A Better, but Not Robust, Forecast

 | Mar 06, 2013 | 4:30 PM EST
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Recent economic data reflecting sentiment of both manufacturing and service-sector businesses suggest they might not be that concerned about either the sequester or the end of the payroll tax holiday. This builds from other reports I've recently covered about the consumer and business investment in equipment and software. As a result, economic growth is likely to continue, perhaps at a higher rate, according to researchers at the San Francisco Fed, who pencil in GDP growth in 2013 of 2.7%.

Let's see what the data tell us. For starters, we can look at service sector companies. This is a wide-ranging sector, including industries as diverse as agriculture and mining in the basic commodities category to more economically sensitive sectors such as retail and wholesale. Also included are healthcare, construction, utilities, finance and others. We see that business activity has picked up, according to the Institute for Supply Management's Non-Manufacturing Index. The headline printed at 56.0, a faster clip than in January's 55.2, in this diffusion index where anything above 50 indicates expansion. This is the best growth in the past 12 months.

New orders, in particular, posted a strong monthly gain of 3.8 points to 58.2, and employment held roughly steady at an expansionary 57.2. Despite problems in Europe, new export orders advanced to 60.5 from 55.5. Survey respondents believe their inventories are too high, however, and this may mean that some could place fewer orders with manufacturers in the future. That hasn't happened yet.

In the separate ISM Manufacturing index, the headline number increased by 1.1 points to 54.2, and new orders instead increased to a decent 57.8 from 53.3. Employment measures show continued growth, and overall business activity advanced to 57.6 from 53.6. Even exports are growing, with a 53.5 reading, up from 50.5 the month before.

That's a lot of numbers, but what do they mean? They mean that economic activity should improve. The growth in new orders from those who deal directly with consumers all point to relatively few worries about economic headwinds. And these survey data are recent, published in the past week with data collected in the past month.

The San Francisco Fed echoes this view that economic activity should pick up. In its recent research, it pointed to the fourth-quarter GDP report that showed underlying private sector demand was strong -- once you strip out a (temporary) inventory correction and a drop in defense spending. As these factors subside, growth in 2013 should be 2.7% vs. 1.5% in 2012, with the unemployment rate falling to 7% by the end of the year.

Of course, there are well-known headwinds. The researchers highlighted a couple of possible detractions from growth, noting the risks from federal government spending cuts, including defense and social services, and the ongoing problems in Europe that could flare up. Still, the risks of economic contraction are low, with separate research from the Cleveland Fed pointing to the odds of a recession in the next 12 months at just 6.4%.

On balance, though, whether you look at business sentiment, consumer survey data or real private final demand, the outlook points to continued growth. Maybe businesses prefer the relative certainty of the sequester and the end of the payroll tax holiday vs. the uncertainty of an ongoing debate of how to cut the deficit. Or maybe they believe that funds not diverted by the government issuing massive amounts of debt to fund the deficit frees up more capital for them to invest. Or perhaps they believe the private sector, including markets overseas (noting the growth in export orders for both the manufacturing and service sectors) will help.

In any case, even though the 2.7% growth forecast by the San Francisco Fed isn't exactly robust compared to what it could be, dire predictions of the impact of federal government spending aren't evident in the data so far.

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