Time to watch and wait
September 9, 2014
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As we approach the end of the third quarter, the U.S. economy maintains a strong position among its peers in the industrialized world. The Federal Reserve is on track to complete its asset purchase program shortly, and there are widespread signs of continued economic expansion.
We ushered in September with a string of strong economic reports, from purchasing managers surveys to auto sales to construction spending, but the August employment report dampened the euphoria somewhat. However, it is premature to draw strong and definitive conclusions from a single months employment data.
We expect the U.S. economy to advance at a steady pace during the balance of this year, with all major components of gross domestic product (GDP) making a positive contribution. Our expectation for a very solid 2015 remains in place.
Key Economic Indicators
Key elements of the forecast:
- Real consumer spending slipped in July (-0.2%), inclusive of weakness in purchases of both goods and services. The significant increase in auto sales during August (17.5 million units versus 16.5 million in July) is a partial offset that will help lift overall consumer spending in the third quarter. Support from gains in household wealth due to higher equity and home prices should not be overlooked.
- Sales of existing homes moved up in each of the last four months, but purchases of new homes stalled. The Mortgage Purchase Index of the Mortgage Bankers Association maintains a declining trend since June. Although mortgage rates are attractive, the housing sector remains challenged by the credit constraints associated with mortgage re-regulation.
- A small turnaround in federal government spending after more than three years of decline is embedded in the forecast. State and local government spending should show stronger gains than federal government spending. Fiscal year 2014 should end with the federal budget deficit as a percent of GDP (2.9%) at the lowest level since 2007.
- Exports posted a strong performance in the second quarter, but imports also advanced and resulted in a widening of the trade gap. A moderation in import growth is likely to result in a smaller trade gap for the third quarter, which is less of drag on GDP growth.
- The 142,000 gain in August payrolls overshadows other recent positive economic signals. But it should be noted that the three-month moving average of payroll employment remains a little above 200,000, and initial jobless claims match the low readings seen prior to the Great Recession. A pickup in hiring in the months ahead should not be surprising, given the nature of other incoming economic data.
- Inflation readings are trending closer to the Feds 2.0% inflation target. The personal consumption expenditure price index and the core price measure stood at 1.6% and 1.5%, respectively, in July. The subdued inflation environment remains supportive of the Feds accommodative stance.
- The VIX, the index of volatility, is hovering around historical lows, despite pockets of political instability in several parts of the world. The rally at the long end of the yield curve reflects the impact of geopolitical concerns, and it is not indicative of weak economic fundamentals. An easing of geopolitical tensions and a string of consistently strong economic data could result in higher interest rates.
- The Fed is on the sidelines watching economic developments closely as it winds down the asset purchase program. Developments in the labor markets hold the key to timing of monetary policy changes to normalize interest rates. If employment numbers retrace the trend seen in the three months prior to August, the next Fed action could be brought forward from current market expectations. The September 16-17 Federal Open Market Committee meeting is likely to end as a non-event.