- Q2, 3, 4: 200,000 to 230,000 new jobs/month, GDP up 3%/month.
- Quantitative easing to stop around October, if jobs and recovery continue.
- Short-term interest rates to start gradually rising in June or July 2015, and the 10-year bond rate.
Harlan Levy: Is the economy poised for a setback?
Ed Deak: I am cautiously optimistic that the U.S. economy is going to be stronger in the final three quarters, much stronger than it was in the first quarter, when there was basically no growth at all.
My expectation is that job growth will be in the neighborhood of 200,000 to 230,000 on average per month, and that should be more than enough to keep Gross Domestic Product growth around 3 percent for each of the remaining three quarters.
Q: What about some of the big sectors, like autos and homes?
A: As far as automobile sales, the pace has been very good. I expect that to continue because the average age of the fleet was over 10 years in early 2012, and that's just a lot of aged rolling stock. So people with low interest rates and attractive sale prices will keep people buying cars at a healthy pace.
That should boost employment in the upper Midwest.
As far as housing, it's certainly hit a low. I don't think it has stalled. Rather, it has hit a lull, partly because of bad weather and because of the moderate pace of job growth.
As job growth picks up people will feel more confident about buying existing homes, which should help some with new construction.
Also, more applicants with better credit ratings should encourage more bank mortgage lending.
All of that will make housing a positive growth force for the remainder of 2014 and into 2015.
I would not expect a significant enough rise in long-term mortgage rates that would discourage home-buying.
Q: Federal Reserve Chairwoman Janet Yellen has refused to state exactly when interest rates might rise or when the monthly Treasury note and mortgage-backed security purchases will stop. What do you think of Fed policy?
A: I expect the Fed to continue to back away slowly but steadily from its quantitative easing. At its current pace - $45 billion this month, down from $85 billion last year - the Fed should end that phase in around October. Of course, that assumes jobs continue to be created and labor markets look stronger, as the easing ceases.
The next question is when will short-term interest rates increase. They've been close to zero for more than four years. They are most likely to begin a gradual increase in short-term rates sometime in mid-2015, roughly June or July, and, again, the timing and pace of the increase will depend upon conditions in the job market and the rate of growth in Real GDP.
The point is when they start to raise the short-term rate, it's the tricky part, because they will be facing some inflation pressure while not wanting to cause a halt in the rate of economic recovery. That's a tightrope - inflation versus growth - that would try even the wisdom of King Solomon as well as the Federal Reserve.
Q: Some economists question the wisdom of even doing the monthly purchases. What do you think?
A: For the past few years the only growth game in town has been the Fed. Fiscal policy has been absent. Without the Fed's quantitative easing there would have been less growth in spending and much less of a recovery in the stock market, which has helped to support spending.
While the 1 percent has gained the most from the Fed actions, the rest of the economy has benefited at a level that would have been much lower without the Fed's quantitative easing.
QE is not a precise tool or a perfect tool of economic policy, but it's been the only tool.
Q: The stock market seems to be not only volatile but also moving up as if the bull market is still in effect. But there are a lot of skeptics. Are you one?
A: It is susceptible to the easing of Fed bond purchases and to the Fed's eventual increases in short-term interest rates, including the Fed funds rate [the rate banks pay to borrow from other banks], which has been near zero over four years to encourage bank borrowing and to provide liquidity to the banking system.
The stock market could show a tendency to retreat in the face of that action, because it would be more costly to borrow, and rising interest rates makes fixed-rate investments in bonds and CDs more attractive.
However, the second issue is that the stock market in general and the real economy - jobs and GDP - rarely move opposite to one another for long periods or by large amounts. So if the real economy continues to grow that should help to offset any negative stock effects from higher interest rates.
If stocks rise by 5 percent at the end of this year, with the Dow Jones up from 16,300 to about 17,000, that would be a good year, considering the substantial gains registered in 2013, and I think it's at least 60 percent likely if jobs and the economy continue to grow.
Q: What about bonds? The 10-year continues to go down. What does that say?
A: The 10-year yield was 2.6 percent last week, and that was down from about 3 percent at its 52-week high. I attribute at least some of that decline to the unstable geopolitical conditions in the Ukraine and the Middle East.
However, as those conditions work themselves into a more stable environment and the U.S. economy continues to expand, and the Fed gradually tightens monetary policy over the next 12 to 18 months, it's very likely that you'll see the 10-year rate back above 3 percent, indicating a more normal financial environment. That will encourage people to invest more in bonds, as long as they don't' fear an acceleration in long-term inflation rates.
Higher 10-year yields will lead to higher 30-year yields, which will boost home mortgage rates as well. With a bit of luck all of these interest rate increases in combination with continued economic growth will encourage home buying and home building. That's the tightrope I mentioned before that the Fed faces.
Q: What do you think of first-quarter earnings?
A: If you look at the reports and the estimates for near-term future earnings they were marginally better than expected. That's a positive sign, given the fact that we're dealing with the first quarter of the year, normally a slow quarter, and the unusually harsh weather conditions that affected the Northeast, the Midwest, and the Southeast with the drought.
Earnings reports and the guidance have provided a mild positive support for stocks more than originally anticipated.
Q: Are businesses beginning to spend more of the domestic cash they're hoarding?
A: Yes. They're spending more of the domestic cash. The unsettling reaction is that some, like Pfizer (NYSE:PFE), are trying to access their overseas cash by merging with foreign companies and relocating their headquarters outside of the U.S.
That's a disturbing trend which could get worse in the absence of an agreement on tax reform coming from Washington, depending on how many think they can do better by operating abroad where taxes are more favorable.
Congress really needs to get its act together to deal with tax reform, immigration, climate change, and long-term job growth and unemployment.
Congress is still dysfunctional but no longer destructive. However, it needs to become a positive force for the U.S. economy. And that's why the Fed has had to take such aggressive action to keep the economy afloat.
Q: How can you think Ukraine and Russia will settle down?
A: It just looks to me that the Ukraine situation has to reach some sort of level of stability with a semi-autonomous Eastern region, and I would say it's 60-40 that it will. The conflict has at least 300 years of history, with actions in the World War II mixed in.
You have the Muslims, the Jews, the Christian autocrats who sided with the Nazis, Russian emperor Peter the Great crushing the Tatars in the region in the 1500s, and the oppression of the Eastern Ukrainian Russians and Jews in World War II, all of which has created an intense history of ethnic conflict, which is bubbling up now.
Nevertheless, I think it will work itself out to some stable environment. If it doesn't, it will continue to be a disruptive force in the U.S. economy.