Nicholas Perna is the economic adviser to Webster Bank. and chief economist and managing director of the consulting firm Perna Associates. He is also a visiting lecturer at Yale University.
Harlan Levy: What do the latest Gross Domestic Product data - low inflation and weak growth - and sharply higher consumer sentiment tell you about where the economy is heading?
Nicholas Perna: Everything that's coming out confirms the fact that we're growing, but we're still growing slowly. But it's a lot stronger than it was in the early part of 2011. Fourth quarter GDP grew by 2.8 percent, and we're almost where we were during 2010, when GDP grew around 3 percent, and that's close to what I expect to happen in 2012.
One consequence of this is that we're likely to get a small further decline in the unemployment rate down to the vicinity of 8 percent by next December. Alongside that, I'm forecasting an inflation increase of just under 2 percent. All in all, current data, whether it's durable goods orders, initial jobless claims, or consumer confidence, corroborates my forecast of less than 3 percent GDP growth this year.
But there's an awful lot of downside risk in this at home and abroad.
H.L.: Go on.
N.P.: Domestically there are loose cannons in the Cannon Office Building and elsewhere in Washington. Congress passed a two-month extension in the payroll tax cut. What are they going to do next? This is the same cast of characters who almost shut the government down over raising the debt ceiling a few months ago. One of the biggest sources of domestic uncertainty is not regulation. It's the government in Washington.
Internationally, Europe refuses to get better. What we've gone from is those fun-loving Greeks having trouble paying their bills two years ago to a recession encompassing the entire eurozone. The one breath of fresh air seems to be the new European Central Bank president, Mario Draghi, who is using some of the same tactics as Federal Reserve Chairman Ben Bernanke to keep the system afloat. It shouldn't surprise us that they both got Ph.Ds in economics from MIT [H.L.: as did Nick Perna]. Draghi's predecessor, Jean-Claude Trichet, single-mindedly fought inflation which didn't exist and raised interest rates in 2011, further weakening the European economy. Here we are still worried about the ability of the Greeks to repay their debts and now a number of other countries as well. One consequence is that, depending on the severity of what unfolds, this could adversely affect the U.S. financial system and U.S. exports.
H.L.: Fed Chief Bernanke last week was not in the positive camp on the economy in his remarks on keeping interest rates close to zero through 2014. What will be the effect?
N.P.: This is either good news or bad news, depending on whether you're an interest-payer or a recipient. His economic forecast for 2012 is similar to mine and the consensus. What I thought was really interesting is that when the Fed gave the Federal Open Market Committee member forecast for fed funds for the "longer run," there was a very close consensus of something like 4.25 percent. When the "longer run" occurs is not so much a specific year as much as it's when the U.S. economy is performing more normally with, for example, 5.5 percent unemployment. My guess is that we're talking about five, six, or seven years out in the future. However, this means that the Fed is expecting it will have to increase the fed funds rate significantly by then. This means all other short-term interest rates will be rising more or less in lockstep. That's why it's bad news for the payers and good news for the recipients. The cost of funds for borrowers and banks will be going up.
Given what Bernanke said, there's little risk to those having adjustable-rate mortgages until at least 2014. After that there's more risk. In this exercise in "glasnost," the Fed said nothing about long-term interest rates. That's because, while it has some influence on them, it doesn't control them directly, as they do with the fed funds rate. However, a reasonable guess would be that the 10-year Treasury note, which is hovering around 2 percent, would probably rise to the vicinity of 5 percent in the "longer run."
H.L.: How bad is the job situation?
N.D.: The jobs situation has been getting better. We've had a number of weeks where initial claims have been significantly below 400,000, and in December we had 200,000 new jobs. We've got some additional momentum that we hope uncertainty won't dampen.
H.L.: A lot of economists say the housing market is finally bottoming. Is it, and if so when do you see a recovery?
N.P.: It is bottoming, but the bottom is so low that you can hardly see it. Home prices are still off more than 30 percent nationally, and Bernanke's staff estimated that this decline has wiped out some $7 trillion in homeowner equity, erasing half of what existed in 2006. Nationally, one in five home mortgages is underwater, where the amount of the mortgage exceeds the value of the house. I think we're getting signs of some modest pick-up in housing, but there are a lot of obstacles in the way, such as additional foreclosures which are likely to occur this year.
However, that during the course of this year, we'll see some uptick in housing starts and home sales, but by the end of the year we'll be far below any measure of normal.
H.L.: How solid is the stock market surge we've seen so far in 2012?
N.P.: I think it's interesting to look at positive and negative forces that will influence where stock prices will go this year. Short-term interest rates won't be a problem, but there might be some increase in long-term rates, but I doubt it will be very large in 2012. Furthermore, if my GDP forecast is right, we'll pick up an extra point of real growth, which should be good for business volume and profits.
Europe is a big question mark. You can think of a scenario where Europe will be a drag on the U.S. stock market even if there's no serious financial stress here. If the dollar strengthens versus the euro, and European economic growth is negative, that will have a double-negative whammy on the profits of U.S. multi-nationals operating in Europe. The recession would reduce profits measured in euros, while a stronger dollar would further reduce those profits when they're translated into dollars.
H.L.: Who do you think will win the presidential election?
N.P.: My colleague Ray Fair has developed a well-known model that forecasts the presidential popular vote outcome based on the economy, and his model is saying that it's a 50-50 chance that Obama would retain the presidency based on an economic forecast similar to the one above.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL ,GE over the next 72 hours.
