Nariman Behravesh is chief economist at international economic forecasting and analysis firm IHS and is responsible for the economic outlook and risk analysis for the U.S., Europe, Japan, China, and other emerging markets.
Harlan Levy: Is the good news on housing, jobs, and earnings: sustainable?
Nariman Behravesh: The good news is that the U.S. is doing well, and it looks like it’s probably sustainable, because so much of U.S. growth depends on the U.S. itself. By that I mean that a very large chunk of the U.S. economy is driven by domestic demand rather than foreign demand.
For example, 70 percent of the U.S. economy is consumer spending, whereas only 13 percent is exports. And U.S. consumers are in very good financial shape and in a good mood. Certainly what’s helped the U.S. consumer is the improvement in the job situation in the economy. More people have jobs and more are spending.
The other factor is that U.S. households have done a really good job of reducing their debt levels, so they’re in much better financial shape than they were even 10 years ago.
Another positive development is the big drop in oil and especially gasoline prices. Our rule of thumb is that every 10-cent drop in the price of gasoline is the equivalent of a $10 billion tax cut. So we’ve had approximately an 80-cent drop in oil prices, which then translates to an $80 billion tax cut. All this is good news for a very very large chunk of the U.S. economy, which is to say consumer spending.
Q: Goldman Sachs predicts three more years of economic growth in the U.S. at 3 percent a year before a slowdown. Do you agree?
A: I think U.S. growth is very solid and is likely to be in the 2.5 to 3 percent range. So we don’t have a big disagreement with Goldman Sachs on this. In 2015 and 2016 we have growth in the high 2 percent range, and in 2017 we’re saying 3 percent, so in that sense we’re very much in tune with what Goldman Sachs is saying.
Q: How do you like third-quarter earnings?
A: The earnings picture is still looking pretty good in the sense that companies are keeping a very tight control over costs and the fact that commodity prices, especially oil prices, have dropped will help those industries that are big users of oil, especially transportation, like airlines.
Transportation is looking good. Anything related to the consumer is looking good, and anything that has a large U.S. market is good. Any company where a majority of their sales are in the U.S. rather than overseas is in good shape.
Q: What doesn’t look good?
A: Right now sectors that have huge exposure overseas are struggling a little bit. And the energy sectors will be hurt a little bit because of the drop in oil prices. Their earnings will be hit.
Q: The Federal Reserve has $2.75 trillion in excess free reserves kept at 1.25 percent interest. If the Fed raises interest rates 1 percent then they have to pay 1 percent above 1.25 percent on that amount, so how can they find it easy to raise interest rates?
A: That’s the least of our concerns. The real question is not so much what the impact will be on the Fed’s portfolio but what impact it will have on the economy?
We argue that the earliest they will start raising rates would be June 2015. There’s a distinct risk that they’ll wait longer because of weakness overseas and the fact that inflation is still not a problem.
When they raise rates they’re going to do it very slowly. They don’t want to derail this recovery. What I mean is maybe raising rates by 25 basis points every other meeting.
If the economy is doing well growing at 3 percent, and if they raise interest rates slowly, I don’t see a lot of damage to the economy.
Q: What do the latest housing data tell you?
A: The latest housing data is mixed, not so much because of the state of the economy, but it’s a reflection of some underlying demographic trends. Specifically, what we have is household formation, the number of people each year who form new households by getting married or moving out of their parents’ homes. That number is historically very weak right now. The question is why. Our best guess is it’s still a bit of a hangover from the Great Recession and the fact that people in their 20s and 30s are still shell-shocked by this event.
Q: Is the job situation improving much, in light of the low labor market participation rate?
A: There are two aspects of the job situation. One is the employers’ payroll survey of jobs, and that’s actually doing very well in the sense that we’ve had nine months of job growth over 200,000 each month. That’s really good. It’s very solid. The participation rate does not affect that number in any way.
In the household survey the participation rate is a big factor. The fact that it has fallen so much in the last few years and is at about a 50-year low undermines the low unemployment rate we have now, because some of the decline is a function of the low participation rates.
Another way of saying it is that there’s more slack in the labor market than is indicated by the unemployment rate being below 6 percent right now.
Our best guess is that some of the decline in the participation rate is demographic and long-term and may never come back. Some of it is cyclical, and as things continue to improve, we will see a rise in the participation rate.
Q: How do you rate U.S. industrial production and manufacturing?
A: Manufacturing has had a very good run in the U.S. recently for a variety of factors. One is that the dollar has recently been very weak. That makes U.S. manufacturers competitive.
The other factor is that we’re enjoying very low energy prices generally, but especially natural gas and electricity prices. Both of these are fractions of what they are in the rest of the world. Natural gas prices are about a third of what they are in Europe and about a fifth of what they are in Asia.
Electricity prices are about half what they are in Europe and about a third of what they are in Asia. This gives industries and sectors that use natural gas and electricity a big advantage in the global economy. In that sense, the U.S. manufacturers, at least some sectors like chemicals and steel, have gotten what some people refer to as a competitive stimulus, a nice shot in the arm.
Q: Congress once again at odds: Does that necessarily foreshadow a market decline coming shortly?
A: You have to look at the political situation. My instinct is that we will not likely see a market correction because of Washington. Most Republicans understand that they’d be playing with fire if they go down that road again. Their popularity took a big hit the last few years because of that brinkmanship.
This past election the Republicans were lucky, because the Democrats’ popularity was even lower than the Republicans’, so they benefited in an odd way.
The other issue is that assuming there’s no default on U.S. debt and we continue to pay our debt obligations, then even if there’s a confrontation between Republicans and the president or the Republicans and Democrats, the markets are likely to shrug this off, because they’ve been through this so many times, and they’re getting jaded.
Q: What do you think of Europe, now that the European Central Bank chief Mario Draghi has decided to pursue quantitative easing, buying euro zone countries’ bonds?
A: It looks like the European Central Bank will conduct fairly large purchases of asset-backed securities. Those operations are likely to pump a fair amount of liquidity into the euro zone economies and to ease credit conditions. That will help growth, and we anticipate that there will be a slight acceleration of growth from this year into next year. We’re saying 0.8 percent growth in 2014 and 1.4 percent for 2015.
Q: What about China, which just lowered interest rates?
A: It’s fair to say Chinese growth is decelerating in a gradual way, but this has the Chinese central bank and the government worried. They don’t know where the bottom is going to be in terms of the growth rate.
The interest rate cut put in place on Friday is likely to be one of many steps in trying to stimulate the economy.
Q: How will that situation affect the U.S.?
A: The good news is that we don’t export that much to China -- somewhere between 1percent and 2 percent of Gross Domestic Product. So even if growth in China collapses it’s not going to have a huge impact on the U.S. It will on other economies but not the U.S.. mostly other Asian economies and countries that export raw materials and commodities to China, like Brazil and South Africa.
Q: What’s your take on what’s happening in Syria, Iraq, and the rest of the Middle East?
A: Clearly the Middle East is in turmoil. Some of it has to do with the so-called Arab Spring in the sense that a lot of people don’t like the dictators in power and have tried to overthrow them. Some of it has to do with the sectarian violence between the Sunnis and Shiites. It’s true in Iraq, Lebanon, and Syria.
The good news is that this has not has a big impact on oil prices. In fact, it has had no impact on oil prices. The reason is U.S. oil production and the fact that it has risen so much in recent years. So, what’s going on here is that the U.S. production has become a buffer in oil markets and has helped stabilize oil prices.
Q: What’s your biggest concern?
A: In the very near term I would say if things get out of control in Europe over the whole Russia – Ukraine situation. That’s a big risk right now. It’s just a wild card, and I would say that’s one of my bigger concerns.
The issue is that it is so unpredictable, because there are lots of bits and pieces in play, and I think the Russians are getting desperate to some extent, not only because of the fighting, but also because a combination of factors, including the sanctions that are really6 hurting their economy. Their economy is entering into recession, and right now we’re saying it will contract by 1.7 percent in 2015.
Given how dire things are in their economy there is always the worry that they may do something more provocative than what they’re doing so far. What we’ve had is the Russians testing NATO air space, and then NATO doing exercises in the Baltics, showing force. Those kinds of things could trigger conflict. The risk of an accidental confrontation between NATO forces and Russian forces is high. Then anything could happen. An all-out war between NATO and Russian forces in Europe could be very damaging, and it’s something that we worry about.