The US Economy is Headed for a Katrina-Induced Soft Patch

As information pours in about the extent of the devastation from Hurricane Katrina, Global Insight has been updating its assessment regarding the economic damage from the storm. The following is our assessment as of Friday, 2 September.

• While most hurricanes inflict severe damage to the local economy, their impact can be barely detected in the national statistics. During the quarter in which the hurricane occurs, GDP growth usually takes a small hit (0.1% to 0.2%). Subsequently, because of reconstruction activity, real GDP growth is a little higher for a couple of quarters.
• The impact of Katrina on the national economy will be considerably larger for three reasons:
  • First, the devastation from the storm is much larger than any other hurricane in recent history. New Orleans, with a $40 billion economy (about 0.4% of the national economy), is under water and may be "shut down" for three to six months.
  • Second, the port of New Orleans is the second largest in the country. It handles a large volume of imports of commodities, such as steel, coffee, and bananas. Also, most of the nation's exports of wheat, corn, and soybeans go through New Orleans. Any prolonged disruption could affect trade, especially grain exports.
  • Third, and by far the most important, the vast energy infrastructure in the region has been damaged. The full extent of the damage is still unknown; however, it now looks as if the supply of refined goods (gasoline, jet fuel, home heating oil, and diesel) is at greater risk than the supply of crude. Not only is it possible that the refineries in this region have been more damaged than the offshore rigs, but crude oil supplies are being bolstered by releases of the Strategic Petroleum Reserve and by supplies from the European Union.

• Based on current information, Global Insight believes that oil prices will not rise much higher (as long as there are no further supply disruptions). We expect that, as the energy infrastructure is repaired and becomes fully operational, oil prices will fall gradually from current levels to around $66 a barrel (for WTI crude) by the end of the year.
• The gasoline price outlook is a little more clouded. Nevertheless, Global Insight believes that gasoline prices will average between $3.00 and $3.50 nationally during September and then fall gradually to around $2.60 by the end of the year.

• In the end, three things will combine to reduce growth in the third and fourth quarters: 1) the shutting down of the New Orleans economy for an extended period of time; 2) the disruptions in the energy industry; and 3) the impact of higher gasoline and other fuels on consumer and business spending.
• Global Insight believes that these impacts, alone, will reduce growth in both the third and fourth quarters between 0.5% and 1.0%. This means that third-quarter growth will likely be 3.5% to 4%, and fourth-quarter growth will be 2.0% to 2.5%.
• There will likely be a rebound in growth in early 2006, as the reconstruction of New Orleans begins and as oil prices fall.
• In the meantime, the data on the US economy (especially employment and industrial production) will look very weak in the next few months.

• The uncertainty about the damage from Katrina will make the Fed's task far more complicated.
• Global Insight believes that, at most, the Fed will hike the federal funds rate another 25 basis points before the end of the year (probably at the September meeting).
• After that, Mr. Greenspan and his colleagues are likely to take a "wait-and-see" attitude for a couple of meetings.

• Most of the risks in the next few months will continue to be on the down side.
• Energy markets are still tight and the full extent of the damage is still unknown. This means that any downward revision of supply estimates (or any energy disruptions outside the United States) could send prices much higher.
• There is also a risk that both consumers and businesses will react more negatively to the record-high energy prices, and cut spending a lot more than Global Insight expects. This could reduce growth in the next few months by a larger margin.