Bright Economic Outlook Dimmed by Employment and Inflation Worries

The U.S. economy is experiencing the equivalent of a sunny Spring day, with much promise and a hopeful outlook. However, dark clouds related to employment and inflation lurk on the horizon, causing some anxiety about the longer term economic outlook.

The 512 U.S. CFOs that we recently surveyed say that their optimism about the U.S. economy has increased, now resting at 61on a scale from 0 to 100. This is the first time that the Business Optimism Index has exceeded the long-run average since September 2007, indicating that the economy should most likely continue to improve in 2011.

Over the next 12 months, CFOs expect that capital spending at their firms will increase 12%, tech spending nearly 6%, and bottom line profits 18%. In other promising news, 36% of U.S. CFOs say that their firms plan to be active in acquiring other firms, expecially in the tech industry.

However, employment and inflation pose risks to the fledgling economic recovery.

Fulltime domestic employment in the U.S. is expected to increase by 1.2% over the next year. Given anticipated growth in overall labor force, this is barely enough growth to push umemployment much below 9% this year. (If the labor force participation rate were to increase, unemployment might even rise in the coming months.) In fact, one in five companies say that employment at their firms will never return to pre-recession levels. Another 43% say that it will take substantial topline growth (40% increase in sales revenue) to return to pre-recession employment.

Inflation is becoming a bigger concern. In the short-term, companies only expect to be able to increase the prices of their products by about 2.3%, suggesting that for the time being, inflation will remain moderate. However, inflationary pressures are starting to build. Both fuel price inflation and commodity price inflation are in the top half-dozen corporate concerns. Health care costs are expected to rise more than 8% in the next year. Manufacturing firms say that they expect to increase capacity utlization from 73.5% at year-end 2010 to nearly 80%. This robust level of utilization has not been seen since before the recession and could lead to upward price pressure.

If headline inflation were to increase to a hypothetical 4% this year, 43% of CFOs indicate that it would negatively affect their firms. Among these companies, the rate of earnings growth would fall by about half should inflation reach such a level.

Borrowing conditions have improved overall, with 36% of firms saying borrowing is easier now than it was at year-end 2009. However, among the smallest firms (sales revenue less than $100 million), 57% say that borrowing conditions have tightened. This is worrisome because small, young firms create the most jobs in the U.S.

The economic situation is similar but a bit worse in Europe, especially when it comes to employment. European CFOs expect to continue to lay off employees in 2011. The outlook in Asia, on all fronts, is much stronger than in the West. Optimism is higher, and employment and spending plans are more robust. The Chinese outlook is strong but more tempered than in the past. For more details, see the link below.

John Graham is the D. Richard Mead Jr. Family Professor of Finance at Duke University’s Fuqua School of Business

Kate O’Sullivan is Deputy Editor at CFO Magazine

Each quarter the Duke University / CFO Magazine Global Business Outlook Survey polls thousands of chief financial officers around the world. The most recent survey reflects the views of 854 CFOs in the U.S., Europe, and Asia. The survey has been conducted for60 consecutive quarters. The most recent survey contains much information not reported above. See http://www.cfosurvey.org for more details.