The U.S. economy has shown remarkable resilience in the face of recent hurricanes and the associated energy-price spike. The economy had strong momentum pre-Hurricane Katrina, and it remains on track for solid growth in the fourth quarter, albeit slower than the 4.3 percent seen in the third quarter of 2005. [??] Growth should be strong in the first half of this year, boosted by rebuilding efforts, but should taper off later in the year. Although gasoline prices have receded significantly from their high immediately after the hurricanes, the elevated level of natural gas prices presents a risk for the economy going forward. [??] Consumers have been spending more than they earn, thanks to large gains in wealth--especially from unusually strong home-price appreciation--allowing homeowners to extract a significant amount of home equity, boosting consumption spending. As of this writing, the saving rate has been negative for five consecutive months starting in June. However, the saving rate is trending higher after hitting an all-time low in August.
Continued increases in interest rates as well as an expected moderation in home-price appreciation should decrease home-equity extraction, further dampening consumer spending growth. In addition, consumers will likely face extremely high heating bills this winter, reducing their disposable income.
Economic growth should slow to more sustainable levels in the second half of this year, when expenditures for rebuilding in the storm-damaged regions wane (see Figure 1) and consumption spending growth starts to slow. Economic growth will continue to be healthy, however, as growth in business investment should pick up to offset slowing consumption growth.
Labor markets will remain solid
The weakness in the labor market during the hurricanes turned out to be temporary rather than the start of a deteriorating trend. Payroll employment showed solid gains of 215,000 jobs in November and, with an upward revision to the September data, it turned out that the labor market overall managed to add jobs despite thousands of job losses in the devastated Gulf Coast region.
Going forward, positive economic indicators--including expanding manufacturing activity, low inventories and receding energy prices--point to a continued strong labor market, with job gains averaging around 190,000 a month over this year.
The Fed will continue its modest tightening
Following the hurricanes, inflationary pressures have become more of a concern. Although core inflation continues to be contained, it is still hovering near the upper end of the Fed's comfort zone consistent with price stability. For example, the personal consumption expenditures (PCE) index, excluding food and energy items--the Fed's favorite measure of inflation--increased by 1.8 percent in October from a year earlier, near the 2 percent upper end of the Fed's zone.
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Strong employment growth in a tight labor market is still a concern for the Fed, as wage pressures could be building. The November payroll report showed that average hourly earnings increased strongly from a year earlier. That is consistent with anecdotal reports by the 12 Federal Reserve banks on current economic activity (better known as the Beige Book) that signs of tightening in labor markets and difficultly in...