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The year began with markets optimistic about the new president’s plans to boost economic growth. At mid-year, market expectations about tax cuts and infrastructure spending have changed. The probability of these programs being implemented in 2017 is dwindling as the current administration and Congress struggle to reach a consensus.
Nonetheless, growth is likely to continue after eight years of a moderate business expansion. Real gross domestic product (GDP) is projected to advance slightly faster than its potential capacity during the rest of the year. In particular, second quarter growth should be higher than the modest performance in the first quarter.
Key Economic Indicators
Key Elements of the Forecast
- A strong labor market, rising income and wealth, and favorable consumer sentiment will support consumer spending. Auto sales are most likely to stabilize at the current level of 16.8 million units for the rest of the year. Despite the recent weakness of car sales, consumer discretionary spending maintains an upward trend, which is unlikely to be affected in the near term.
- Construction of new single-family homes and apartment buildings fell during the March-May period. Sales of existing homes increased 1.1% to a 5.62 million annual rate, while new home sales increased 2.9% to a 610,000 annual rate. Unsold inventory of existing homes is below the historical average. Prices of single-family existing homes have advanced 5.5% from a year ago. Construction spending in April and May is up marginally from the first quarter. Putting this information together, the residential construction component of GDP is likely to show a modest increase in the second quarter after a strong performance in the October 2016-March 2017 period.
- The June Institute for Supply Management’s manufacturing composite index rose to the highest level for the year, reflecting noteworthy improvements in new orders and production. Shipments of non-defense capital goods excluding aircraft, the input for business equipment spending in the GDP report, moved up in April and May. Factory production rose in March but slipped in May. It appears that soft data continue to send a stronger message than hard data.
- Employment conditions are strong in the United States. Payrolls increased 222,000 in June, putting the 3-month moving average at 194,000. The diffusion index rose in June, indicating broad-based hiring in the economy. The unemployment rate moved up one notch to 4.4%, which was due to an increase in the participation rate and does not represent a weakening of labor market conditions. Labor flows data indicate that an increasing number of people who were not in the labor force obtained employment in June. Year-over-year gains in hourly earnings continue to hover around the 2.5% trend, far below levels consistent with a fully employed economy.
- Inflation measures continue to track below the Fed’s 2.0% target. The overall and core personal consumption price indices increased 1.4% for the twelve months ending in May. The Fed holds the view that temporary factors such as cheap cell phone plans and lower prescription drug prices are the major reasons for this trend and it believes inflation will turn around as the economy continues to grow.
- The 10-year Treasury note yield stands at 2.33%, up from a low of 2.14% in June. The repricing reflects a re-assessment of U.S. economic conditions and a consideration of the Fed’s plans to proceed with both policy tightening and a balance sheet reduction plan.
- Financial conditions remain supportive of economic growth. Equity prices continue to advance and credit spreads are tight. Year-to-date, the dollar is still down from the high seen late last year. The Chicago Board Options Exchange Volatility Index (VIX), a measure of market volatility, maintains a subdued trend.
- Incoming economic reports suggest downside risks to economic growth from international developments are less threatening than they were a few months ago. At the cost of being repetitive, we continue to view China’s credit challenges as a source of risk for the global economy, despite the nature of recent economic data.
- The U.S. Federal Reserve is poised to commence the balance sheet reduction program soon. Its communication strategy appears to be successful on this front. The next policy rate hike is likely in December. Near-term risks to the economic outlook are balanced and the economy is on a trajectory of sustained growth.
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GDP growth, unemployment rate, inflation, Federal Reserve, policy rate