The state of the general economy can help or hinder a business’ prospects and therefore has a direct impact on the value of a business. The economic recovery following the recession of 2007-2009 continues, but modestly. Following the September 17-18, 2013, meeting of the Federal Open Market Committee (the “Committee”) of the Federal Reserve, the Committee issued a statement that economic activity appears to have returned to moderate growth in the third quarter of 2013. Household spending and business fixed investment have advanced and the housing market has strengthened, although the unemployment rate remains elevated and fiscal policy has become more restrictive.
Gross Domestic Product
The U.S. Bureau of Economic Analysis (BEA) estimates that real gross domestic product (GDP) — the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 2.5 percent in the second quarter of 2013. Quarterly GDP data for the preceding ten years is shown in the following figure.
QUARTERLY U.S. GDP GROWTH
Seasonally Adjusted Annualized Rates; Shaded Bar Indicates Recession
Sources: U.S. Bureau of Economic Analysis and National Bureau of Economic Research. GDP percent change is based on chained 2005 dollars.
The employment situation in the Untied States remains weak. In the 25 consecutive months from February 2008 to February 2010, 8.7 million non-farm jobs (net) were lost. In the 43 consecutive months from March 2010 to September 2013, 7.0 million non-farm jobs (net) were created.1 The unemployment rate peaked at 10.0 percent in October 2009 and has abated somewhat to a still-elevated 7.2 percent as of September 2013.2 This statistic omits discouraged workers who have left the workforce and part-time workers who would prefer full-time work. A more expansive measure of labor underutilization was 13.6 percent as of September 2013.3 Such a high level of underemployment places severe strain on the economy as consumers are unable or hesitant to spend. The past ten years of employment data are presented in the following figure.
MEASURES OF STRESS IN THE LABOR MARKET
Shaded Bar Indicates Recession
Sources: Department of Labor, Bureau of Labor Statistics, and National Bureau of Economic Research. Data represents non-farm payrolls.
The Committee meets periodically to assess economic conditions and determine appropriate policies to fulfill its dual mandate of fostering maximum employment and price stability. At its September 17-18, 2013, meeting the Committee kept the target federal funds rate at zero to 0.25 percent and anticipated that an exceptionally low federal funds rate is likely to be warranted as long as unemployment is greater than 6.5 percent and inflation expectations remain close to the Committee’s goal of 2.0 percent. The Committee also announced that it would continue its quantitative-easing policy of purchasing mortgage-backed securities at a rate of $40 billion per month and longer-term Treasury bonds at a rate of $45 billion per month, with an end date dependent on the evolution of the economic outlook and progress towards the Committee’s longer-term employment and inflation objectives. Recent Federal Reserve communications have indicated that a reduction in bond purchases could begin as early as the end of 2013. The Committee will continue extending the average maturity of the Treasury securities it holds and reinvesting proceeds from maturing bonds.
Uncertainty regarding the timing and severity of reductions in accommodative monetary policy drove yields on U.S. Treasury securities higher during the third quarter of 2013. As a result, corporate bond yields and 30-year mortgage rates increased considerably during the third quarter. Housing sector activity slowed during the period, possibly reflecting the effects of increased mortgage rates. Despite this increase in interest rates, the issuance of commercial and industrial loans, automobile loans, and student loans expanded moderately since June. Ten years of historical interest rate data are shown in the following figure.
SELECTED INTEREST RATES
Shaded Bar Indicates Recession
Source: Federal Reserve Statistical Release H.15 (519) Selected Interest Rates
Financial markets in the Untied States remained volatile during the third quarter of 2013, as investors reacted to economic data, Federal Reserve communications, and increasing political uncertainty. As of September 30, 2013, the Republican-let House of Representatives and the Democratic-led Senate have remained unable to enact regular appropriations or a continuing resolution related to government spending for the 2014 fiscal year that begins on October 1, 2013. At midnight on September 30 a partial government shutdown commenced, the first since 1996. Estimates suggest 800,000 workers will be furloughed without pay and many government services will be suspended until an agreement is reached. Goldman Sachs estimates that a three-week shutdown could reduce fourth-quarter GDP by as much as 0.9 percent.4
Congress has traditionally placed a limit on the total amount of debt that the U.S. Department of the Treasury (the “Treasury”) can issue to fund expenditures commonly known as the “debt ceiling”. The Treasury’s borrowing has been at the statutory limit of $16.7 trillion since May 2013, although extraordinary measures have allowed it to borrow additional funds without breaching the debt ceiling. On September 25, 2013, the Treasury estimated that its ability to use these extraordinary measures will be exhausted by October 17, leaving a cash balance of approximately $30 billion. As government expenditures exceed receipts, a failure to raise the debt ceiling would result in the inability to satisfy all financial obligations and possibly cause a first-ever default on the nation’s debts. at the end of the third quarter of 2013, there remains significant uncertainty regarding resolutions to both the government shutdown and the debt ceiling.
The European sovereign debt crisis that began in earnest with Greece in 2010 and the subsequent recession continue to adversely affect local economies and employment levels. Although the proximate cause was the 2007-2009 financial crisis, a combination of persistent structural deficits, trade imbalances, and real estate bubbles in the decade prior have resulted in a series of European nations requiring substantial financial bailouts. A “troika” of international lenders consisting of the European Union, the European Central Bank, and the International Monetary Fund has provided extraordinary financial support to five of seventeen euro area countries: Greece (April 2010), Ireland (November 2010), Portugal (May 2011), Spain (June 2012), and Cyprus (June 2012). The unemployment rate in the European Union was 10.9 percent as of August 2013, falling slightly from the May 2013 record-high of 11.0 percent.
In recent months, various statistical reporting agencies have revised the U.S. economy’s projected growth rate downward due to tighter financial conditions and uncertainty regarding the ability of American and European governments to enact policies that will stabilize debt levels while supporting economic growth. In September, the Federal Reserve lowered its projected range of near-term GDP growth from its June forecast, decreased its expectations of 2014 GDP growth, and narrowed its projected range of GDP growth in 2015. This data is presented in the following figure.
U.S. GDP GROWTH ESTIMATES
Source: Federal Reserve.
The Congressional Budget Office’s (CBO) May 2013 report estimated that the federal budget deficit for fiscal 2013, which ends September 30, will be $642 billion, the lowest level since 2008. The CBO projects subdued economic growth in 2013, reflecting the sharp increase in federal taxes and the reduction in federal spending that have already begun or are scheduled to occur under current law.5 The CBO estimates that real GDP will grow 1.4 percent in 2013 and 3.4 percent in 2014, with growth averaging 3.6 percent from 2015-2018. GDP is expected to remain below the economy’s potential until 2017.6
Inflation, as measured by the Core Consumer Price Index, which excludes the effects of food and oil, is forecast to be 1.5 percent in 2013, eventually increasing to an average of 2.0 percent per year in the 2019-2023 period.7 In August 2013, Moody’s Investor Service upgraded the United States’ credit rating outlook from “negative” to “stable” due to improving labor and housing markets and strong stock market performance. Although the global economy continues to recover from the severe recessionary shocks which began in 2007, the process has been slow and unsteady, and consumers, businesses, and investors remain cautious.
1 Source: Bureau of Labor Statistics. “Employment, Hours, and Earnings from the Current Employment Statistics survey (National).” http://data.bls.gov/timeseries/CES0000000001?output_view=net_1mth.
2 Source: Bureau of Labor Statistics. “U-3 total unemployed, as a percent of the civilian workforce (official unemployment rate)”. Reported on a seasonally adjusted basis. http://www.bls.gov/news.release/empsit.t15.htm
3 Ibid. “U-6 total unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all persons marginally attached to the labor force.” Reported on a seasonally adjusted basis.
4 “What’s the economic impact of a U.S. government shutdown?” BBC News, October 1 2013. http://www.bbc.co.uk/news/business-24341406 Accessed on October 2, 2013.
5 U.S. CBO. “Updated Budget Projections: Fiscal Years 2013-2013.” May 2013. http://www.cbo.gov/sites/default/files/cbofiles/attachments/44172-Baseline2.pdf
6 U.S. CBO. “an Update to the Budget and Economic Outlook: Fiscal Years 2013-2023.” February 2013. http://www.cbo.gov/sties/default/files/cbofiles/attachments/43907-BudgetOutlook.pdf