U.S. economy ready for Fed tapering later this year

Despite domestic fiscal headwinds and moderate economic growth in the first half of the year, the U.S. economy has proved surprisingly resilient, paving the way for the Federal Reserve to start tightening its monetary stance later this year.

Resilient consumers

Despite payroll tax increases and government spending cuts at the start of this year, U.S. consumers are still optimistic about the economy and increasing their spending.

The latest figures show U.S. personal consumption expenditures rose 0.3 percent in May after edging down 0.3 percent in April, indicating consumer spending will continue to drive growth in the second quarter.

In the first quarter, the U.S. economy grew at a sluggish pace of just 1.8 percent, but consumer spending rose at the fastest pace in two years. Consumer spending accounts for about 70 percent of U.S. economic output and has been a key driver of overall economic growth in recent quarters.

U.S. consumers are being encouraged to open their wallets by a steadily improving labor market, rising house prices and a booming stock market, which have boosted confidence. The Thomson Reuters/University of Michigan index, an important indicator of consumer confidence, remained at a high level of 82.7 in June, slightly below a near six-year high of 84.5 in May.

"Consumers now believe the recovery has achieved an upward momentum that will not be easily reversed," said Richard Curtin, chief economist at the University of Michigan's Surveys of Consumers.

Struggling maunfacturers

However, U.S. manufacturers are less optimistic than consumers. A mild recession in Europe, a broad slowdown in emerging markets and domestic fiscal contraction have kept business cautious about hiring and capital spending.

The U.S. manufacturing output, the largest component of the overall industrial production, edged up only 0.1 percent in May after declines in the two previous months, according to the Federal Reserve.

The latest Institute for Supply Management (ISM) survey showed the manufacturing sector struggled to expand in June from an unexpected contraction in May, despite an increase in new orders and stronger production.

As manufacturing represents about 20 percent of the U.S. economy, experts believe the struggling sector cannot drag the economy back into recession.

Adam Posen, president of the Peterson Institute for International Economics in Washington, told Xinhua the U.S. economic recovery was "self-sustaining." He was confident the economy would grow at 2.5 percent this year and 3 percent next year.

"The sequester, as I expected, took less off the economy than some people feared," said Posen at a seminar on Tuesday, referring to the roughly 85 billion dollars of federal government spending cuts starting on March 1.

He said the housing recovery was sufficiently strong to help sustain the economy in spite of recent increase in government bond yields.

Ready for Fed's tapering?

U.S. Federal Reserve Chairman Ben Bernanke said last month the central bank could start scaling back its 85-billion-U.S. dollar monthly bond purchasing program later this year and end its purchases around the middle of 2014, if the economy continued to progress as the Fed expected.

The Labor Department's latest jobs report, released Friday, indicated a steady and solid improvement in the labor market despite the recent economic slowdown, signaling the Fed may stick to its timetable for the tapering plan.

The U.S. had added an average of 202,000 jobs per month over the past six months, up from 97,000 in the six months prior to the Fed's launch of its third quantitative easing (QE3) in September, 2012, and the unemployment rate had declined by 0.5 percentage point to 7.6 percent since last September, the report said.

Economists at J.P. Morgan and Goldman Sachs said the Fed would begin tapering its bond purchase program in September, sooner than their previous forecast of December, after the June jobs report.

Tim Duy, a professor of economics at the University of Oregon, shared the same view. "At this point, it is pretty unlikely the data will come in sufficiently weak to postpone a September cut in the pace of asset purchases," he said.

Jeremy Stein, a governor on the Federal Reserve Board, said last month September could be an opportune time for the Fed to consider winding down its bond purchasing program. He also stressed the Fed must take a long view of economic progress and not be blinded by the most recent data.

When the Federal Reserve starts to wind down its stimulus, it will be a real test of the U.S. economic recovery's resilience.