Nariman Behravesh, chief economist at IHS Inc. in Lexington, Massachusetts.

And the low interest rates the central bank has engineered through its easy monetary policies play a key role in turning the housing market around, Shapiro added. Sales of previously owned homes climbed in April to the highest level in more than three years, and the median price rose 11 percent to $192,800, the highest since August 2008, from $173,700 in April 2012, the Realtors association reported May 22.

Production Shortfall

Still, the economy is far from full health – a fact that Bernanke himself has acknowledged more than once. The April jobless rate of 7.5 percent was 2.5 percentage points higher than the rate at the start of the 18-month recession in December 2007, according to Labor Department data. Industrial production, as measured by the Fed in inflation-adjusted terms, also remains short of 2007 levels, and manufacturing unexpectedly contracted in May at the fastest pace in four years, based on the Institute for Supply Management's factory index.

"The patient got very sick," said Neal Soss, chief economist at Credit Suisse Group AG in New York and a one-time assistant to former Fed Chairman Paul Volcker. "The patient is clearly mending but probably isn't ready run a sprint."

Former Fed Vice Chairman Alan Blinder is concerned that another political standoff over raising the country's debt ceiling could undercut confidence later this year, he said in an interview. He sees the economy expanding 2 percent to 2.5 percent in 2014.

'Very Worried'

Blinder, a professor at Princeton University in New Jersey, also said he is "very worried" that financial markets will over-react to signs the Fed is pulling back on its stimulus to the economy and push interest rates sharply higher in response.

The yield on the 10-year Treasury note rose to 2.12 percent Monday in New York  from 1.93 percent on May 21, according to Bloomberg Bond Trader data. That was the day before Bernanke told Congress the Fed could scale back its monthly asset purchases if it were confident the recent improvement in the labor market will be sustained. The central bank currently is buying $85 billion of assets a month.

Yields have risen as confidence grows in the durability of the expansion. That optimism has been fed by the economy's ability, so far, to weather a federal-budget squeeze the CBO reckons will lop about 1.5 percentage points off growth this year through a combination of spending cuts and tax increases.

"A few months ago, I was on the pessimistic side, given the fiscal contraction," said Jeffrey Frankel, an economist at Harvard University in Cambridge, Massachusetts, and a former economic adviser to President Bill Clinton. The recent "spate of good news" gives "me real hope that the economy is finally moving into higher gear."

Payroll Growth

Payrolls rose by an average 196,000 a month from January through April, compared with 183,000 in 2012, and Labor Department data to be released on June 7 will show a further 168,000 increase in May, according to the median forecast of economists surveyed by Bloomberg.

Stuart Litwer, 51, a business analyst in Lilburn, Georgia, for a pharmaceuticals company, is among those feeling more optimistic about the outlook.

"I think it is getting better," he said. "Home prices are starting to pick up. The deficits are lower than they thought they would be."

Litwer recently bought a Lexus RX 350 sport-utility vehicle to replace a 13-year-old Honda Odyssey as his wife’s main transportation, after he was close to paying off the loan on a 4 1/2-year-old Honda Accord he drives. "We didn’t want to have two car payments at once," he explained.

Vehicle Sales

U.S. sales of automobiles and light-duty trucks rose to a seasonally adjusted annual rate of 15.3 million in May, up from 14 million a year earlier, according to Woodcliff Lake, New Jersey-based Autodata Corp.

Responding to the stronger demand, Fiat SpA-controlled Chrysler Group LLC said on May 22 that three of its assembly plants and all except one of its engine, transmission and stamping factories will skip summer shutdown this year.

Nathan Sheets, the Fed's top international economist from 2007 until 2011, said the expansion is "nearing an inflection point."

"Headwinds that have restrained growth -- deleveraging by households, lagging credit availability and labor-market weakness -- are now abating," and "some powerful tailwinds have taken hold," said Sheets, who is now global head of international economics at Citigroup Inc. in New York. These include "the surprisingly strong recovery in the housing market – which supports the economy though a whole range of channels – rising equity prices and robust consumer confidence."

Business Confidence

What needs to happen next is for businesses to grow more confident in the outlook and boost spending, Sheets and Morgan Stanley's Reinhart said.

Blinder, author of the recently published book "After the Music Stopped: The Financial Crisis, the Response and the Work Ahead," said he'd give Bernanke top marks for his handling of the economy since Lehman Brothers Holdings Inc. went bankrupt in September 2008.

The Fed chairman "was dealt a bad hand and he played it well," Reinhart added.

© Copyright 2014 Bloomberg News. All rights reserved.

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