With the unemployment rate at 5% reported for
October, the economy is operating at or very close to the
traditional definition of full employment. (See Figure 1).
However, because the employment to population ratio of
59.3% is four percentage points below that recorded prior
to the start of the financial crisis in 2006, for more than a
few Americans the economy does not feel anywhere close
to full employment. (See Figure 2). Nevertheless, employment
growth remains healthy with the economy generating
jobs at a 200,000 a month clip that will bring with it further
declines in the unemployment rate to 4.6% (See Figure 3).
Although GDP growth stalled in the third quarter at
a tepid 2.1% annual rate, a mini-inventory cycle knocked
0.6% off the reported growth rate. The growth in real inventories
declined from $113.5 billion in the second quarter to
a more normal $90.2 billion in the third quarter. (See Figure
4, revised data not reflected in the chart) With the bulk
Figure 1 Unemployment Rate 2007Q1- 2017Q4F
Sources: U.S. Bureau of Labor Statistics and UCLA Anderson
Figure 2 Employment to Population Ratio, 1948 – Oct 2015, Monthly Data, Percent
Sources: U.S Bureau of Labor Statistics via FRED.
the inventory correction behind us, we anticipate that real
GDP will grow at a 2.9% annual rate in the current quarter
and grow at a 3.1% year-over-year pace in 2016, the highest
since 2005. (See Figure 5). The seemingly high 3.8%
growth we are forecasting in the first quarter of 2016 is due
to the temporary end of the “sequester” just agreed to by
Congress that will trigger a surge in federal spending that
quarter. Our preliminary view for 2017 is that growth will
slow to 2.6% as a result of the tightening labor market and
the move towards interest rate normalization. (See below)
Higher Wages and Inflation
The tightening labor market will bring with it the
long-awaited increase in employee compensation. Instead
of increasing at the 2010-2015 average of 2.1% a year,
compensation is forecast to increase at a 3.5% and 4.2% rate
in 2016 and 2017, respectively. (See Figure 6) Anecdotal
evidence coming from the retail, construction, meat packing
and professional services sectors indicate that wages are
already rising well above what the official data is reporting.
Figure 3 Payroll Employment, 2007Q1 -2017Q4F, SAAR
Sources: U.S. Bureau of Labor Statistics and UCLA Anderson Forecast
Figure 4 Real Change in Inventories, 2007Q1 -2017Q4F
Sources: U.S. Department of Commerce and UCLA Anderson Forecast
Figure 5 Real GDP Growth, 2007Q1-2017Q4
Sources: U.S. Department of Commerce and UCLA Anderson Forecast
Figure 6 Employee Compensation per Hour, 2005Q1 -2017Q4F
Bureau of Labor Statistics and UCLA Anderson Forecast
Adding to the cost pressures coming from the labor
market, especially in the broadly defined services sector, it
is our expectation that oil prices will begin to rebound in
2016 as domestic output from the very short-lived fracking
wells is cut by about a million barrels a day and the intense
budget pressures on OPEC and Russia lead to some degree of
output restrictions. (See Figure 7) Further, as we have noted
in the past, housing costs are already rising at a 3% pace
coming from the continued tightness in the rental market.
As a result, inflation as measured by the Consumer
Price Index (CPI) will ramp up to 2.1% in 2016 and 3.4%
in 2017. (See Figure 8) Perhaps more important, the core
CPI, which excludes food and energy is forecast to increase
2.3% and 2.6% in 2016 and 2017, respectively. The Fed is
about to get the inflation it has been waiting for.
The Fed to Start Normalizing Interest Rates
Seven years ago this month, in response to the rapidly
metastasizing financial crisis, the Federal Reserve embarked
upon its zero interest rate policy and later adopted three
massive programs of quantitative easing. With the financial
emergency long over, the unemployment rate indicating
near full-employment and the likelihood that inflation will
soon approach its 2% target, we expect the Fed to begin
normalizing interest rates by increasing the Federal Funds
rate this month. Thereafter, we anticipate that the initial pace
towards the normalization of policy will be gradual, but if
we are correct about our outlook for inflation, the Fed will
begin to speed up the process. Thus, we forecast that by the
end of 2016 the federal funds rate will be about 1.5% and it
will approximate 3.25% at the end of 2017. (See Figure 9)
Figure 7 Oil Price, West Texas Intermediate Crude,
2007Q1 – 2017Q4
Sources: Commodity Research Bureau and UCLA Anderson Forecast
Figure 8 Consumer Price Index vs. Core CPI, 2007Q1 - 2017Q4
Sources: U.S. Bureau of Labor Statistics and UCLA Anderson Forecast
Figure 9 Federal Funds vs. 10-Year U.S. Treasury Bonds,
2007Q1 -2017Q4
Sources: Federal Reserve Board and UCLA Anderson Forecast
The Consumer in the Driver’s Seat
Driven by a strengthening labor market and an improved
balance sheet, the consumer is once again playing
its leading role in the economy. Real consumption spending
is expected to increase by 3.2% this year and again in 2016.
(See Figure 10) Don’t be all that concerned about the negative
headlines affecting such retail stalwarts as Macy’s and
Nordstrom. The fact remains that the retail landscape has
long shifted away from the traditional department stores
to more innovative formats and more importantly, internet
retailing.
Evidence of the robustness of consumer demand is
coming from red hot automobile sales where is now appears
that selling rates on the order of 18 million units might be
the new normal. (See Figure 11) Further, as we noted last
quarter, the new housing market is rapidly improving and we
anticipate that housing starts will exceed 1.4 million units in
both 2016 and 2017 compared to an estimated 1.13 million
units this year. (See Figure 12) Indeed the fourth quarter of
this year is forecast to come in at a 1.23 unit million annual
rate. We also expect the housing baton to be passed from
the white hot multi-family sector to the construction of
single-family homes which remains well below prior levels
of activity. If we are wrong here it will not be due to higher
interest rates, but rather to a shortage of construction workers
that is already hampering the delivery of new homes.
Nonresidential Construction: A Tale of
Two Markets
Investment in nonresidential construction stalled in
2015. (See Figure 13) While growing in most categories,
investment in mines and wells, almost all of it related to
oil and gas drilling, collapsed under the weight of the 60%
decline in oil prices. For example, from the 4Q2014 through
Figure 10 Real Consumption Spending, 2007Q1 -2017Q4F
Sources: U.S. Department of Commerce and UCLA Anderson Forecast
Figure 11 Light Vehicle Sales, 2007Q1 – 2017Q4,
In Millions of Units
Sources: BEA and UCLA Anderson Forecast
Figure 12 Housing Starts, 2007Q1 -2017Q4
Sources: U.S. Department of Commerce and UCLA Anderson Forecast
the current quarter of this year, real investment in mines and
wells will have declined from $137 billion to $70 billion, a
decline of nearly 50%. (See Figure 14) On a purely arithmetic
basis this decline whacked 0.4% off 2015 real GDP.
In contrast, commercial construction of office buildings,
shopping centers and warehouses is ramping up in
response to growing demand for modern offices and the
need to improve the retail supply chain. This investment is
being funded by the flood of capital reaching for real estate
yields in a yield starved world. Since the low in the 1Q2011
to the third quarter of 2015, real investment in commercial
construction has increased from $63 billion to $108 billion.
(See Figure 15) Further, because this sector is still just ramping
up, we forecast real commercial construction spending
to be $145 billion in 2017, still well below the $191 billion
recorded in the long ago year of 2000.
Exports Remain the Big Risk
Already weak export growth has gotten weaker in
recent quarters. (See Figure 16) American exporters are
facing the twin challenges of weak foreign economies and a
very strong dollar which is up 18% over the past year. (See
Figure 17) Where earlier in the recovery real exports were
growing at a 12% rate, we will now be lucky to achieve 4%
growth. Because we believe that most of the global weakness
is behind us, we anticipate that the foreign exchange
value of the dollar will soon peak and then gradually decline.
We would note that if we are wrong here and the global
economy continues to weaken and the dollar continues to
strengthen, our forecast of 3% growth in 2016 would be
way over optimistic.
There are two other risks with respect to trade. With
the leading contenders for both parties’ presidential nominations
opposed to the proposed Trans Pacific Partnership there
is a very real possibility that the United States will turn down
its first major trade deal since the 1930s. Although turning
down the deal in the short run would not have an immedi-
Figure 13 Real Investment in Nonresidential Construction,
2007Q1 -2017Q4F
Sources: U.S. Department of Commerce and UCLA Anderson Forecast
Figure 14 Real Investment in Mines and Wells,
2007Q1 -2017Q4F
Sources: U.S. Department of Commerce and UCLA Anderson Forecast
Figure 15 Real Investment in Commercial Structures,
2007Q1 -2017Q4
Sources: U.S. Department of Commerce and UCLA Anderson Forecast
ate impact on real GDP, it could nevertheless negatively
impact the stock market and over the longer run seriously
hamper exports as our Asian trading partners make separate
deals among themselves and with China. Second, the
mass migration crisis facing Europe along with the horrific
acts of terrorism in Paris have the potential to break apart
the Eurozone with unknown consequences for the global
economy. Compared to immigration, the Greek crisis was
a walk in the park for the European elite.
Defense Spending on the Rebound
As we have been arguing for over a year, the five year
decline in real defense spending is over. Congress recently
amended its “sequester” program to allow defense spending
to increase. We have modeled in further increases in defense
spending for 2017 to account for the increasingly dangerous
geopolitical environment. In our view this increase will
not be a one-off event, but rather the start of a major trend.
Meantime, we forecast that real defense purchases will
increase by 2.9% and 2.4% in 2016 and 2017, respectively.
(See Figure 18)
Conclusion
Continued job growth along with wage increases
will power consumption in 2016 leading to the first year
of greater than 3% growth in real GDP since 2005. Higher
wages along with a modest rebound in oil prices and higher
housing costs will push the inflation rate above 2% leading
the Federal Reserve to embark on a gradual tightening cycle
that will begin this month. Strength will be evidenced in
housing and commercial construction along with a booming
automobile market. The collapse in oil-related capital
spending will come to an end next year and defense spending
will be increasing after five years of decline.
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