THE U.S.

ECONOMIC MONITOR

october 15, 2013 Ian Shepherdson, Chief Economist

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2013 Pantheon Macroeconomics | 399 Knollwood Road Suite 312, White Plains, NY 10603, United States | All rights reserved | No secondary distribution without express permission.

THE U.S. ECONOMIC MONITOR

october 15, 2013 Ian Shepherdson, Chief Economist

The Senate deal on debt and the budget can only pass the House over the Tea Partys head That might require the Speaker to sacrifice himself, so dont expect an immediate vote. In the meantime, the Empire State survey does not like political chaos; downside risk today.

floor. Presumably, he does not want his legacy to be that he was the Speaker when the U.S. defaulted, but equally he presumably does not want to lose his job, and splitting his party over fiscal policy yet again would prompt a serious Tea Party challenge for the job after the mid-terms. None of this has changed since the shutdown began, but what is different now is the intensity of the pressure on the Speaker from the business lobby to end the impasse. The U.S. Chamber of Commerce outspends all other lobbying and interest groups, with most of its largesse going to Republicans, but last week it sent a letter to Congress jointly with trade union federation, the AFL-CIO, urging Congress to end the stand-off. This pressure is not going to fade, and sooner or laterbut not necessarily by Thursdayit will force the Speaker to bring the Senate bill, or something like it, to the floor. The longer the government shutdown and uncertainty over the ultimate outcome of the debt ceiling squabble continues, the bigger will be the impact on the real economy and the slower will be the eventual rebound. At the end of the third quarter, real momentum seemed to be building in an array of labor market indicators, with the claims numbers and the ISM/NFIB hiring indexes clearly pointing to better times ahead. Now, we think payroll gains will not return to the 200K-plus mark needed to signify a real improvement in conditions until early next year. We believe no grand bargain budget deal will be reached over the next couple of months, so fears over default will linger for some time yet. Accordingly, we are inclined already to write off the fourth quarter as something of a lost cause both in terms of the labor market and the wider growth picture. We look for growth of zero-to-1%; without the fiscal chaos, we would have hoped for about 1% better.

Will the House Accept the Senate Bill to End the Standoff?
As we go to press, at 4pm Eastern, it looks as though the Senate will pass a bill today or on Wednesday to re-open the government through the end of the year, pending a budget deal, and to raise the debt ceiling, through the end of January or perhaps a bit further. Media reports suggest the bill will pass with at least some Republican votes. If all goes according to plan, that will increase the pressure on House Speaker Boehner to bring the bill onto the floor of the House for a vote Thursday, the first date on which the Treasury, in theory, cannot be sure it can pay all its bills. For the Speaker, the basic problem has not changed. A significant number of Tea Party sympathizers in the Republican caucus will not vote for the Senate bill, because it does not defund Obamacare and it raises the debt ceiling. That means the bill can only pass if at least some non-Tea Party Republicans vote with Democrats, thereby inviting charges of treason from the Tea Party on the eve of the primaries, ahead of the 2014 mid-term elections. Mr. Boehner is in a very difficult position, which is why he has not previously brought legislation to raise the debt ceiling and re-open the government to the

2013 Pantheon Macroeconomics | 399 Knollwood Road Suite 312, White Plains, NY 10603, United States | All rights reserved | No secondary distribution without express permission.

THE U.S. ECONOMIC MONITOR

We expect the FOMC to take a similar view. It would be astonishing to us if the Fed decided to start tapering at its meeting, in two weeks, time, given the extreme uncertainty of the political backdrop. December also looks too soon, not least because only three payroll reports are due for release before the meeting; none of them will be great. Looking into next year, we would be surprised if Dr. Yellen were to taper at her first meeting as Chairman, on March 18/19. Dr. Yellen has set the bar quite high in terms of sustained labor market improvement, and we doubt she will find enough evidence to convince her in the January and February employment reports. We think tapering is most likely to start in June.
40 30 20 10 0 -10 -20 -30 -40 05 06 07 08 09 10

october 15, 2013 www.pantheonmacro.COM

the empire state does not like political chaos

Empire State index (Le) ISM index (Right) 65 60 55 50 45 40 35 11 12 13 30

above shows how the headline index dropped sharply on both occasions, and then took a couple of months after the crises were over to return to its prior level. Over time, the Empire State survey follows the same broad trend as the ISM, but the two headline indexes can tell very different stories over short periods. We think of the Empire State as a business/ consumer survey hybrid. It captures the views of smaller firms than the ISM, which is dominated by medium-to-large concerns, but views of these firms often are indistinguishable from the sentiment of their owners. We know from the NFIB survey that owners of small firms respond to the same pressures as consumers, which means they dont like to see chaos in Washington or falling stock prices. Recent reports have shown something of a gap between the ISM manufacturing index and the Empire State, but this predates the government shutdown. The numbers are noisy from month-to-month even when the trend is stable, so we need evidence of a widening spread between the indexes before we can confidently blame the chaos in Congress. Today, we expect to see the headline Empire State index dip to about zero from 6.3 in September. The consensus forecast is for a small increase to 8.0, presumably reflecting a view that the upward pull from the strength of the ISM index is more powerful than the drag from the debt ceiling mess.
Ian Shepherdson ian@pantheonmacro.com +1 914 610 3830

Downside risk for Empire State survey?

Today brings two reports which rarely move the markets, in the form of the weekly Redbook chain store sales numbers and Empire State survey. In the absence of official numbers, surveys like these offer our only clues as to how the economy is performing. The Redbook softened last week, with year-over-year same store sales growth slowing to 3.3%, the weakest performance since July, but this followed an outsized 3.8% gain the previous week. It is possible that at least part of the slowing captures the impact of the shutdown, but we need to see softer numbers for at least a week or two before we can be sure. Stepping back from the very latest numbers, the four-week moving average has slowed sharply in recent weeks, but this is misleading. The 4%-plus gains recorded over the Labor Day weekend, which boosted two weeks numbers because the survey captures data from Sunday through Saturday each week, were never going to be sustainable. Without the shutdown, wed expect sales growth to trend at 3%. In the industrial sector, meanwhile, we expect to see a weakening in the Empire State survey, which responded much more negatively than the national ISM survey to the debt ceiling fight in 2011 and the fiscal cliff fiasco at the end of last year. Our chart

2013 Pantheon Macroeconomics | 399 Knollwood Road Suite 312, White Plains, NY 10603, United States | All rights reserved | No secondary distribution without express permission.

THE U.S. ECONOMIC MONITOR

October 15, 2013 www.pantheonmacro.COM

This Week in Brief

This Weeks Funding

Note: D prefix denotes Datanotes for these releases. Some official releases are subject to cancellation as a result of the shutdown of non-essential government services. Monday, October 14 Holiday, Columbus Day Tuesday, October 15 Redbook Chain Store Sales (10/12)/8.55 EDT Sales growth slowed to 3.3% year-over-year last week, the slowest since late July, but this followed a strong 3.8% gain the previous week. The pre-shutdown trend was about 3.5%. D: Empire State Manufacturing (10)/8:30 EDT The index is much more sensitive to political events and the state of the stock market than large company surveys like the ISM, so we expect it to drop to about zero from 6.3. Consensus: 7.0. Wednesday, October 16 MBA Mortgage Applications (10/11)/7:00 EDT The purchase index dipped trivially last week to 188.1. The trend is about flat, as far as we can tell, so far. D: NAHB Survey (10)/10:00 EDT The index is overstretched compared to other housing indictors, so we expect a drop to about 54 from 58. Consensus: 57. Federal Reserve Beige Book /14:00 EDT We expect mixed reports from around the country, with the manufacturing sector likely doing quite well while the housing market slows in the face of higher mortgage rates. Thursday, October 17 D: Initial Jobless Claims (10/12)/8:30 EDT Claims leaped to 374K last week, thanks in part to further sytems problems in California and a hit of about 15K from nongovernment job losses directly tied to the shutdown. We think it reasonable to expect a sharp drop this week, to about 340K, but anything could happen. Consensus: 335K. D: Consumer Prices (9)/8:30 EDT: MAY BE CANCELLED The headline and core should both rise 0.2%, with rebounds in apparel, lodging costs and education lifting the latter. Watch out for rents too. Consensus: Headline 0.2%, core 0.2%. D: Housing Starts (9)/8:30 EDT: MAY BE CANCELLED We expect starts and permits to be little changed, at 890K and 930K respectively. Consensus: Starts 910K, permits 935K. D: Industrial Production (9)/9:15 EDT We expect total production to rise about 0.5%, boosted by a rebound in utility output. Manufacturing should be up about 0.3%. Capacity use should climb to 78.2% from 77.8%. Consensus: Production 0.4%, capacity utilization 78.0%. D: Philadelphia Fed Survey (10)/10:00 EDT The index looks hugely overstretched so we expect a drop to about 10 from 22.3. Consensus: 15.0. Friday, October 18 D: Index of Leading Indicators (9)/10:00 EDT The index likely rose a hefty 0.7%, boosted by the positive yield curve, falling jobless claims, better credit conditions and rising stock prices. Consensus: 0.6%.

Monday 14 Tuesday 15

Nothing Announcement: 4-week bills Auction: $35B 3-month, $30B 6-month bills

Wednesday 16 Auction: 4-week bills Thursday 17 Friday 18 Auction: $22B 1-year bills (settles Oct. 17) Announcement: 3-month, 6-month bills (Oct. 21) Announcement: 30-year TIPS (Oct. 24) Nothing

Pantheons Financial Forecasts

End-month: 2-yr 10-yr 30-yr Curve 10-2 Curve 30-2 Dow Jones IA Dollar/Yen Dollar/Euro Dollar/Sterling 4:00pm Mon. Dec Mar 0.1 0.35 2.69 3.75 234 340 15,301 98.5 1.36 1.60 0.20 0.40 2.75 3.70 235 330 15,500 99 1.34 1.58 0.20 0.50 3.00 4.00 250 350 15,500 101 1.30 1.56 Jun 0.20 0.60 3.25 4.25 265 365 15,750 103 1.28 1.53 Sep .20 .70 3.50 4.50 280 380 16,000 105 1.26 1.50 Fed funds actual

Pantheons Economic Forecasts

GDP CPI

Q4 third Q1 third Q2 third Q3 forecast Q4 forecast Q1 forecast

0.1% 1.1% 2.5% 1-to-2% >2%

2011 year: 2012 year: 2013 year: 2014 year:

1.8% 2.8% 1% 3.0%

0-to-1%

Aug: 0.1% (1.5% y/y); core 0.1% (1.8% y/y) December 2013 forecast: 1.9% y/y; core 1.8% y/y June 2014 forecast: 2.0% y/y; core 1.8% y/y

Unemployment: December 2013, 7.2%; June 2014, 7.0% Federal budget: FY 14 forecast: -$500B (2.9% of GDP)

2013 Pantheon Macroeconomics | 399 Knollwood Road Suite 312, White Plains, NY 10603, United States | All rights reserved | No secondary distribution without express permission.

THE U.S. ECONOMIC MONITOR

october 15, 2013 Ian Shepherdson, Chief Economist

To sign up for a complimentay trial to Pantheon Macroecomics U.S. Economic Monitor, click here: www.pantheonmacro.com/trial/

2013 Pantheon Macroeconomics | 399 Knollwood Road Suite 312, White Plains, NY 10603, United States | All rights reserved | No secondary distribution without express permission.