July 25, 2014

Alan Levenson Alan Levenson, T. Rowe Price Chief Economist

After a precipitous decline in the first quarter, the U.S. economy is rebounding and could grow at a 3% annual rate over the second half of the year, says T. Rowe Price Chief Economist Alan Levenson.

Mr. Levenson says the 2.9% decline in real gross domestic product in the first quarter does not reflect any underlying fragility in the economy. Rather, slower growth in inventories, a widening of the nation's trade deficit, and lower-than-expected spending on health care were key drivers of the earlier economic weakness. Since then, inventories are growing and business capital spending and housing sectors are improving, Mr. Levenson says.

With job growth strong in recent months, the U.S. has finally regained all the jobs lost in the recession five years ago, but Mr. Levenson says he is concerned about the changing profile of the job markets. He notes that traditional higher-paying jobs in manufacturing and construction and government "are not coming back in a big way" and that much of the growth has been in lower-paying sectors such as retail, leisure, and hospitality. However, he notes that professional and business service jobs with above-average pay have grown as fast as the lower-paying sectors.

With inflation remaining at moderate levels, the Federal Reserve will keep on a path that should end its asset purchases of securities by this October and maintain interest rates at record-low levels for another year. "The Fed is trying to avoid surprising the market by changing plans," Mr. Levenson says. "That's always disruptive to market trends."

While the economic recovery from the global financial crisis hit the five-year mark in June, it has been one of the more lackluster expansions in U.S. history. "For all the aggressive policy that we put in place," Mr. Levenson says, "we've had 2% [annual growth rate] since the recession ended in mid-2009. The last 12-month period was just 1.5% growth and only 1.3% growth in the 12 months before that. That's very sluggish. We're not firing on all cylinders. One sector will do well and then it falters and something else picks up a little bit of the slack."

However, he adds that the U.S. economy "should be poised to rise from that 2% trend toward 3%. The drag from the tax increases at the beginning of last year and the sequester has faded. We've got a new consumer credit cycle that's started, but housing and business investment haven't picked up the way anyone thought they would."

Although this recovery is relatively long, Mr. Levenson does not see it faltering because of age. "We've never gone into a recession or even been halfway through an expansion with the Fed still holding interest rates at the lowest possible level. Generally, we see inflation rising and profit margins falling when entering a peak in the economy. Those things aren't happening. We're at the bottom of the household borrowing cycle. So, we're looking at the patient not in terms of the birth certificate but taking the vital signs, and the vital signs speak about early to middle age, not old age."

Mr. Levenson says one concern is that while there is not as much leverage in the financial system compared with seven years ago, "there has been a lot of inflow to bank loan mutual funds and ETFs [exchange traded funds], and emerging markets and sectors that are basically driven by the promise of low interest rates in a stable environment.

"If something upsets that and you get money flowing the other way, I'm concerned that there could be some systemic linkage that we didn't anticipate that could undermine the economy from the financial side even if the real economy is not indicating fragility."

Looking at the sluggish global economy, Mr. Levenson says, "We are still in a very long, drawn out, and non-synchronized adjustment to the financial crisis. The U.S. had a more aggressive policy response in 2008 and 2009, so we were able to grow more quickly than Europe. Europe is finally turning the corner out of recession this year, but it has a low-inflation problem and still has a lot of debt to work off. Europe was not as aggressive as the U.S. in terms of monetary, fiscal, or banking policies, so we should be cautious about the kind of growth we expect from that region.

"Meanwhile, most emerging economies are still managing their growth rates downward as they adjust to no longer having the U.S. as a big export market and have to depend more on internal drivers of growth. So if you look around the world, growth won't be a lot different this year than last year. Europe is moving to modest growth, China is shifting downward, and the U.S. and Japan will grow about the same rate as last year. But I'm hopeful that the global economy can get back to that mid-3% growth rate next year."