The US economy continues to expand at a moderate pace, despite headwinds created by the fiscal cliff and debt ceiling debate in Washington. US stocks finished slightly higher for the week after positive reports on housing and labor, both of which seem to be benefiting from the Federal Reserve’s pledge to keep interest rates near zero. Housing, which was once a drag on the nation’s economic recovery that began in late 2009, is now delivering momentum to keep the turnaround on track. According to the Commerce Department, home construction and improvements have contributed to economic growth for six consecutive quarters. In the latest report released last week, new home construction in December grew 37% from the prior year, rising to its highest level in four years. Meanwhile, permits to break ground—an indicator of future construction—grew 29% from the prior year.
Separately, the labor market got some positive news. Initial jobless claims for the week ending January 12th fell to the lowest level in five years. This weekly figure tends to be volatile, so it’s too early to call a trend that will make a dent in the stubbornly high unemployment rate, which stands at 7.8%, versus the Federal Reserve’s target of 6.5%. Nonetheless, we view it as another positive sign, despite clouds of uncertainty.
It’s still unclear what effect the 2% increase in payroll taxes, which kicked in at the start of the year, may have on consumer spending. We don’t think the additional tax will derail the recovery, but it may temper the upside. Anecdotally, we’re hearing that some wage earners are contemplating minor lifestyle changes, whether it’s working more hours or forgoing name brands for generics. For an individual earning $50,000 per year, the payroll tax increase translates into about $20 per week. In rough terms, we estimate this is equivalent to a $1.50 per-gallon change in the price of gasoline, assuming that person drives 15,000 miles per year. Some of the pinch may be relieved if energy prices fall and borrowing costs remain stable. Energy prices are anyone’s guess, but we anticipate borrowing costs will remain low, given the Federal Reserve’s plan to keep interest rates at record lows until mid-2015.
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