Overall economic picture
Interview: Goldman Sachs---Dudley, William---Economist
>> tomorrow the employment report is a key indicator and most economists are expect ag slight drop in the unemployment rampt william dudley is the chief economist at goldman sachs. he joins us to talk about the overall economic picture following the news we got today. mr. dudley, welcome.
>> great to be here.
>> great to talk to you. we saw a g.d.p. number this morning that only three of 69 economists surveyed by bloomberg got correct. were you surprised by that 2.4% number?
>> yes, we were. there were two things that really struck us. one was the huge increase in defense spending. it was difficult to pencil that in, although we obviously know the source of it, the war with iraq. second, nonresidential structures, office buildings, were quite a bit firmer than expected. it was a decent report. it suggested the economy was gathering momentum even before the tax cuts are hitting. i think we can be pretty comfortable we are going to have a second half recovery.
>> you know the largest jump in defense spending since the korean war. is that sustainable going forward? are we going to see more of that? without that would we have seen a much more disappointing figure in the g.d.p.?
>> that contributed about over 1.5 percentage points to the g.d.p. rise of 2.4%. and hopefully we are not going to see more of that. the big increase in defense spending probably was in the second quarter, and it should flatten out. it will actually go down if we can start to pull people out of iraq.
>> how about second half g.d.p.? what is your expectation right now?
>> we are looking for 3.5% growth in the second half. i think the risks may be that it could be firmer than that, given the fact we are taking more momentum into the second half. the economy is doing quite well. you’ve got lots of tax cuts coming. i think the only negative for the outlook is really a little later than that which is the fact that the backup in the mortgage rates will lead to a sharp drop in mortgage refinancing activity. that’s one of the factors really supporting consumer spending and why the economy has held up as well as it has up to now.
>> rate your concern about that at this point, if the consumer no longer has that money in their pocket to refinance, there is only so much they can do on that front, if those rates continue to rise. how much of a concern is that for the consumer to perhaps pull back on their spending in the second half?
>> i think what people don’t realize is how big this source of funding has been. if you take the total amount of money that people are pulling out of their homes through mortgage refinancing, home equity loans and just buying new homes, it’s running at about a $300 billion annual rate. that’s bigger, much bigger than the tax cuts that we are getting. and that’s going to go away pretty quickly now that we’ve had this big backup in rates. i think the good news is that there is still a lot of refinancing activity in the pipeline. obviously when people get that money it takes a while for them to actually spend it. so you probably have six months of momentum left from the drop in rates that we saw earlier this year. but after that we are going to lose that support and that’s probably going to maybe even lead to the economy slowing down a bit as we get into the first half of 2004 and beyond.
>> let’s talk about 2004 and beyond. because until recently your team at goldman had a remarkably gloomy view on groth. you turned that around six, seven weeks ago. what’s your view now going into 2004.
>> we became more optimistic. one, the tax cut package was very big in the first year, $122 billion for households over% -pthe nextwave four quarters, starting the third quarter of 2003. second, financial conditions had become much more accommodative. the stock market was rallying and rekt aing positively to the fed’s rates cuts. those are very much true so i think we are still optimistic. the big thing is this backup in interest rates is going to kill the mortgage refinancing activity. that’s the first concern t second concern is that the u.s. is still trying to do it alone. we don’t have much growth in europe and japan. we really need some help elsewhere. one of the weaker parts of the report today was we saw very very sharp deterioration in the trade deficit in the second quarter.
>> let’s talk about that trade deficit issue. because that’s clearly affecting the mind set and the bond trading and rates as a whole. when you take a look at that do you have any concern about what that could do long term to the economy right now, or to the fed’s decision making process about interest rates?
>> i think the key question is does the rest of the world start growing a little faster? if that happens, we won’t see much further trade deterioration. but if we continue to be in a situation where the u.s. is growing faster than europe and japan, that’s just going to sap our energy and our momentum. if that’s the case, you know, then you have to start to worry about the economy, will it be able to maintain this forward momentum.
>> we have the budget deficits which would be affecting those interest rates as well. concerned about the way the budget deficit is ballooning?
>> i’m not worried about it in the short run. i think it was sort of inevitable. we had a stock market bubble bursting and it caused a very weak economy. it was inevitable the budget deficits would go up sharply. the tax cuts are appropriate in the current environment. what i’m worried about is not the deficits in 2003, 2004. i’m worried about the fact that the deficits look like they are going to be chronic, that they are going to be with us even after the economy recovers. if that’s the case there will be a collision between the public and private sector for money. then there will be an interest rate consequence. right now i don’t think it’s a huge factor in the fixed income markets.
>> i’m afraid we are running out of time. i want to bring up the economic report tomorrow, the big one, the employment number. what’s your expectation for the unemployment rate and the job growth expectation?
>> we are pretty much in line with consensus. we are looking for a small gain of payroll employment of 25,000. initial unemployment claims have been coming counsel over the last couple weeks. we think the rate will tick down 1/10 to 6.3. remember last month it went up from 6.1 to 6.4, so i think we’ll get back a little of that.
>> william dudley, chief u.s. economist at goldman sachs joining us. still to come, profit at canon surged 35%. when we return we are off to the tokyo bureau for a check on earnings and a preview of friday’s market action in the pacific rim.
