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Board = Conference Board, New York, New York; Fannie Mae = Fannie Mae, Washington, D.C.; IHS Markit = IHS Global Insight, Lexington, MA; GSU - EFC = Georgia State University, Economic Forecasting Center, Atlanta, Georgia; Moody's Economy = Moody's Economy. com, Westchester, Pennsylvania; Mortgage = Mortgage Bankers Association, Washington, D.C.; NAM = National Association of Manufacturers, Washington, D.C.; Perryman Gp = The Perryman Group, Waco, Texas; Royal Bank of Canada, Toronto, Ontario, Canada; S&P = Standard & Poor's, New York, New York; US Bank = U.S. Bank, Minneapolis, Minnesota; US Chamber = U.S. Chamber of Commerce, Washington, D.C.; Wells Fargo = Wells Fargo Bank, San Francisco, California. The crash of 2007-2008 has contributed to the maturity of consumers and, with the exception of home prices, the business community is being responsive by avoiding erratic price changes despite the strong job market. The question is whether the economy can handle further growth in aggregate demand while there is an upper cap on economic expansion placed by supplyside factors, such as sluggish productivity, stubbornly low labor force participation, and tightening migrant labor market. Persistent missing of the inflation target by the Fed is pointing to limits of the monetary policy to impact economic activities that begs fiscal policy options controlled by Congress and the White House to run a hotter economy.
PARTICIPANTS | Conf. Board = Conference Board, New York, New York; Fannie Mae = Fannie Mae, Washington, D.C.; IHS Markit = IHS Global Insight, Lexington, MA; GSU - EFC = Georgia State University, Economic Forecasting Center, Atlanta, Georgia; Moody's Economy = Moody's Economy. com, Westchester, Pennsylvania; Mortgage = Mortgage Bankers Association, Washington, D.C.; NAM = National Association of Manufacturers, Washington, D.C.; Perryman Gp = The Perryman Group, Waco, Texas; Royal Bank of Canada, Toronto, Ontario, Canada; S&P = Standard & Poor's, New York, New York; US Bank = U.S. Bank, Minneapolis, Minnesota; US Chamber = U.S. Chamber of Commerce, Washington, D.C.; Wells Fargo = Wells Fargo Bank, San Francisco, California.
The U.S. economy remains on a steady and gradual growth trajectory, and appears to be decoupling from Washington's politics. The combination of steady job growth and low inflation are contributing to the strength of the equity market. The Fed is conducting itself predictably with a data-based gradual and cautious interest rate normalization strategy. Both the business community and consumers have lost their taste for bubbles, preferring stability and predictability in their decision-making. The crash of 2007-2008 has contributed to the maturity of consumers and, with the exception of home prices, the business community is being responsive by avoiding erratic price changes despite the strong job market. For the time being, the looming uncertainty about the timing and scope of tax reform and infrastructure spending has been filtered out across the board. The question is whether the economy can handle further growth in aggregate demand while there is an upper cap on economic expansion placed by supplyside factors, such as sluggish productivity, stubbornly low labor force participation, and tightening migrant labor market. The numbing political and legal quagmire in Washington is nudging state and local governments to map their own course of economic policies ranging from tax and investment incentive policies to green technology and labor force development.
Consensus puts growth in GDP at 1.63 percent by the second quarter of 2018, significantly below the assertion made by the administration of more impressive growth. Rajeev Dhawan of Georgia State University is among optimists with forecasts of 2.2 and 2.9 percent GDP growth in 2018 and 2019, respectively. Persistent missing of the inflation target by the Fed is pointing to limits of the monetary policy to impact economic activities that begs fiscal policy options controlled by Congress and the White House to run a hotter economy.
CONSUMERS
We believe that the 2007-2008 economic crash and very slow recovery has created a new and long-lasting consumer psychology with some degree of maturity that was totally absent in the pre-crash era. Baby boomers and millennials alike are demonstrating a higher level of sophistication, evident from their reluctance to rack up short-term debt. Slow wage inflation-despite the tightening of the labor market-points to households that understand and process economic data previously reserved for experts. Workers fully understand that demanding wage hikes while inflation remains tamed would lead to a reduction in demand for labor and dwindling employment opportunities. Consensus puts growth in personal consumption expenditure at 4.44 percent by the second quarter of 2018, a full percent point higher than the 3.46 percent growth in disposable income. The expected consumption-income ratio is at 0.91 for the rest of 2017 and 0.92 for 2018, suggesting that consumers remain unexcitable to spend beyond their means despite growing employment. The Fed research indicates that household income used to finance debt is holding steady with the exception of lower income families. The notable absence of the "buy now and pay five years later" ads from the mass media points to growing household sophistication in borrowing and spending decisions. The reduction in employment will slow down in part due to the insufficient pool of skilled workers. A 2015 study by the Manufacturing Institute forecasts that two million jobs will be unfulfilled due to the skill gap, making the re-emergence of the lost middle class more challenging. To close the supply-side gap, an increasing number of state and local governments along with private firms are beefing up labor-force training programs through community colleges and stand-alone training centers. However, it will take several years before a critical mass of newly trained workers are fully integrated and the persistent sluggish labor productivity is turned around. It is clear that easy credit policies of the past are no longer perceived as a source of sustained demand and, instead, a rise in real income and employment is necessary.
Consensus puts the unemployment rate at 4.44 by mid2018, only a fraction of a point below the 4.48 percent predicted for the third quarter of 2017. Further reductions in unemployment can only come from a combination of the reentry of discouraged workers (who often lack needed skills) and marginal workers to fill positions vacated by migrant labor. Consensus puts the change in the consumer price index and chained price index at 1.73 and 1.54 percent, respectively, between the third quarter of 2017 and the second quarter of 2018. Fierce competition among retail giants like Walmart and Amazon is feeding the households' frenzy of seeking lower prices for necessities like groceries and discretionary spending, reflected in a lower chained price index.
FIRMS
Awash with capital, firms are underperforming with new investments. Consensus puts growth in non-residential fixed investment at 2.92 percent, grossly insufficient to provide the tools and technology workers need to improve their productivity. It is unclear if the proposed corporate tax cut will translate to a higher investment spending without dramatically higher consumer spending outside of home buying. The industrial capacity utilization rate is expected to increase meagerly from 76 percent in the third quarter of 2017 to 76.3 percent by the second quarter of 2018, providing disincentive for further investment in capital formation. Consensus expects non-residential fixed investment to grow by 2.92 percent by the second quarter of 2018. Sluggish wage inflation reduces urgency for capital deepening by firms. Single home construction has returned to the 2008 level, but remains well below pre-crash numbers. Consensus expects private housing starts to reach 1.35 million units by the second quarter of 2018, a 5.35 percent rise from the third quarter of 2017. Home prices are rising in many municipalities, including cities that traditionally experienced very slow or no price growth. The National Association of Realtors reports that the inventory of homes for sale is at an all-time low of 16 units per 1,000 households, pushing prices higher. Potential sellers are unsure where they can purchase a new home if they sold theirs. Lawrence Yun, chief economist of the National Association of Realtors, expects the cost of 30-year fixed mortgages to increase to 4.7 percent from the current 4.3 percent by the end of 2017 and increase to 5.5 percent by mid-2018, contributing to higher demand. Rising mortgage rates will eventually slow down the growth of the housing market. The rising default rate on auto and credit card loans has pushed the credit market to tighten requirements. Consensus expects total light vehicle sales to decline slightly to 17.17 million units by mid-2018.
INTEREST, CREDIT, AND THE FED
The Fed hiked the key interest rate as expected in mid-June to the range of 1.0 to 1.25. The market remains uncertain as to whether the Fed will hike the rate more than once in 2017. Federal Reserve Bank of Minneapolis President Neel Kashkari again has argued against rate hikes in light of the softening inflation data. On the other hand, the Fed chair, Janet Yellen, considers current soft inflation as transitory. She is relying on the labor market condition and is hinting on further rate normalization in 2017 and 2018. Consensus expects the federal fund rate to rise slightly to 1.65 percent by the second quarter of 2018. That amounts to no more than two additional 25 basis points hikes by the Fed. Keith Hembre of Nuveen Asset Management believes that the Fed will pause on further rate hikes based on the two-year Treasury yield that coincides with the Fed policy rate.
The triple A corporate bond rate is expected to increase from 4.28 percent in the third quarter of 2017 to 4.81 percent by the end of the second quarter of 2018. It is clear that the cost of borrowing is not the reason for low investment in fixed capital by the business community. M2 money supply is expected to grow by 1.92 percent by the second quarter of 2018, only slightly higher than the 1.63 percent expected growth in GDP. This is a significant reversal of the M2 growth rate compared with 2015 and 2016, when the money supply grew at twice the rate of output growth and still failed to be a source of inflation.
CONCLUSION
With exception of the equity markets, which have a significant irrational component tied to the psychology of hyperactive wealth, main street U.S.A. seems grounded and increasingly more mature. The business sector did not wait for a new administration and promise of tax and spend policies to decide on reindustrialization and reshoring of manufacturing that started long before the 2016 election. We believe that there is a silver lining to the crash of 2007-2008 that provided an opportunity for millions of young and old people without advanced education to experimentally learn economics 101 first hand. The Fed abandoned the opaque policies that contributed to erratic market behavior and remains firm with data-based policy formulation. The retail market is expected to struggle with growing fierce competition in groceries and apparel in particular. Households are inundated with consumer electronics and the release of a new cell phone no longer creates the excitement that it once did. The nature and extent of healthcare reform remains uncertain, but it is not impacting hiring decisions at this point. As the economy continues to expand with a very tight labor market, the justification for fiscal stimulus, tax cuts, and deregulation weakens. Productivity enhancing investments seem to be the primary source of supply side growth. However, CEOs do not make investment decisions based on promised growth in aggregate demand.
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Copyright Journal of Business Forecasting Summer 2017