View PDF version
The U.S. economy continues to make progress toward the Federal Reserve’s dual mandate of full employment and price stability. Although these goals look more attainable than a year ago, there are areas of concern that have kept the Fed from raising interest rates, for now.
The U.S. economy expanded at an annual rate of 3.5% in the third quarter; in four of the last five quarters, growth of real gross domestic product (GDP) has exceeded 3.0%. The 16% jump in defense outlays in the third quarter is a one-off event that is unlikely to be repeated in the near term. Even with better results expected from consumer spending, we could easily get slower growth in the fourth quarter compared with the third quarter.
Key Economic Indicators
Key elements of the forecast:
- Consumer spending advanced at an annualized rate of 1.8% in the third quarter, but a pickup is projected for the fourth quarter. The dip in oil prices provides an extra boost to expectations of acceleration in consumer spending growth.
- The 7.7% increase in business equipment spending in the third quarter was the best since the second quarter of 2012. October’s strong Institute of Supply Management’s factory survey reflects significant gains in indexes tracking production and new orders. Both of these gauges are leading indicators of business equipment spending.
- Sales of existing homes and new homes posted a modest increase in the third quarter, but construction outlays declined. Consistent with these numbers, residential investment expenditures in GDP rose only 1.9% in the third quarter. The latest readings of the Mortgage Purchase Index slipped in October and augur poorly for housing sector activity. Recent clarifications of mortgage underwriting rules are likely to support home purchase activity. The gains in employment and favorable mortgage interest rates may also assist.
Federal government spending increased 10% in the third quarter, partly due to the aforementioned temporary gain in defense spending. Although a large increase in defense spending will not occur in the fourth quarter, the newly elected Congress is likely to deliberate on increased investment in defense during the quarters ahead.
- The unemployment rate at 5.8% in October is down from 6.3% in April. During this period, the participation rate has held steady, implying that the decline of the labor force as baby boomers retired was offset by re-entrance of discouraged workers. The persistent subdued trend of wages and the elevated level of long-term unemployment are aspects of the labor market that cast a shadow on positive developments.
- Inflation continues to hover far below 2.0%, based on the personal consumption expenditure price index. In addition to muted gains in wages, the low-inflation environment is on the Fed’s worry list. The Fed downplayed the signal from inflation expectations in its policy statement published following the October Federal Open Market Committee meeting, stressing that survey-based inflation expectations remain anchored. The Fed is unlikely to step on the monetary policy brakes if inflation remains significantly below its inflation target.
- The 10-year Treasury note yield continues to trade around 2.35%, partly due to developments abroad. The continued sluggish performance of the eurozone, disappointing economic news from China and the Bank of Japan’s aggressive easing have all placed downward pressure on long-term rates. We expect yields to begin rising in the new year in preparation for the Fed’s first rate hike, which we continue to forecast for September 2015.
- Concern about setbacks to U.S. economic growth from weak conditions abroad is legitimate, but a severe hit is unlikely because domestic consumer spending is the main driver of U.S. growth. The low-interest environment and falling commodity prices are favorable and supportive forces.