Interview With Nariman Behravesh: Buoyed By Housing, 2014 Growth 3-3.5%

Includes: DIA, IYR, QQQ, SPY
by: Harlan Levy

Nariman Behravesh is chief economist at economic forecasting and analysis firm IHS and develops the economic outlook and risk analysis for the U.S., Europe, Japan, China, and other emerging markets.

Harlan Levy: From the most recent data, including robust retail sales, slightly declining consumer confidence, and weak manufacturing, what is keeping the U.S. economy recovering at its subpar pace?

Nariman Behravesh: This year the strongest headwind and constraint on growth is the federal spending sequester and also the tax hikes we had at the beginning of the year. When you put those two together they probably reduced the growth rate by one full percentage point. Instead of growing 3 percent we are growing closer to 2 percent right now.

The good news is that by and large consumers don't seem that spooked by the sequester, and housing is booming. Between them they're creating a foundation for a pretty solid recovery.

H.L.: So what kind of growth do you predict for this year and 2014?

N.B.: The sequester will affect most of this year, because we predict that it will last for the entire year. Because of that we feel that the second and third quarters will grow somewhere between 1.5 percent and 2 percent. By the fourth quarter we could be up to 2.5 percent, and by next year we could be between 3 percent and 3.5 percent.

H.L.: How do you rate U.S. industrial production and manufacturing?

N.B.: That is the one part of the U.S. economy that is struggling. Services are doing well, but manufacturing is struggling. The reason is the extended recession in Europe and very sluggish growth in China.

H.L.: Is housing going to make a big difference?

N.B.: Yes. The simple reason is that the component that accounts for housing -- residential fixed investment -- is growing at a rate of 15 to 20 percent. That's huge.

H.L.: Can job growth really accelerate?

N.B.: Once the impact of the sequester wears off, which we think will occur at the end of this year, both economic growth and jobs growth will accelerate. Next year we could easily see monthly gains in employment of between 200,000 and 250,000.

The unemployment rate will come down slowly this year and faster next year. We think by the end of next year the unemployment rate will be between 6.5 and 7 percent.

H.L.: How do you describe the U.S. fiscal policy, if it's even possible to characterize it as a unified policy instead of just a series of results of political conflict?

N.B.: The fiscal policy is quite tight, because we've had tax increases and spending cuts. If you add all the fiscal tightening that has occurred in the last two years and look at the savings over 10 years, it amounts to $3 trillion. That's big. Congress has made substantial progress on deficit reduction, but they have done it in the worst possible way, which is to say, it's been very chaotic and damaging to confidence.

The way they've done it is through a series of confrontations and brinkmanship, which was unnecessary. It certainly could be called austerity but the good news for the U.S., unlike Europe, is that our growth is strong enough that we can take it and absorb it.

My guess is that Congress won't do anything between now and the end of the year, because it doesn't need to, mostly because the deficit situation is actually improving and is down substantially.

Next year has the mid-term elections at the end of the year, so it may be that they won't do that much before the end of the year. It's not good, in the sense that more needs to be done, but it's not bad, because they've made a lot of progress. If you look at a 10-year horizon, they will have cut the deficit by $3 trillion, and that's a lot.

But there are a lot of issues that they're working on, like immigration. It's unclear what's happening with healthcare. That's still an open question on implementation. There's a lot to do, but I'm not sure they will make much progress. That is bad. We need to reform immigration, and we probably need to fix some of the healthcare stuff. Also, we probably need to revisit the Dodd-Frank financial reform bill. At this point I don't see a lot of progress on a lot of these issues.

H.L.: The stock market, hedge fund managers, banks, and investors were all aflutter about Federal Reserve Chairman Ben Bernanke's comments about possibly tapering off on its monthly purchase of $85 billion worth of Treasury bonds and mortgage-backed securities. What do you think will happen when the Fed meets later this week, and what do you expect on Fed purchases?

N.B.: I don't think the Fed is going to taper its bond-buying program until some time early next year. Growth is still lackluster because of the sequester, and the unemployment rate is still not 6.5 percent, the Fed target, so they may talk about it but not do anything until early next year.

H.L: Do you see the global economy, including the euro situation, deteriorating

N.B.: Some parts of the global economy might be, but other parts of the global economy are looking better. In terms of looking worse, the euro zone tops the list. Not only is it the longest recession in the post-war period in the euro zone, but it's spread from south to north, and we have a lot more northern European economies in recession. including France, Finland, and the Netherlands.

I'd argue that German growth will probably pick up later this year and in 2014, and it will act as a little locomotive of growth. We think by the end of this year Europe will come out of recession.

In the trouble spots, some of the emerging markets have seen a growth rate that has slowed substantially in China, Brazil, India, and Russia.

The bright spots are the U.S. economy, which will accelerate as the year progresses, the economy of Japan, the third largest economy in the world, and the United Kingdom's economy is starting to look a little stronger. Also, parts of Asia are beginning to do quite well. A pick-up in growth in these bright spots will help the rest of the global economy.

H.L: What's ahead for the volatile stock market?

N.B.: More volatility, because we're approaching a regime shift in terms of Fed policy. At some point in the next year, the Fed will taper off its bond purchases, As it does that and as the market anticipates that, we're likely to see some big swings in the stock market. I think for the U.S. it's not going to end up badly, because the economy will pick up. So, while worrying about the Fed, the market will feel pretty good about the U.S. economy, so it's going to be a balancing act, but investors will be relatively optimistic about U.S. companies and U.S. earnings.

In the rest of the world, it's a little less certain. In the emerging markets we could see their stock markets taking big hits in the coming year.

H.L.: What do you think will be the headline news this week?

N.B.: In terms of the financial markets, the attention will remain on the Fed and the Fed's intentions, so any pronouncements will be headline news. In terms of the U.S. economy, the headlines will be news suggesting that either the economy is accelerating or not, and there will be a lot of attention on data on growth in coming quarters.

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