July 26 (Bloomberg) -- Goldman Sachs Group Inc. is among major banks cutting their forecasts for third-quarter U.S. growth as business inventories swell and consumer confidence declines.
Goldman Sachs, JPMorgan Chase & Co. and Bank of America-Merrill Lynch said the economy will expand at a 2.5 percent pace, down from earlier projections of as much as 3.25 percent. A more-muted rebound from a slow first half would keep pressure on the Federal Reserve to hold interest rates near zero, according to the banks’ economists.
“The soft patch is giving way to a spongy patch,” said Michael Feroli, chief U.S. economist at JPMorgan in New York, who cut his third-quarter forecast from 3 percent on July 14.
Both Feroli and Jan Hatzius, chief economist at Goldman Sachs in New York, said it’s possible the U.S. is headed into a recession, though they added this isn’t their base forecast.
While Feroli said he believes “the economy will be able to avoid a recession,” he added that recent economic reports make it a “legitimate question” to ask if the U.S. is in danger of a slump.
With third quarter growth looking weaker than before, the probability that the Fed will ease monetary policy has risen, Hatzius said in a July 15 report. Fed Chairman Ben S. Bernanke told Congress on July 13 the central bank is prepared to take additional action, including buying more government bonds, if the economy appears to be in danger of stalling.
“Fed officials would undoubtedly ease if the economy returned to recession -- not our forecast, but clearly a possibility,” said Hatzius, who reduced his third quarter growth forecast from 3.25 percent.
More Explicit Pledge
Federal Reserve Bank of Chicago President Charles Evans said July 21 that he would back a more explicit pledge by the central bank to keep interest rates low if this quarter proves to be weak. The Fed cut its target for the federal funds rate to a range of zero to 0.25 percent in December 2008 and has held it there since.
“If we continue to have weakness in the third quarter, it’s going to be harder to plausibly sustain this idea, ‘The next six months is going to get better,’” Evans told reporters in Chicago. “We’ve been saying that for quite some time.”
The economy shrank 0.4 percent in May, according to Macroeconomic Advisers, which compiles its own estimate of monthly gross domestic product. The contraction, which followed a flat reading in April and a 1.2 percent expansion in March, “is still in line with a rising trend,” the St. Louis-based company said in a July 15 release to clients.
For the second quarter, GDP grew at a 1.8 percent pace, after a 1.9 percent gain in the first, according to the median forecast in a Bloomberg News survey before Commerce Department figures due July 29.
What’s worrying economists like Hatzius and Feroli is that much of the growth in the second quarter came from an expansion of inventories rather than from demand. Domestic final sales -- which strip out inventories, exports and imports -- rose at an annualized pace of just a half percent in April-June, according to Hatzius.
Business inventories climbed 1 percent in both April and May, according to Commerce Department figures released on July 14. The rise brought the stockpile-to-sales ratio to 1.28 months, the most this year, from 1.27 months in April.
Manufacturing companies reported that their stocks of unsold goods expanded further in June, according to a July 1 report from the Institute for Supply Management in Tempe, Arizona. Its inventories index came in at 54.1 last month, up from 48.7 in May. Readings over 42.7 are consistent with a rise in stockpiles, the institute said.
“We’re entering the quarter with somewhat of an inventory overhang,” Feroli said, suggesting that companies will need to rein in production during the next few months.
The rise in inventories comes as Americans have become more worried about the future. The Thomson Reuters/University of Michigan preliminary index of consumer sentiment fell in July to 63.8, the weakest reading since March 2009, three months before the recession ended. And while the Bloomberg Consumer Comfort Index showed that confidence picked up a bit in the week ended July 17, its minus 43.3 reading was still at a level consistent with an economic slump.
PepsiCo Inc., the world’s largest snack-food maker, said July 21 that profit this year will increase more slowly than it previously projected because of rising commodity costs and cooling customer demand.
Slowing Earnings Growth
Earnings per share for the Purchase, New York-based company will grow 5 percent to 7 percent in 2011, excluding a benefit from translating overseas currencies into dollars, Chief Financial Officer Hugh Johnston said on a conference call. PepsiCo forecast in April a 7 percent to 8 percent gain.
“It’s the consumer and competitive picture that has become more difficult than we expected,” Chief Executive Officer Indra Nooyi said on the same conference call.
One reason for the bleaker mood is the struggling labor market. The unemployment rate rose to 9.2 percent in June from 9.1 percent in May and 8.8 percent in March. More cuts are in the offing. Cisco Systems Inc., the world’s largest networking-equipment maker, said July 18 it plans to eliminate about 6,500 jobs, or 9 percent of its full-time workforce, to help trim $1 billion in annual costs.
A day later, Goldman Sachs, which makes most of its money from trading, said it will trim about 1,000 employees after a plunge in fixed-income revenue that was bigger than analysts estimated.
“We have penciled in a bigger delay in the recovery in the job market,” Ethan Harris, head of developed-markets economic research at Bank of America Merrill Lynch in New York, said in a July 15 note.
The unemployment rate will be “essentially flat” this year, added Harris, who trimmed his third-quarter GDP growth forecast to 2.5 percent from 2.9 percent.
Not everyone is so pessimistic. James Paulsen, chief investment strategist for Wells Capital Management in Minneapolis, sees the economy growing 3.5 percent in the second half of the year as the temporary forces that held it back in the first half dissipate. These include supply-chain disruptions from the Japanese earthquake and rising gasoline prices.
“The wind increasingly is now at the back of the economic boat,” he said in a July 15 note.
Business and consumer confidence also may have been hurt by nervousness over the outcome of negotiations on the U.S. debt ceiling and the debt crisis in Europe, said Chris Varvares, senior managing director of Macroeconomic Advisers. If policy makers can quiet those fears, the economy should benefit, said Varvares, who forecasts third-quarter growth of 3.3 percent.
“Given all the shocks we’ve had over the first half of the year, the fact we’re growing 2 percent is pretty damn good,” he said, adding “we don’t feel we’re at a knife’s edge and about to fall into a double dip.”
The strong start to the corporate-earnings season also suggests the economy will revive as companies have the financial firepower to invest and hire, said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities in New York.
“I’m not writing off the third quarter,” said LaVorgna, who sees growth of 3.5 percent in the period.
Among 161 companies in the Standard & Poor’s 500 Index of stocks that have reported earnings for the second quarter, 75 percent exceeded the average analysts’ estimates, according to data compiled by Bloomberg as of July 22.
While acknowledging that the economy will benefit from an unwinding of temporary constraints that held it back it in the first half, Feroli argues that the impact may turn out to be less than he initially thought.
Automakers have yet to ramp up production disrupted by supply-chain bottlenecks, while gasoline prices have risen since early July, he said. A gallon of regular fuel at the pump cost $3.70 on July 21, up from $3.55 at the end of June, according to AAA, the nation’s largest motoring group.
“The third quarter should be better than what was a very weak second quarter, but that in itself isn’t saying much,” Feroli said.
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