MH&LC Day 2: It’s sunny in Philadelphia

It’s Day 2 in Park City, but my focus this morning shifts to Philadelphia, hometown of Mark Zandi, the chief economist for Moody’s Analytics and a self-described middle of the roader. “The outlook for the U.S. economy is very bright, especially over the next few years.” In Zandi’s estimation, many of the headwinds that have held back the economy are behind us and the wind is now in our sails. His bottom line: The outlook for the U.S. economy is very bright, especially over the next few years. “We are at a Field of Dreams business moment,” he said. “Business is moving from containing costs to looking for opportunity.”

If the economy follows Zandi’s script, he is anticipating GDP growth of close to 4% per year for the next few years, up from about 3% per year today and 2% per year since the recovery began 5 years ago. Zandi anticipates full employment – defined as 5.5% unemployment rate, down from our current unemployment rate of 6.1% and the peak of 10% during the recession – by late 2016. To get there, Zandi says, we will need to add about 3 million jobs per year, up from the 2-1/2 million jobs we are presently creating.

He offered 3 reasons for optimism.

Fiscal policy: Zandi noted that the sequester – an increase in some tax rates coupled with government spending cuts – have been a major drag on economic growth, amounting to about 1-1/2% per year. The sequester, however, ends soon. “If Congress and the administration do nothing, which is a good bet, that headwind will be gone next year,” Zandi said.

Housing is improving: During the recession, the housing market lost 1/3rd of its value, something that hadn’t happened since the depression. Zandi believes that a combination of pent up demand, new household formation (all those 20-somethings sleeping in their childhood bedrooms want to move out on their own) and obsolescence will jump housing starts from 1 million units a year to 1.7 million units a year for the next two to three years. “Every single home represents 3 to 4 new jobs,” Zandi said.

Our fiscal house is mostly in order: “We have righted the wrongs that got us into this mess,” Zandi said. By that, he meant household and private sector debts. Household debt is now at record lows and corporate balance sheets are “in fabulous shape.” Profit margins are at record highs and US unit labor costs are where they were 30 years ago. In fact, we are the only major economy where unit labor costs have dropped since the recession.

So, why aren’t things better? Zandi said the missing ingredient has been a lack of confidence, both on the part of households and business. That lack is the result of the recession, economic shocks such as crisis in Europe and major reforms such as Dodd-Frank and healthcare reform. That said, Moody’s weekly survey of business confidence is at its highest rate since Zandi began conducting the survey in 2003. That leads to the Field of Dreams business moment.

Of course, not all fields are full of dreams and you can always have a thunder storm on a sunny day, even in Philadelphia. Zandi said that several factors could rewrite his script.

The key risk is higher interest rates. Zandi expects that as the economy continues to improve, the Fed will allow interest rates on the ten year bond to rise from 2.5% to 4.5%, which is closer to the norm. “They have the tools and the will to do that gracefully,” Zandi said, adding that the Fed chairman, in his view, is the right person for the job. “The risk is that they don’t do that gracefully.”