Quick Comment: Our First Assessment of Greece's Loan and Austerity Package
May 04, 2010
By Danielle Antonucci & Elga Bartsch | London
What's new: Greece will get a three-year loan amounting to €110 billion. EMU countries will provide €80 billion in total and €30 billion in the first year (first disbursement ahead of redemption on May 19) - interest rate of around 5%. The various EMU countries will contribute according to the respective central banks' contribution to the ECB's capital. Clearly, this is a big number. Effectively, it removes Greece from the market for at least two years (assuming no private capital inflows), i.e., Greece will not need to issue for quite some time. In the meanwhile, Greece will have to work very hard to fix its fiscal problems, which remain substantial, to reduce appreciably long-term solvency risk. Many press reports over the past few days had already mentioned a financial aid package of €100-120 billion, i.e., the overall amount is in line with expectations, we think, but the fiscal consolidation programme is a lot tougher than expected.
Conditionality: The loan is conditional on further belt-tightening in Greece, which will have to put in place yet another fiscal austerity package amounting to about €30 billion over three years (about 12.5% of 2009 GDP) on top of the tightening already implemented. Basically, the tightening will amount to 9.5% of GDP this year alone (including previously announced measures and the portion of the newly announced measures for the first year). There will be strict monitoring of Greece's progress on the fiscal front, with Greece reporting to the European Commission and the IMF at least every quarter. The loan is conditional upon Greece staying on track in terms of deficit-reduction targets.
Will this be enough? It depends on what enough really means. We believe that this is aggressive tightening, and share the ECB's and IMF's favourable opinion on Greece's fiscal consolidation effort.
We think that this is enough to mirror the case of Ireland - when markets convinced themselves that the consolidation programme would have helped address at least some of Ireland's fiscal challenges. Whether this will happen in the case of Greece too remains to be seen. Indeed, for a financial aid package to work, it is not so much the size of the package that matters. Of course, the bigger the package the better, because an eventual ‘shock and awe' therapy would effectively remove Greece from the market, i.e., Greece would not need to issue for at least two years. Still, the key is to boost investor confidence by sounding fiscally credible, in order to attract private investors' capital on top of the financial aid package. In this way, the chances of restructuring the economy (NOT the debt) will increase.
New measures include:
• Rise in VAT rate to 23% from 21%;
• 10% hike in fuel, alcohol and tobacco taxes;
• Cuts in public investment programme;
• Reductions in public sector bonuses and pensions;
• Three-year public sector pay freeze;
• Recruitment frozen; and
• No renewals for short-term public sector contracts.
Besides the fiscal consolidation measures, a financial stability fund (€10 billion) will be set up for potential stabilisation needs of the Greek banking sector.
What happens next? There will be no disbursement right away. EMU countries and the IMF will disburse funds jointly. For the money to come in, it might take a few more days, but there will be funds in time for the debt redemption on May 19. The various EMU governments will have to put through legislation on the Greek rescue agreement, but it looks like they will do this very quickly.
Germany's Finance Minister Wolfgang Schaeuble mentioned that Germany is "well-prepared to pass legislation on the Greek rescue agreement by next Friday", according to Reuters. In Germany, the private sector might contribute, but just ‘symbolically' at this stage (press reports have mentioned an overall contribution of about €1 billion). France too is expected to approve the loan next week. And Greece will pass the fiscal consolidation package through parliament over the next few days.
Key Events
May 3 - Germany: Cabinet to approve draft law on Greek loan (morning)
May 3 - Germany: Budget Select Committee of the lower house (Bundestag) to debate draft law (evening)
May 5 - Germany: first reading of the draft law and debate in the lower house
May 5 - European Commission's economic forecasts
May 6 - ECB Council meeting and press conference
May 3-6 - France to pass legislation on Greek loan
May 5-7 - Greek parliament expected to approve new €30 billion fiscal consolidation programme
May 5-7 - Biannual estimate of tax revenue in Germany
May 7 - European Council on Greece
May 7 - Germany expects to have concluded parliamentary approval of loans: second and third reading and final vote in the lower house. As soon as the lower house has approved the law, the upper house will vote on it
May 9 - Regional election in German state of North Rhine-Westphalia
May 19 - Greece to redeem €8.5 billion
What about the risk of a short-term restructuring of the debt? If the boost to confidence turns out to be material, the chances are that the credit event (restructuring) that some expect pretty soon will be pushed further out, should it happen at all. Why? For two reasons. First, because, if investor confidence is key, there is a disincentive for the Greek government to take the money and restructure (unless it really becomes inevitable), as such a move would obviously hurt confidence. Second, the EMU governments, the Commission and the Fund do not want and will not push for a restructuring at this stage - they do not want to disburse a large sum and take a severe haircut right away.
But can a restructuring still happen within the three-year loan period? Yes, it can. We could envisage three possible scenarios. First, Greece might not deliver on this programme (possible, but so far it is on track) and so the money flow might stop (the disbursement will be in tranches). Second, Greece might refuse to tighten sufficiently at some point because Greek policymakers think it excessive (unlikely in the short term - we think they will try first, and very hard). Third, there might still be some kind of voluntary restructuring further down the line, i.e., the parties involved agree on ‘what's the right thing to do'.
What are the implications for economic growth? Of course, we will have to work out various details. The timing of the various measures, for example, has not yet been made public. Depending on when exactly spending cuts and tax hikes kick in, the impact on GDP might be more severe this year than the next, or vice versa. Moreover, what exactly the headline number of €30 billion includes is not clear. The GDP growth forecasts behind Greece's adjustment programme indicate a 4% contraction in 2010, followed by a further decline of 2.6% in 2011. GDP growth is then expected to return to positive territory - at a touch above 1% - only in 2012. (The IMF, in a conference call with analysts, seemed more pessimistic to us.)
These forecasts are well in the range of possible outcomes, in our view. Yet we believe that there are grounds to remain cautious. As we argued previously, this fiscal package points to a substantial contraction, of at least 4% this year alone (based on a less aggressive tightening programme of €24 billion, as initially reported). At this stage, we feel comfortable with our new below-consensus GDP growth forecasts of -5% in 2010 and -3.5% in 2011. In other words, we expect the Greek economy to shrink for at least three years in a row (the latest published consensus forecast - April, i.e., before the announcement of this fiscal adjustment programme - is -2.6% in 2010 and -0.5% in 2011). How sharp a fall in GDP is this? Quite sharp. For example, the most severe economic contraction that Greece has experienced since records began was -2.3% in 1985; in the worst post-war economic crisis last year, euro area GDP fell by 4%.
Debt stabilisation - will it be achieved? A different question is whether the overall tightening, implemented and announced, will ultimately be enough to stave off insolvency. The assumption behind Greece's fiscal adjustment is that the debt-to-GDP ratio will increase to 140% before starting to decline; the deficit-to-GDP ratio is expected to decline by more than 5pp in 2010 to 8.1% and 4pp in 2011, and should fall below 3% only in 2014.
Our rough-and-ready calculations suggest that debt stabilisation will be a considerable challenge even under very optimistic assumptions. For example, we illustrate what the change in Greek debt-to-GDP ratio will be for different combinations of primary balance and nominal GDP growth. Starting point is debt-to-GDP ratio = 115% and average coupon on the debt of around 4.5%, i.e., similar to what one could reasonably expect in the event of a major boost to market sentiment. Even in this - admittedly very favourable - case, Greece will need to run a very large primary surplus and/or have nominal GDP expanding at a very fast pace (or really high inflation) for debt-to-GDP to stabilise. As an illustrative example, if Greece runs a balanced primary budget, nominal GDP would need to increase by at least 5% for debt-to-GDP to decline. But that nominal GDP growth will be negative over the next couple of years can almost be taken for granted, we think.
Of course, higher interest rates will make debt stabilisation even more challenging. For example, assuming 10%, the debt-to-GDP ratio will increase even if Greece runs a primary balance of 6% and nominal GDP expands by 4%.
Clearly, you can't have a debt stabilisation in a year or in a short timeframe, i.e., longer-term solvency risk remains firmly in place, we think. This means that even next year and beyond we might still be talking about debt, deficit, imbalances, competitiveness, whether Greece will avoid insolvency, which big peripheral or core EMU countries are also vulnerable, what all this means for the euro, etc.
Critical situation in Greece not new. What about elsewhere? Spain most challenged, Italy better placed: Over the past several months, we have looked at macroeconomic and fiscal risks from several perspectives. Perhaps unsurprisingly, all the sustainability exercises tell you that debt stabilisation will be a very challenging task for Greece. At this juncture, this is already priced into all markets, we think, and we doubt that minor differences in the underlying assumptions really matter. So, apart from Greece, what country should we focus on? Our analyses indicate that, among the other EMU peripherals, the scale of the macroeconomic challenges is greatest in Spain, while Italy looks to be in a more favourable position from a fundamental standpoint. Portugal seems mainly a contagion story at this stage, we think, and its economic and fiscal backdrop looks more robust than Greece's.
The Short-Term Perspective
In our full report, we plot the 2007-11e public debt as a percentage of GDP on the horizontal axis and interest expenditure as a percentage of total revenue on the vertical axis, based on our forecasts. In other words, they show the sensitivity of interest rates to the debt trajectory: the flatter the slope, the better the ability to finance the debt at an affordable cost. The charts show that debt affordability has hardly deteriorated in Italy since 2007 - and we expect it to worsen only to a small extent over the next two years despite rising public debt. What's more, the slope of the debt trajectory in Italy is similar to that of core EMU countries, reflecting its ability to contract a larger debt at an affordable cost.
So, Italy may well be the core of the EMU periphery. However, the difference between the solid debt affordability of Italy from the less robust one of other peripherals (with the exception of Portugal, which looks like a core EMU country from this perspective) does not necessarily make Italy and, say, Germany alike. Indeed, the starting point in Italy (higher debt and interest) is different from that of core EMU countries (and less favourable). Still, the steep debt-affordability curves of Greece, Ireland and, to a lesser extent, Spain do indicate that, as the debt/GDP ratio rises, so does the cost of servicing the debt as a share of revenues (which gives an indication of a country's ability to cover interest expenses) - and quite quickly. Conversely, rising debt implies smaller increases in the cost of debt servicing in Italy. With debt and interest payments rising everywhere, Italy's position is an advantage.
The Long-Term Perspective
The scale of the fiscal problems in Greece is truly remarkable, as shown by virtually all debt-sustainability simulations. Clearly, these are long-term simulation exercises by nature and - quite naturally - the further ahead you look in time, the more the uncertainty around the calculations increases. In spreadsheet-land, back-of-the-envelope calculations indicate that debt stabilisation would require a combination of primary budget surpluses (the primary balance is the overall budget balance excluding interest payments), low debt-servicing costs, and/or high growth to avert a debt trap - i.e., ever-increasing debt-to-GDP - or, at the very minimum, to try to change market expectations that a debt trap is necessarily the end-game.
Of course, the number of moving parts in these debt-sustainability exercises is quite large, ranging from potential GDP growth to demographic variables such as working age population projections, old age dependency ratios and what happens to ageing-related spending (pensions, healthcare, etc.) based on the reforms implemented in recent years in various countries. What's more, privatisations/asset sales - as well as the continued EU subsidies coming in under a range channel (over and above the bailout) - can potentially make a difference. For example, factoring in ageing-related spending (i.e., pensions, healthcare, etc.), the European Commission simulated the debt trajectory of all European countries based on unchanged policies. Based on these calculations, Greece, Spain and Ireland are at risk. Naturally, these projections - based on the assumption of no government policy change - are unrealistic, and in the above-mentioned report the Commission clarified that the simulation exercise is not a forecasting exercise.
Of course, it is unlikely that bond markets would keep financing government debts amounting to a multiple of the GDP of the respective countries - or that governments would maintain their policies unchanged in the presence of ever-increasing debts. Still, these simulations are useful, we think, because they rank all the European countries on the same metrics, thus highlighting the risks faced and the need for more tightening and deep structural reforms in some EMU countries more than in others to bring potentially sky-rocketing public finances under control. The main underlying assumptions of these calculations are in Portugal and the EMU Periphery, February 15, 2010, which also contains cross-country comparisons on other relevant aspects (interest expenses/tax revenues, private sector indebtedness, how the current account deficits are financed). For all the assumptions behind these simulations, see the European Commission's Sustainability Report.
Over the past few months, we have written extensively on the theme of sovereign risk. The following Morgan Stanley Research reports provide helpful background material and cross-country comparisons.
We compared debt sustainability in Greece and Ireland under different scenarios in From Athens to Dublin: Fiscal Sustainability in the EMU Periphery, November 2, 2009. We also looked at the same topic for countries with debt levels similar to Greece's - namely Italy - in Assessing the Damage, October 26, 2009, and expanded on the reasons why Italy is in a better position than Greece and other EMU peripherals in Inching into the Core, March 15, 2010.
Our latest thoughts on Spain - which seems to be coming increasingly under the market spotlight - are spelled out in The Housing Market and the Savings Banks' Restructuring, April 12, 2010.
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Review and Preview
May 04, 2010
By Ted Wieseman | New York
Treasuries posted big 5-year-led gains over the past week as worries about Greece and the potential for Greece's severe fiscal and financing problems to spread more broadly across Europe supported strong results at the latest run of Treasury supply and added to the month-end bid on Friday. Interest rate markets showed notably more worries and distortions from the problems in Europe than equity or credit markets, which partly reversed big Tuesday losses through the rest of the week even as Treasury yields continued moving lower. As Treasuries rallied, unusual moves in swap spreads and interbank rates added to nervousness, as there seemed to be notable pressures continuing to come out of European markets even as Greece and other fiscally troubled EMU members saw their yield spreads over Germany pull back a fair amount from the Tuesday wides. Late in the week, there was a major flattening in the swap spread curve, as 2-year spreads moved much higher while longer-end spreads came way down, resulting in a big flattening in the 2s-10s and 2s-30s swap rates curves that was not seen at all in the Treasury yield curve. Libor and Libor/fed funds spreads at the same time saw big upward moves, especially on a near-term forward basis as the June 2010 and September 2010 eurodollar futures contracts saw unusually big losses even as a slightly more dovish Fed path over the next six months was priced into fed funds futures after the continued lack of movement towards an exit strategy in Wednesday's FOMC announcement and some expectation that Europe's problems could slow the Fed even more. This was certainly not seen as being fundamentally the right policy choice at this point, however, as TIPS actually managed to outperform the big nominal gains on the week, as inflation expectations rose substantially after the FOMC meeting to more than reverse a small moderation seen early in the week as Greece's yield spreads spiked higher.
There was a lot of uncertainty and speculation about just what was driving the big moves in swap and forward Libor/OIS spreads late in the week. European banks and other investors with exposure to strained European government bond markets were seen as possible catalysts, and there was also notable pressure on short-dated euribor futures and short euro swap spreads, but the uncertainty added to jitters. Worries about implications of financial sector reform and oversight developments also may have played a role. Big upward pressure on Libor/OIS spreads was the first major dislocation in mid-2007 when the financial crisis began, so certainly no one likes seeing this happening again (though in a comparatively quite minor way so far), especially when the sources of the upside are unclear. It was a quiet week for economic data, which kept the Treasury market focused on supply and the impact of problems in Europe. Real GDP grew 3.2% in 1Q, close to expectations, extending the rebound since the recession ended in 2Q to +3.7% annualized. We see 2Q running near +3.5% with potential upside risks given how much robust the economy was in March. Looking ahead to a much busier economic calendar in the coming week, big upside in the second round of regional manufacturing surveys supported expectations for further improvement in the ISM, while jobless claims extended their pullback from the seasonally distorted early April readings, again showing the underlying improvement in labor market conditions. We boosted our ISM forecast to a lofty 60.5, and we continue to forecast a 250,000 gain in payrolls.
For the week, benchmark Treasury yields plunged 14-20bp, led by the intermediate part of the curve. The old 2-year yield fell 15bp to 0.92%, 3-year 19bp to 1.49%, old 5-year 20bp to 2.39%, old 7-year 19bp to 3.10%, 10-year 16bp to 3.66% and 30-year 14bp to 4.53%. Although they came off multi-month highs Friday, TIPS inflation breakevens moved a bit higher on the week, and a very strong showing for the typically lower-beta TIPS sector. And the robust showing came with minimal support from commodity prices. Oil prices rose on the week, with June oil up 1% to US$86 a barrel, but a rally by the dollar and risk-reduction trades put pressure broadly on commodity prices aside from this, with the LME's base metals composite index down 3%. The 10-year TIPS yield fell 17bp to 1.27% and 30-year 14bp to 1.86%, while the new 5-year rallied 15bp to 0.40% from Monday's auction level.
Notable pressure on Libor and short-dated eurodollar futures and unusual divergences in swap spreads caused a lot of nervousness in rates markets late in the week, partly because the source of the moves was unclear. The big recent losses in peripheral Euroland government bond markets were seen as possible drivers even as government yield spreads of Greece, Portugal, Ireland, Spain and Italy narrowed a fair amount versus Germany from the Tuesday wides through Friday (though still moving much wider for the week as a whole). Financial stocks saw significant weakness also, as financial reform continued to be debated in Congress, and this may have been behind some of the interbank pressures. 3-month Libor rose 2.5bp on the week to 0.347%, lifting the spread over expected fed funds over the next three months to 11bp from 9bp. This is still quite low and at pre-crisis norms, but a big further widening is now priced into futures in the months ahead after the June 2010 lost 6.5bp to 0.47% and Sep 2010 3.5bp to 61bp even as overlapping fed funds futures rallied slightly. As a result, the forward Libor/OIS spread to June and September each rose about 7bp to near 22bp for June and 27bp for September. These are not really worrisome levels compared to the extremes of the past few years - the spot 3-month Libor/OIS spread ramped up from 12bp at the end of July 2007 to over 90bp in the first week of September 2007 and eventually reached 364bp in October 2008 - but given that prior experience and the key real-time stress indicator this spread was during the crisis, these moves over the past weeks made market participants nervous. Adding to the jitters were odd moves in swap spreads. The benchmark 2-year swap spread rose to 23.25bp from 18.25bp, which including the roll into the new 2-year benchmark was a more than a 9bp rise. At the same time, the benchmark 10-year spread was unchanged at 0.25bp and the 30-year spread fell 5bp to -23.25bp. This resulted in the 2s-10s swap rates curve flattening about 10bp and 2s-30s 14bp versus almost no movement in these spreads in the Treasury market. The 30-year swap rate plunged almost 19bp to only 4.29%, a low since mid-December, so there was some substantial demand to receive long-end rates out there, but it was unclear what was behind such apparently strong demand for long duration. Amid these moves, mortgages were holding in about in line with Treasuries through Thursday, but they lagged in Friday's big rally as interest rate volatility moved higher. For the week, rates volatility didn't do much on net - 3-month X 10-year normalized swaption volatility ticked up 1bp to 100bp - though there were some meaningful day-to-day swings.
This was in sharp contrast to equity market volatility, with the VIX spiking up over 6 points to over 22%, a high since the first part of February after recently seeing levels under 16% for the first time since mid-2007. On the other hand, the actual net movement in stocks for the week was not too notable compared to rates, even with the much bigger move in implied volatility, with the S&P 500 losing 2.5%. Financials and energy were the worst-performing sectors, with declines near 3.5%, while the more defensive utilities, healthcare and consumer staples areas held up best with declines of around 1%. Credit losses ended up being pretty small for the week, after a good rebound from weak Tuesday closes. In late trading Friday, the investment grade CDX index was 3bp wider on the week at 92bp after hitting 97bp Tuesday, the worst close in two-and-a-half months. The HY CDX index was trading near the 500bp par level at Friday's close, about a 20bp widening on the week (or a bit less than 1% in dollar price terms). Spillover from Europe to US municipal bonds continued to be minor compared to February, with the 5-year MCDX index only trading up to a wide close of 133bp Tuesday compared to a February wide of 180bp and then coming down to near 125bp Friday, only a few basis points wider on the week and not far from the year's best close of 115bp hit on April 20. Meanwhile, after a huge rally in the first half of April followed by a mild pullback as the problems in Europe led to broader risk reduction, the subprime ABX market resumed the surge seen since the mortgage principal forgiveness proposals were announced at the end of March. The AAA ABX index gained 2% on the week and 23% in all of April to reach a new high since October 2008. The AAA CMBX index was flat on the week, but for some reason lower-rated indices also resumed surging and outpaced the ABX gains. The AA, A and BBB CMBX indices did best, with gains of 6%, 11% and 6% for the week and 31%, 31% and 23% for the month, respectively.
Real GDP grew at a 3.2% annual rate in 1Q, a third-straight gain for a 3.7% annualized rise since the 2Q09 trough. Final sales rose 1.6%, about the same as 4Q, boosted by a 3.6% rise in consumption, high in three years, on the strength in non-auto retail sales seen in recent months. Business investment gained 4.1%, as a 13% surge in equipment and software on top of a 19% gain in 4Q offset a further 14% plunge in structures. We had thought that there might be a payback in business purchases of motor vehicles after a doubling in investment in light trucks in 4Q (though off a severely depressed base) accounted for much of that 19% surge in equipment and software investment. Instead, there was another big increase in business truck purchases, so apparently front-loading ahead of the expiration of accelerated depreciation schedules was not as big an issue as we thought it might have been. Real business investment in software also showed a second-straight 22% rise in 1Q, accounting for a substantial portion of the 16% annualized gain in overall equipment and software investment in 4Q and 1Q, the best six-month growth since the peak of the tech bubble in 2000. In addition to the weakness in business investment in structures, residential activity was soft at -11%, though this largely reflected weakness in brokers' commissions as home sales corrected in addition to the impact of the severe February weather. Government spending was also surprisingly weak again at -1.8% as federal spending only rebounded 1.4% after being flat in 4Q. Inventories added another 1.6pp to growth on top of the 3.8pp boost to 4Q, but the level of inventory accumulation only turned slightly positive and was barely changed outside of autos. The end of de-stocking continued to boost imports, resulting in a 0.6pp drag from net exports as import growth (+9%) exceeded exports (+6%). The 1Q results were close enough to our forecasts not to lead to any immediate shifts in our +3.5% 2Q forecast, which we will firm up in coming days as the underlying details of the advance 1Q report are released and some of the missing figures are filled in. There is probably some upside risk to our +3.5% number based on how much momentum the economy had in March, which provided a robust starting point for 2Q. The underlying mix in 2Q almost certainly will be much better than in 1Q, as we see final sales growth moving up near +4% from +1.6% in 1Q and +1.7% in 4Q while inventories will probably temporarily swing to be a modest drag in the current quarter as auto inventories flatten out after a big prior run-up restored more balanced levels.
The economic calendar is very busy in the coming week as we get the initial run of key reports for April - manufacturing ISM and motor vehicle sales Monday, non-manufacturing ISM Wednesday, chain store sales Thursday and employment Friday - which we expect to show the economy extended the robust end to 1Q into the early part of 2Q. Supply will also be in focus, and we should get some slightly positive news there, as we expect the Treasury to start to slightly trim coupon sizes at Wednesday's quarterly refunding announcement and indicate that it intends to gradually extend this in the months ahead. We look for a $39 billion 3-year, $25 billion 10-year and $16 billion 30-year, which would be $1 billion lower for the 3-year and unchanged for 10s and 30s. Key data releases due out include personal income and spending, ISM, construction spending and motor vehicle sales Monday, factory orders Tuesday, productivity Thursday and employment Friday:
* We forecast a 0.2% rise in March personal income and 0.6% gain in spending. The employment report points to only a modest rise on the income side in March as the rise in wages and social insurance payments is partially offset by some further slippage in interest and dividend receipts. Meanwhile, a sharp jump in vehicle sales and continued strength in retail control point to a sizeable gain in March consumer spending. The strength in consumption relative to income, and the accompanying dip in the personal saving rate, suggests one of two possibilities - either the saving rate has begun to unwind the rise seen during the recession or the income data have been understated in recent months. We suspect that a combination of these two factors may be at work. Finally, our translation of the CPI data implies a 0.05% rise in the core PCE price index, with the year-on-year rate holding at +1.3%.
* We look for the ISM to rise to 60.5 in April. All six of the regional surveys that we track showed improvement in April, with the best advances seen in Richmond and Chicago. Thus, we look for some upside in the ISM gauge relative to the 59.6 reading seen in March. In particular, the orders, production and employment categories are all expected to show gains. Finally, the price index is expected to hold near the lofty reading of 75 seen in March.
* We forecast a 1.0% rise in March construction spending. An unusually dramatic improvement in weather conditions is expected to help lead to a turnaround in overall construction activity following four consecutive months of outright declines.
* We expect motor vehicle sales to dip to an 11.5 million unit annual rate in April after the impressive advance seen in March. Industry reports suggest that incentives were reined in somewhat over the course of the month as inventories tightened. Also, there are scattered reports of a slackening in fleet activity after some heavy volume in 1Q.
* We forecast a 0.8% decline in March factory orders, with a sharp drop in the volatile aircraft category expected to be responsible for all of downside. Indeed, core durable goods order volume was quite strong in March, and we should see an energy price-related boost in the non-durables sector. Meanwhile, shipments are expected to be up a bit more than 1% while inventories show only a fractional uptick (+0.1%). This points to some further slippage in the I/S ratio (to 1.28).
* We forecast a 3.0% gain in 1Q productivity and 0.8% decline in unit labor costs. In 1Q, the measure of output that is relevant for the calculation of productivity jumped by even more than overall GDP. So, even though we estimate that hours worked posted the sharpest rise since 2Q07 (+1.3%), it appears that productivity growth will show another solid gain. Meanwhile, unit labor costs should record an outright decline for the third consecutive quarter - although the pace of decline this time round should be relatively modest. On a year-on-year basis, productivity is expected be +6.3%, with unit labor costs at -3.5%.
* We look for payrolls to post a gain of 250,000 in April, including a 125,000 net increase in the number of census workers. A number of factors are pointing to some underlying improvement in labor market conditions over the course of recent months. These include: the steady increase in temp hires, the recent uptick in the average workweek, a plunge in layoff announcements and a sharp pick-up in federal government withheld tax collections. Two special factors are also expected to provide a bit of a boost this month. First, temperatures were unusually mild during early April. Indeed, based on the heating degree day data published by the National Oceanic and Atmospheric Administration, the first half of April was easily the mildest in the 12-year history of the data. Second, we have noticed that a relatively late April survey period - as is the case this year - tends to contribute to some modest upside in the payroll tally. Meanwhile, census hiring has lagged a bit behind our original projections. This appears to reflect a number of factors, including a shortage of candidates with the desired language skills and a reluctance of some individuals who are receiving unemployment insurance to forfeit some or all of their benefits. In any case, we expect to see a modest acceleration in census hiring this month followed by a very sharp spike (amounting to more than 400,000) in May. Finally, the unemployment rate is expected to tick up slightly to 9.8% this month. Even though we look for another sizeable increase in the household survey measure of employment, we detect a bit of upside seasonal bias in the participation rate this month which should lead to a big jump in the labor force.
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