Growth on a strong trajectory
October 9, 2014
View PDF version
The second half of 2014 should be marked by above-trend growth in the United States. Strong job creation, strong markets, an improved fiscal position and very accommodative monetary policy should combine to produce this result. The composition of gross domestic product (GDP) in the third quarter should be somewhat different from the second quarter, with the absence of an accumulation of inventories. Excluding inventories, all major categories are likely to make a positive contribution to GDP.
Risks to the outlook continue to come from outside the United States. Sluggish performance in the eurozone and moderating growth in China lead the list. Conflict in the Middle East remains prominent on the minds of policymakers. These elements were noted in the minutes of the September Federal Open Market Committee (FOMC) meeting as reasons to maintain existing forward guidance.
Key Economic Indicators
Key elements of the forecast:
- Consumer spending in the third quarter is predicted to have risen slightly slower than the 2.5% pace seen in the second quarter. The smaller increase in auto sales (6.3% versus 22.9% in the second quarter) is the primary reason for the modest deceleration in consumer spending. Gasoline prices registered a noticeable decline in the third quarter, which should lift outlays on other consumer goods.
- Business equipment spending gathered steam in the second quarter (11.4% versus -1.0% in the first quarter). July-August shipments data of non-defense capital goods, the proxy for business spending in the GDP report, suggest a moderate performance in the third quarter.
- Housing numbers present a mixed mixture. Housing starts climbed sharply in July but slipped in August. The bias toward construction of multi-family units remains in place. July-August sales of existing homes were positive, but the quarter-to-date gain is smaller than in the second quarter. A significant pickup in sales of new homes in the July-August period is encouraging, given a decline in the first six months of the year. The 30-year fixed-rate mortgage at 4.20% is attractive, but tight mortgage underwriting standards hold back purchases.
- The 5.9% unemployment rate and a 245,000 six-month moving average of payroll employment in September is an impressive performance of the labor market. Although the headline unemployment rate is only 0.6 percentage points away from the Federal Reserves forecast of the long-term unemployment rate, it is widely accepted that the unemployment rate understates the true measure of slack in the labor market. Wage gains have failed to budge from around 2.0% for an extended period. The lack of wage acceleration is an important aspect that justifies the current low interest-rate environment.
- Readings of the Feds preferred inflation gauges (the personal consumption expenditure price index and the corresponding core measure, which excludes food and energy prices) are hovering around 1.5% on a year-to-year basis, which is below the Feds 2.0% inflation target. Also, inflation expectations have declined by around 40 basis points since late July. Lower oil prices, a strong dollar and reductions in commodity prices imply that inflation is not around the corner.
- Uncertainty stemming from geopolitical challenges such as the Russia/Ukraine stand-off to the brewing crisis in the Middle East will continue to play a role in macroeconomic policy decisions. To some extent, the economic ramifications of sanctions imposed on Russia are visible. Significantly weak economic data, such as industrial production and orders of factory goods from Germany, are a good case in point. It remains to be seen if the European Central Banks latest monetary policy measures to support economic activity will be sufficiently effective.
- Economic reports from China have been disappointing, and there is concern about the ability of China to navigate through economic rebalancing without adversely affecting its growth trajectory and employment conditions.
- The dollar has appreciated in recent weeks and certainly may strengthen further. If sustained, this development will affect import and export growth. The dominance of consumer spending in the U.S. national accounts makes the strength of the currency less significant to the determination of GDP than it is in other countries.
- Notwithstanding these global headwinds, we continue to expect the Fed to raise the federal funds rate in September 2015. There are differences of opinion about the timing of normalization of interest rates. Some members of the FOMC would prefer a pre-emptive tightening of monetary policy. However, this risks reversing policy if economic growth falters, and diminishing the Feds ability to shape expectations.