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Board = Conference Board, New York, New York; Fannie Mae = Fannie Mae, Washington, D.C.; 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. Despite the robust labor market, wage inflation remains checked, leaving firms with more resources to invest in long-deferred investment in capital equipment. According to the Pew Research, in the year 2000, about 13 percent of those aged 65 years or older reported working full or part-time. Inflation and inflation expectations remain stubbornly low, leading to flattening of the yield curve, where the gap between short-term and long-term Treasury bill yields have narrowed significantly.
PARTICIPANTS I Conf. Board = Conference Board, New York, New York; Fannie Mae = Fannie Mae, Washington, D.C.; 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 continues with robust employment growth that started in the last quarter of 2009. The Conference Board Employment Trend Index bounced by 5.4 percent-the highest ever-in October 2017, pointing to continued growth in employment in the months to come. The two recent devastating hurricanes created temporary hiccups, with the promise of boosting the GDP figures as recovery and reconstruction takes place. Despite the robust labor market, wage inflation remains checked, leaving firms with more resources to invest in long-deferred investment in capital equipment. The headline unemployment has dropped to 4.1 percent, while broader measures that include discouraged, marginal, and those who can only find parttime work is 7.9 percent, indicating the persistence of labor market slack. The labor participation rate that reached the 18year low of 62.4 percent in September 2015 has rebounded to 63.1 percent by September 2017, but remains far shy of 67.3 percent in April of 2000. The Congressional Budget Office is predicting a decline in labor force participation to 59.2 percent in the next two decades. Members of the American labor force have become more sophisticated regarding their understanding of domestic and global forces that affect their bargaining leverage; they have become cautious and more realistic in their expectations.
CONSUMERS
Despite the back-to-back growth rate of 3 percent in the second and the third quarters of this year, consensus is persistent in its expectation of below 2 percent GDP growth for 2018. The consensus put the GDP growth at 1.75 percent by the fourth quarter of 2018. This level of GDP growth is consistent with the Congressional Budget Office's noninflationary economy that has prevailed for more than a decade. Despite efforts by the Fed to push the inflation rate to 2 percent for several years, the consensus expects the consumer price index to remain non-inflationary at 1.49 percent by the end of 2018. Personal disposable income is expected to grow at 3.16 percent by the fourth quarter of 2018, down from 3.34 percent reported in the last issue. Similarly, the consensus puts growth in personal consumption expenditure to rise by 3.07 percent, down from 3.16 percent we reported in the last issue. One explanation would be that despite steady job growth, consumers have internalized their stagnant wage growth and are expected to remain cautious. The news of lagging wages, rising healthcare cost, and the threat of automation has spilled over from the academic discussions and publications to popular news media. Aggressive expansion of deep discount German grocery chains like Aldi and Lidl as well as the planned expansion of European discount apparel stores in the United States are in anticipation of a long-term shift in the psychology and pocketbooks of the American middle class. The millennials have become less brand conscious, and seeking value in their purchases. While department stores like Macy's are flailing, T.J. Maxx and Marshalls are experiencing long lines at their cash registers-a clear sign of growing price sensitivity across all generations. Personal disposable income is expected to increase at almost twice the rate of the overall economy. However, the distribution of the income remains a source of concern. The Federal Reserve Bank of St. Louis research shows that despite a slight rebound in the past two years, the labor share of the GDP has been on a downward trend for the past 47 years, dropping from a peak of 51.7 percent in 1970 to 43 percent in 2016. These data are particularly alarming for an economy that is structured around consumer spending for 70 percent of its output. The American households are not leveraged, however. The household debt to GDP ratio has stabilized at 80 percent since the first quarter of 2016, down from 99 percent in the first quarter of 2008. Conversely, the government debt to GDP ratio has increased from 30.66 percent in the second quarter of 1981 to 103.77 percent in the third quarter of 2017. Transfer payments to households have risen from 48 billion dollars in the first quarter of 1970 to 2 trillion dollars in the third quarter of 2017. The rise in transfer payments means that without it, the stagnant household wages and salaries are insufficient to absorb the output and propel the economy. One piece of good news is that Americans are postponing retirement, in many cases because they are skilled and enjoy working. According to the Pew Research, in the year 2000, about 13 percent of those aged 65 years or older reported working full or part-time. By May of 2016, the figure has jumped close to 19 percent and is expected to rise to 32 percent by 2022. Most of the employed aging population are mind-workers and earn a high income, adding to consumer spending and saving for their delayed retirement. Growth in wages has subsided since August, reversing upward growth between February and August. The good news is that inflation remains tamed, which allows for modest growth in real wages.
FIRMS
Employers added 228,000 non-farm workers in November. The average annual employment growth has dropped from the high of 250,000 in 2014 to 170,000 in 2017. This is an expected development. For an economy on a continuous recovery since 2009, further growth cannot rely solely on labor input alone. The consensus expects non-residential fixed investment to grow by 3.18 percent in 2018, up from 2.86 percent reported in the last issue. Growth in investment in three quarters prior to the election was 0.9 percent. In the three quarters since the election, the investment growth has been 5.9 percent. Rajeev Dhawan of the Georgia State University calls the increase in business investment the "Trump investment bull run." Industrial capacity utilization is expected to nudge up to 77.2 percent, but remains on a long-run downward trend from the high of 89.4 percent half a century ago. Consensus does not expect a significant change in the total light-vehicle sales at 17.2 million units by the fourth quarter of 2018. The private housing starts are expected to grow by slightly above 5 percent in 2018 at 1.32 million units, a drop from the 6.45 percent growth we reported in the last issue. There is a debate about whether the almost six-decade-old Phillips Curve that depicts the negative correlation between inflation and unemployment is still relevant. The economy is at full employment, and yet there is no sign of wage and price inflation. We believe that the structure of the U.S. and global economies have changed significantly in the last six decades. It is time to consider two separate Phillips Curves. One curve for the traded or exposed sectors of the economy where U.S. workers and firms compete globally. For these sectors, the Phillips Curve has not fared as expected. Manufacturing, apparel, and food are examples of such sectors. For locally produced and nontraded activities, the Phillips Curve remains intact. Examples of such sectors include construction and healthcare where wage inflation has been more than 7.5 and 5.5 percent, respectively. Price inflation measured by the Consumer Price Index and the Chained Price Index are expected to rise 1.49 and 1.37 percent, respectively, by the end of 2018. The gap between the Consumer Price Index and the Chained Price Index has been narrowing, reflecting the bargain-seeking consumers, powered by the Internet, to cope with stagnant paychecks. The triple-A corporate bond rate is expected to rise from 3.94 percent to 4.56 percent between the first and the last quarter of 2018. The low cost of borrowing and low unemployment have finally convinced firms to invest in long-neglected equipment that grew by 8.6 percent for a fourth quarter of growth.
INTEREST, CREDIT, AND THE FED
As widely anticipated, the Fed raised the key interest rate for the third time in 2017 to 1.5 percent and announced intentions for three more hikes in 2018. Jerome Powell, who will replace Janet Yellen as the central bank's head, is expected to continue Yellen's pragmatic and cautious approach to future rate hikes. Inflation and inflation expectations remain stubbornly low, leading to flattening of the yield curve, where the gap between short-term and long-term Treasury bill yields have narrowed significantly. The Fed has announced the end of quantitative easing and rebalancing of its 4.5-trillion-dollar assets balance. However, a successful corporate tax restructure aimed at the repatriation of 2.6 trillion dollars offshore profits can thwart the effect of the Fed's contractionary policy. Consensus expects the Federal Fund Rate to reach 1.98 percent by the end of 2018. The M2 money supply growth forecast is at 2.66 percent by the end of 2018, 50 percent faster than the growth in GDP. However, faster growth in money supply relative to the growth of output has not been a source of inflationary pressure in recent years. Rajeev Dhawan of the Georgia State University believes the Fed's decision regarding further rate hikes in 2018 will hinge on the income-tax cut and its impact on consumer spending.
CONCLUSION
As communities affected by several large-scale hurricanes and fires get back on their feet, the economy will get a short-term boost from rebuilding efforts in the fourth quarter of 2017 and the first quarter of 2018. If the GDP growth of 3 percent persists, it would be considerably above the consensus potential GDP growth of 1.7 to 2 percent, signaling the possibility of overheating of the economy. However, American workers have become sophisticated about the economy and how their wages are determined. Despite the full employment labor market, workers are hesitant to demand a hike in their wages. American workers are not psychologically ready to experience another economic downturn anytime soon. Instead of demanding higher wages, households have conditioned themselves to stretch their paychecks by bargain shopping and are focused on meeting their essentials. The Internet has changed the nature of job searching and contributed to labor market efficiency. Job ads are scanned by geographically more dispersed applicants, competing for open positions, thwarting localized wage inflation. Non-inflationary unitlabor-cost, combined with low inflation in food, apparel, and energy prices means that the economy can sustain lower unemployment rate without inflationary pressure buildup. Furthermore, shrinking of the middle class has caused a growing segment of the population to focus on meeting their necessities and reduce discretionary consumption. Resources relieved from satisfying the discretionary spending helps to keep down the costs of production of the necessities. Starbucks, specialty boutiques, and shopping mall workers are now competing for jobs in industries that produce consumer essentials with low margins.
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Copyright Journal of Business Forecasting Winter 2017/2018