Economist Ethan Harris is managing director and co-head of global
economics at Bank of America Merrill Lynch.
Harlan Levy: What do you make of the latest mixed economic data?
Ethan Harris: We've had a run of very weak data for about two and a
half months now after three strong months in a row. This is consistent
with Gross Domestic Product growth, slowing to just 1.5 percent in the
first quarter. So it has been a very disappointing period.
However, given the timing of the slowdown coinciding almost exactly
with unusually bad winter weather, we think the bulk of the weakness
is related to weather rather than fundamentals.
For the year as a whole we're looking for GDP growth of about 3
percent, starting off at a very slow 1.5 percent pace in the first
quarter. Then we expect solid 3 percent-plus gains in the last three
quarters of the year.
A period of better growth is likely both because of the healing of
many parts of the economy, in particular the banking and housing
industry, and because we also believe the economy will be less subject
to big shocks like the fiscal cliff and the government shutdown.
Q: Will the work-week, average wages and labor participation rise this year?
A: Once we get past the winter season and get into more normal
temperatures and activity we do expect a broad-based pickup in the
jobs market. We think that we'll be seeing employment gains of about
200,000 per month and some pickup in the share of full-time jobs
rather than part-time jobs.
However, the one thing we don't expect is a pick up in wage growth. We think it will take a longer period of recovery in the job market for
workers to regain their wage negotiating ability.
Unfortunately, although the job market may feel a bit better, it's not
going to be back to normal, at least this year.
We think that we'll also see some people who temporarily stopped
looking for work will come back and start participating in the job
market again, searching for work. So we think generally the labor
market will feel a little bit better.
In terms of labor participation, some of the drop is the aging of the
baby-boom generation, people moving from their 40s into their late 50s and early 60s, in some cases taking early retirement.
However, we think a lot of the drop in the participation rate has more
to do with discouragement and the difficulty in finding work. The
participation rate has dropped for most age groups, so we think it
will come back for younger and middle-aged workers, as the job market improves and job searching become less frustrating.
Q: What's your prediction for unemployment?
A: By year-end we expect the unemployment to drop to about 6 percent, and we think the drop will continue in 2015, reaching about 5.5 percent by year-end. We think this is consistent with a more or less full recovery in the job market.
Q: The Federal Reserve sounds optimistic in spite of two months of
weak data. Will it raise interest rates when its threshold jobless
rate hits 6.5 percent in spite of inflation not growing at the other
Fed target of 2 percent?
A: I think the Fed is on a very stable path in terms of both reducing
its asset-buying program and raising interest rates. I think they look
at the recent data and, like most economists, think most of the
weakness is due to the weather. So they remain comfortable slowly
However, interest rate increases are still a long way off. The Fed
wants to see something closer to a full recovery in the economy, and
it wants to also see inflation pick up closer to its 2 percent target
before it starts hiking interest rates.
I think the Fed is looking at a much broader range of indicators than
just the unemployment rate. Before they consider hiking interest rates
they want to see signs of a broad-based economic recovery, with strong payroll employment growth, with signs of a wage pickup, and signs that under-employed or discouraged workers are being put back to work.
So we do not believe that the 6.5 percent unemployment threshold is an important indicator for a change in Fed policy.
Q: Are we going to see 2 percent inflation any time soon?
A: I think that inflation will be stuck at very low levels, probably
in the 1 to 1.5 percent range for the next two years. It's important
to recognize that inflation weakness is not unique to the U.S. It's
low in almost every developed market economy. This weakness reflects slow global growth, lots of spare capacity in global industries, and calm commodity markets.
So even if the U.S. economy picks up a bit, the global environment
will tend to hold back inflation in the U.S. Low inflation is a sign
of a very competitive global environment.
The good thing about this very low inflation is that it allows the Fed
and other central banks to focus on a growth recovery rather than
fighting inflation. That means a very slow pull back in their
asset-buying program followed by a very slow rise in interest rates.
Q: So what does this mean for the stock markets?
A: It's important to distinguish between two kinds of Fed policy
tightening. One is where the Fed is fighting inflation, and those
tightening cycles tend to be very aggressive and hurtful to the
economy and the stock market. The best example of one of these
"bad-cop" Fed tightening cycles was in 1994.
By contrast, if inflation is low you get a "good cop" Fed tightening,
where the Fed moves very slowly and tries to avoid shocking the
markets. That's what happened in 2005.
For this cycle, we're looking for the good cop. In particular, our
equity strategists are looking for the S&P 500 to reach 2,000 by the
end of the year. If correct, that would imply about an 8.5 percent
increase over the course of the year.
Q: Do you think the stock market, which has been particularly
volatile, is getting ahead of itself?
A: We think the stock market did take a bit of a breather at the start
of the year after a big surge last year. However, stepping back and
looking at the fundamentals of the market, we think there's still room
for an increase in multiples, as risk appetite returns. We also think
we'll get pretty good earnings growth as the economy picks up speed.