Michelle Girard is managing director and senior economist at the Royal Bank of Scotland.
H.L.: Is the long-awaited start of job creation faltering in the wake of initial unemployment claims jumping 12,000 from an upwardly revised 460,000 last month?
M.G.: Rather than focusing on the claims figures, which are extremely volatile week to week, particularly around holidays like Memorial Day, I think the better question is “Is the labor market faltering in the wake of the disappointing private sector job gains of 41,000 in May?”
In my view the answer is no. While private sector hiring appeared to cool last month, in fact every other piece of labor market data has really suggested no meaningful weakening in the labor market in the last month or two. Even the claims figures, looking at the four-week moving average to smooth out any volatility, have basically been holding steady at the 460,000 level, again suggesting no meaningful deterioration in labor market conditions.
H.L.: Do you think the 0.2 percent drop in the consumer price index supports fears of deflation, and if so, how serious is the deflation threat?
M.G.: There certainly has been a lot of talk about deflation of late. However, the latest inflation report actually should have assuaged some of those concerns. While the headline index was pulled down by a sharp fall in gasoline prices, given the volatility in food and energy costs when considering the prospects for broad-based deflation, it’s more important to look at the core reading. This month we had a very solid 0.1 percent gain, with nearly every category either flat or up in the month. To me that strongly suggests that fears of deflation taking hold are overdone.
H.L.: The Philly Fed Index of manufacturing activity was expected to come in at 20, down from last month’s 21.4, but the number turned out to be 8 not 20. Does this indicate that the U.S. economy is hitting a wall?
M.G.: The Philly Fed Index looks at just one region of the country, and we can get very mixed messages when comparing the reports from the various regions. For example, we had another regional manufacturing survey out earlier last week which showed that manufacturing activity in the New York region was unchanged.
Looking at national trends, as suggested by the industrial production report, activity in the factory sector continues to advance at a healthy pace. In fact, the manufacturing sector is probably the strongest sector of the economy right now. What’s happening is firms are seeing a pickup in demand, and inventory levels are extremely low. As a result those firms need to increase production to meet increased demand.
I think there’s been a lot of growing pessimism with respect to the U.S. economy as a result of some of these weak data points. But the data through the spring was all consistently stronger than expected. To me, some of the softer readings on employment and retail sales of late simply reflect the normal ebb and flow of the economy and the economic data and are not a sign that the recovery is faltering.
H.L.: Is the housing market headed for a double-dip?
M.G.: The sharp pullback in housing starts in May may have fueled that very concern. However, the expiration of the homebuyer tax credit has distorted the pattern of housing activity this year. We saw a sharp run-up in home construction and sales ahead of the April 30 deadline. Now that the tax credit has expired, we’re seeing some payback from the strength seen earlier this year, so it will be very important to look at the trends in activity this year, as opposed to the month-to-month movements. Housing data will be weak this summer, because activity was pulled forward into the spring to take advantage of the tax credit.
H.L.: What do you think of the financial reform package now being crafted in Congress?
M.G.: The risk of financial regulation is that it burdens financial institutions at a time when we’re trying to encourage banks to be making loans. As a result of these and other regulatory changes, the risk is that credit conditions will remain relatively tight.
H.L.: Deficit hawks are clamoring for immediately reducing the exploding U.S. deficit as opposed to those who want to increase spending to bolster jobs and unemployment benefits to avoid a return to recession. What do you think is the way to go?
M.G.: We don’t believe that the fiscal stimulus package is responsible for the recovery in the economy over the last year, and we don’t believe that government spending is needed to assure that the expansion is sustained. I’m fully in favor of the government getting its fiscal house in order, and I don’t think it represents a threat to the economic outlook unless balancing the budget is going to come mainly through tax increases. In that case there would be an adverse impact on growth. Last year the government spent a lot of money and most of it in the form of tax credits to consumers, and the money was saved and not spent. So I don’t think government spending really added that much to Gross Domestic Product. The good news is that if the government stopped spending so much it would not hurt GDP, so we should cut the deficit now, but do it by controlling spending as opposed to raising taxes.
H.L.: How the debt crises in Greece, Italy, Portugal, Ireland, and Spain dealing with their debt crises now, and is there less threat to the U.S.?
M.G.: We’re just watchful. I do not think at this point that it will derail the U.S. recovery. The risk of such a scenario unfolding comes through the financial market channel. If the debt crisis leads to another financial market meltdown, as we saw when Lehman went bankrupt, then there would be a meaningful impact on U.S growth, but that dire scenario is not our base-case view. I think that issues in the eurozone will remain a eurozone problem. Also, the U.S. is benefiting from a flight to quality. U.S. Treasury yields are coming down as investors move out of euro-denominated assets to dollar-denominated assets.
Disclosure: No position