OSK US: 2011 is Better but Equally Confusing?

• The US economy grew at an annual rate of around 2% over the recent two quarters after the initial spurt in late 2009 and early 2010.  The available data suggests that real GDP growth is tracking slightly more than 3% in 4q10 (up from our previous forecast of less than 3%).  The bump-up in our forecast primarily reflects the pick-up in consumer spending through Nov, which appears to be rising at an annualized pace of 4% or better.  But the wild cards in our 4q10 forecast are net exports and the change in inventories, the two highly capricious categories of GDP.  Specifically, we anticipate net trade to add around 1.5%-points to growth, while inventory adjustments might detract more than 1.5%-points.  Overall, we expect real GDP growth to average 2.9% in 2010 (or 2.8% in terms of 4q10/4q09), up from our prior forecast of 2.8%.                            
• Our 2011 US outlook, which undergoes a more noticeable upgrade, is highly influenced by recent fiscal policy considerations, formally known as H.R. 4853 or commonly referred to as the “Obama-GOP tax deal”.  The so-called “tax deal”--with opposition from both parties, though for different reasons--was signed into law roughly one week before Christmas.  Among the list of provisions, the 2%-point reduction in withholding tax (employee portion only, to 4.2%) of more than $110bn for one-year is a key driver in our 2011 forecast.  According to our calculations, full-year 2011 real GDP growth could come-in at 3.2% on average (or 3.4% in terms of 4q11/4q10), approximately 0.6%-point (with a plausible range between 0.3% and 0.9%-point) higher than our prior estimate of 2.6%.  Although businesses benefit directly (from other tax provisions) and indirectly (from an apparently firmer economy) from the temporary fiscal impact, the main lift is to consumer spending in 2011.  Accordingly, we expect real consumer spending growth to step-up to around 3.3% in 2011, up from our previous forecast of about 2.5%.
• One of the implications for the upward revisions to growth per se is the tendency for a more favorable trajectory in unemployment.  With the usual coefficient estimates, the aforementioned growth backdrop appears consonant with an improvement between 0.2% and 0.3%-point in the unemployment rate relative to our prior forecast.  Hence, we anticipate the unemployment rate to average 9.3% in 2011 (or around 9% in 4q11) down from 9.7% this year.  The other implication on underlying inflation, however, is fairly minor at best.  Our outlook is for continued modest disinflation in the near-term, with core PCE inflation settling around 1% in the first-half and averaging 1.2% in 2011.    
• Nevertheless, possible risks to the 2011 forecast include a more muted response to transitory tax cuts, continued caution in housing and hiring, ongoing household balance sheet adjustment and abrupt negative market reaction to the fiscal deficit.  And given the palliative nature of the “tax deal”, the implications for growth in 2012 and 2013, all else equal, are likely to be more negative and bumpy.  Our rough estimate suggests that the expiration of the tax provisions might potentially exert some drag on growth in the vicinity of 0.5% to 1%-point on balance.
• Finally, our Fed call for the next four quarters is unrevised for now.  We still expect the $600bn purchases of longer-term Treasury securities to be fully absorbed by June 2011 (but the 2011 FOMC lineup is unlikely to produce fewer dissents than in 2010) and a 25bps hike at the tail-end of 2011.