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Proposed tax policies to repatriate offshore corporate profits will reduce pressure on the credit market and the cost of borrowing for business expansion. The combination of a tight labor market, a historically low capital formation, and stagnant labor productivity will increase the labor cost and limit supply-side expansion in the short to medium term. According to a survey commissioned by the National Institute on Retirement Security (NIRS), there is high anxiety among the elderly about their future. Board = Conference Board, New York, New York; Fannie Mae = Fannie Mae, Washington, D.C.; IHS = 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.
Several weeks into the new administration, a new sense of optimism about future economic growth pushed the equity market into a new high. The Fed has hinted strongly on plans to hike the interest rate as often as necessary in 2017 to thwart overheating of the economy. The question is whether to expect inflation or reflation in light of the glut in the energy market as well as the considerable time that it will take for infrastructure spending to translate in higher employment and income. The market remains uncertain as to how to process risks and rewards associated with the much-anticipated trade restrictions on real output, employment, and inflation. It is much easier to remove or reduce regulations on producers or implement tax cuts, while identifying and funding shovel-ready infrastructure projects with a significant impact on demand for workers and material is substantially time consuming. The proposed immigration policies will adversely affect many sectors of the economy, including construction, food services, agriculture, and retail. The impact on the construction and agriculture industries will be more immediate. Inflation in home prices will be quickly noticeable in many municipalities where excess demand conditions prevail. In anticipation of rate hikes by the Fed, the 30-year fixed mortgage rate has hit a high for this year, adding to cost of home ownership.
Consensus puts growth in the GDP at 1.71 percent by the first quarter of 2018, which is only slightly higher than the 1.59 percent reported in the last issue of this journal and far short of the administration's aim of 3 or even 4 percent. Georgia State University economist, Rajeev Dhawan, is slightly more optimistic with 2.2, 2.3, and 2.5 percent growth in the GDP in 2017, 2018, and 2019, respectively. John Silva, Wells Fargo's chief economist, predicts above-consensus GDP growth for 2017 and 2018.
CONSUMERS
Consensus puts growth in Personal Consumption Expenditure (PCE) at 3.58 percent. Meanwhile, Personal Disposable Income is expected to grow at a slightly higher rate of 3.82 percent. This is the first in a good time when the income of households is expected to grow faster than their consumption. This outcome is expected, given that after a prolonged recession, it takes time for growth in income to catch up with pent-up demand before households consider saving. The Plan Sponsor Council of America reports that workers' contributions to their 401(k) retirement plans are on the rise and participation has grown by 5 percent since 2010. If sustained, this phenomenon is not particularly good news for the credit market or economic growth. Consensus puts the unemployment rate at 4.63 percent by the first quarter of 2018. The economy added an impressive 235,000 new jobs in February, slightly lower than the 238,000 in January. Hourly wage inflation has nudged up to 2.8 percent in February, considerably lower than the prior tight labor market conditions. Laborers have adapted and are more accommodating to their employers. The workers who were the hardest hit in 2007-2008 know friends and family members who are either unemployed or working part time. Labor understands the Philips Curve, which depicts the inverse relation between employment and wage inflation. High labor costs mean a drop in hiring and more offshoring and automation. Workers are breathing a sigh of relief and are unwilling to experience job loss again any time soon. Consumer sentiments published by the University of Michigan has hit 96.3 in February, which is slightly lower than 98.5 in January but considerably higher than 91.7 from a year earlier. Similarly, Bloomberg's Consumer Comfort Index has hit a new high at 50.6, almost a point higher than the last high a decade ago. Brick-and-mortar retailers continue to see sluggish demand with rising bankruptcies and store closings. Online retailers like Amazon and Walmart are the direct beneficiaries of more price elastic consumers who have embraced cyber marketing. Baby boomers and even aging population have developed a functional dexterity with computers and smartphones. An aging Facebook demographic points to the penetration of cyber technology by all ages. Higher home and equity prices will help baby boomers to recover from the 2007-2008 wealth destruction with a potential wealth effect on consumption spending. A segment of baby boomers who postponed retirement now has the option to leave the labor market. Consensus puts the Consumer Price Index at 1.99 percent by the first quarter of 2018. As expected, the Chained Price Index is lagging at 1.55 percent. Consumers have become more price savvy, thanks in large part to the pervasiveness of cyber retail, where price comparisons have become much easier. Tax cuts for the middle class could be delayed until late 2017 or even into 2018. However, when it happens, it will affect the GDP growth quickly, particularly through consumer discretionary spending on durables, automobiles, and leisure. A new study by Peter Ganong and Pascal Noel suggests that households respond quickly to tax cuts even if they are not permanent. This finding challenges Milton Friedman's permanent income hypothesis that assumed tax cuts add to savings instead of consumption.
FIRMS
The combination of low unemployment, the tightening of immigration policy, and the proposed border tax adjustment on imports is expected to spur investment in capital equipment and reenergized interest in automation. Consensus puts growth in non-residential fixed investment at 2.89 percent by the first quarter of 2018, which is considerably insufficient to reverse stagnant labor productivity but is moving in right direction. We reported 2.39 percent growth in fixed capital investment in the last issue of the JBF. With inflation remaining tame, expected hikes in the Fed's key interest rate will contribute to a strong dollar that serves as an impediment to the administration's aim to reduce trade deficit and spur domestic production. Consensus expects private housing starts to grow by 1.3 million units by the first quarter of 2018. Tight immigration policy will drastically affect the cost of construction and affordability. Oil and copper prices are not showing signs of rebounding, raising the probability of reflationary policies such as tax cuts and spending on defense and infrastructure. Industrial capacity utilization is expected to grow slightly to 75.85 percent, compared with 75.42 percent reported in the JBF's last issue but is well below the historic high of 80 percent. Lagging capital spending is one of several causes of persistent labor productivity stagnation. The high-grade corporate bond rate is expected to grow only slightly to 4.67 percent by early 2018. Proposed tax policies to repatriate offshore corporate profits will reduce pressure on the credit market and the cost of borrowing for business expansion. One headwind against growth in labor productivity is the absence of sufficient innovation. The U.S. Trade Commission has released a number of studies suggesting growth in market concentration and declining competition in the United States. Firms with high market power tend to lose their incentive to innovate. Other studies point to the declining rate of new business formation. One explanation is high household debt that has led to risk aversion and declining entrepreneurial spirit as the engine for job creation and disruptive innovations. The healthcare sector accounts for close to one fifth of the economy. The effort to repeal and replace the Affordable Care Act (ACA) has created a wave of uncertainty on both the provider side as well as the medical insurance and consumer side. Whether any replacement will focus on cost bending policies or will aim at managing access to medical care is uncertain. What is clear is that rising coinsurance and the administration's push for healthcare savings accounts will dampen consumer spending on staples as well as discretionary goods, such as durables and leisure. The high cost of medical care is in part responsible for the shrinking of the middle-class population with significant economic ramifications.
INTEREST, CREDIT, AND THE FED
The Fed has repeatedly espoused evidence-based policy formulation. Continued impressive growth in new jobs combined with soft inflation has made it certain that we will see at least two interest rate hikes in 2017. Consensus puts the Federal Fund Rate at 1.25 percent by the first quarter of 2018. M2 money supply is expected to grow by 2.36 percent, in line with what was reported in the previous issue of JBF despite a faster-than-expected growth in GDP. This is the first time in a while that money supply growth is expected to be slower than growth in economic activities. However, we do not believe that it will lead to a tight credit market. The combination of a tight labor market, a historically low capital formation, and stagnant labor productivity will increase the labor cost and limit supply-side expansion in the short to medium term. We believe that Fed's target of 2 percent core inflation is probable by the end of 2017 and early 2018.
CONCLUSION
Today's sense of optimism is being fed by many developments in the economy, such as growing employment, stable prices, rising home and equity values, and revived interest in manufacturing. Anticipated deregulation, tax cuts, and spending on infrastructure and defense are contributing to the expectation of further reductions in the unemployment rate into 2018. However, almost 6 million part-time workers are yet to find full time work. In addition, it is estimated that there are 20 million working age folks who are structurally unemployed because of where they live, their prior work experience, skills they do not have, and/or their drug use or criminal history. Without deliberate intervention to relocate, reeducate, and rehabilitate this population, they remain sidestepped and forgotten. This population segment has a higher birthrate than the national average. In his book titled The New Geography of Jobs, Enrico Moretti of UC Berkeley argues that expansion of thriving urban centers is a key factor in spreading wealth to those who are not high skilled workers through a multiplier effect. According to a survey commissioned by the National Institute on Retirement Security (NIRS), there is high anxiety among the elderly about their future. Four million of 18 million 55 to 64 year olds will be poor at age 65; 2.6 million were considered middle-class prior to retirement.
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Copyright Journal of Business Forecasting Spring 2017