Sunny 2018, Cloudy 2019
David
Shulman
Senior
Economist
UCLA
Anderson Forecast
December
2017
Of a sudden, propelled by strength (8%
quarterly growth) in equipment spending, the economy is growing at a 3% clip
and the near term outlook has become decidedly sunny. (See Figures 1 and 2)
Moreover the 3% pace of growth is expected to continue through the second
quarter of 2018. However as the unemployment rate drops below 4% and employment
growth stalls in the face of a labor shortage, economic growth will drop back
to the 2% growth rate we have been used to since the end of the financial
crisis eight long years ago. Indeed by the end of the forecast horizon in 2019
real GDP growth could very well be running at a rate below 1.5% as the outlook
becomes cloudy. (See Figures 3 and 4)
Figure 1. Real GDP Growth, 2007Q1 – 2019Q4F
Sources: U.S. Department of Commerce and
UCLA Anderson Forecast
Figure 2. Real Equipment Spending, 2007Q1
– 2019Q4
Sources: U.S. Department of Commerce and
UCLA Anderson Forecast
Figure 3. Nonfarm Employment, 2007Q1
-2019Q4
Sources: U.S. Bureau of Labor Statistics
and UCLA Anderson Forecast
Figure 4. Unemployment Rate, 2007Q1
-2019Q4
Sources: U.S. Bureau of Labor Statistics
and UCLA Anderson Forecast
Questions
about Fiscal Policy
As we are writing in late November many
questions remain about the major tax bills now working their way through
Congress. There is uncertainty surrounding the corporate tax rate, state and
local tax deductions, child credits and the permanence of the entire package.
For modeling purposes we have assumed a ten year $1.5 trillion tax cut, with a
25% corporate tax rate (a compromise from 20%), some allowance for state and
local tax deductions and $100 billion in revenues coming from a tax on
repatriated corporate profits in 2018. This last point is one of the reasons
why the federal deficit declines in 2018. (See Figure 5)
Figure 5. Federal Deficit, FY2007 – FY2019F
Sources: Office of Management and Budget
and UCLA Anderson Forecast
We are more certain that the next few
years will reverse the seven year annual decline in defense spending. (See
Figure 6) With the potential for missiles from North Korea reaching the West
Coast, continued fighting in the Middle-East and growing worries about Russia
and China defense spending will likely be on the rise over the next several
years. We are assuming real defense spending will increase by 2% and 2.7% in
2018 and 2019, respectively. If anything, our forecast is more likely to be low
than high.
Figure 6. Real Defense Spending, FY2007
– FY2019F
Sources: U.S. Department of Commerce and
UCLA Anderson Forecast
Monetary
Policy in the Post-Yellen Era
With the appointment of Jerome Powell as
Fed chairman the Janet Yellen era is coming to an end. Because Powell’s views
on monetary policy are very similar to Yellen’s we do not anticipate any
significant changes. However, with respect to regulatory policy, Powell is
believed to be far more open than Yellen to reviewing the financial crisis regulations
that were put into place from 2009 – 2012.
Thus we expect that the gradual interest
rate normalization policy that has been underway for a year will continue well
into 2019 with a 25 basis point increase from the current 1.375% rate in
December and three more increases in 2018. By the end of 2019 the fed funds
rate will likely approximate 3%. (See Figure 7) We caution that the futures
markets, in contrast to our forecast and the Fed’s “dot plots”, are forecasting
only one rate hike next year.
Concomitantly with the rise in short
term interest rates long rates will rise as well and we would not be surprised
to see the yield on 10-year U.S. Treasury bonds to exceed 4%, up from the
current 2.4%. Rising inflation will be the driver in the increase in long
rates, more on that below.
Figure 7. Federal Funds vs. 10 Year U.S.
Treasury Bond Rates, 2007Q1 – 2019Q4F
Sources: Federal Reserve Board and UCLA
Anderson Forecast
The Powell Fed will also continue the
policy of gradually shrinking the Fed’s bloated balance sheet that began in
October. (See Figure 8) Simply put after three phases of quantitative easing
that expanded the balance sheet from $800 billion to over four trillion dollars
will be unwound over a period of several years with the ultimate target of $2.5
- $3.0 trillion, quantitative tightening if you will. (See Figure 8) But make no mistake the balance sheet shrink the Fed is attempting to
do is unprecedented.
Figure 8. Federal Reserve Assets, 2003
–Nov 15, 2017, In $ Millions, SA
Source: Federal Reserve Board via Fred
Inflation
on the Rise
It now appears that the second quarter
slowdown in inflation was transitory and the future quarterly track in
inflation will be in excess of 2% throughout the forecast horizon. (See Figure
9) This will hold true for both “headline” and “core” consumer prices. Further
oil prices now appear to be tracking about $10/barrel higher than our forecast
of just one quarter ago.
Figure 9. Headline vs. Core Inflation,
2007Q1- 2019Q4F
Sources: U.S. Bureau of Labor Statistics
and UCLA Anderson Forecast
The primary source of the rising rate of
inflation will be a significant rebound in wage growth. After creeping along in
the 2% range, we forecast acceleration in total compensation growth to
approximately 4% by late 2018 on a year-over-year basis. (See Figure 10) The
recent rise in labor productivity buttresses our view that the long anticipated
increase in wages is at hand.
Figure 10. Total Compensation per Hour,
2007Q1 – 2019Q4
Sources: U.S. Bureau of Labor Statistics
and UCLA Anderson Forecast
Consumer
Spending Supported by Rising Wages and Asset Prices
Real consumption spending is rebounding
from the 1.5% increase in 2016 to 2.7% and 2.8% in 2017 and 2018, respectively.
(See Figure 11) However, as auto sales slow in 2019 consumption growth will
slip back to 2.2%. (See Figure 12) Simply put it is getting very late in the
auto cycle. However as long as stock and house prices remain elevated the
consumer, or at least the high end consumer, will remain in good shape. (See
Figures 13 and 14) In the case of the lower end consumer we are encouraged by
Wal*Mart reporting a strong 2.7% increase in year-over-year same store sales in
their latest quarter.
Figure 11. Real Consumption Expenditures,
2007 – 2019F
Sources: U.S. Department of Commerce and
UCLA Anderson Forecast
Figure 12. Light Vehicle Unit Sales,
2007 – 2019F
Sources: Bureau of Economic Analysis and
UCLA Anderson Forecast
Figure 13. S&P/Case-Shiller 20-City
Composite Home Price Index, Dec 1999 – Aug 2017, December 1999 =100, SA
Sources: Standard & Poor’s via FRED
Figure 14. S&P 500 Stock Index, 18
Nov 2007 – 17 Nov 17
Sources: Standard & Poor’s via
BigCharts.com
One of the big puzzles in recent years
is the lack of robustness in new single family housing construction. Given low
interest rates and strong employment growth housing activity should be doing
much better. Two factors that are being
discussed more and more are the unwillingness of the baby boom generation to
move as they age in place and highly restrictive zoning in the booming coastal
cities. As a result housing starts have remained below the underlying
demographic demand of 1.4 – 1.5 million units a year for a decade. We are
forecasting modest increases in housing starts from an estimated 1.19 million
units this year to 1.27 million and 1.34 million in 2018 and 2019,
respectively. (See Figure 15)
Figure 15. Housing Starts 2007Q1 -2019Q4F
Sources: Bureau of the Census and UCLA
Anderson Forecast
Exports
Rebounding, But NAFTA Risk Looms
In response to a recovering global
economy real exports are recovering from the near zero growth of 2015 and 2016.
Real exports are estimated to increase by 3.2% this year and 4.5% and 4.1% in
2018 and 2019, respectively. (See Figure 16) According to a recent Goldman
Sachs report world economic growth is forecast to increase 3.7% this year and
4.1% in 2018.[i]
Growth will come from, 2+% growth in the Euro Area, 6.5% in China, a very
strong 8% in India and a rebound in Brazil from O.9% in 2017 to 2.7% in
2018. (See Figure 17)
Figure 16. Real Export Growth, 2007 – 2019F
Sources: U.S. Department of Commerce and
UCLA Anderson Forecast
Figure 17. Global Real GDP Growth, 2016
– 2019F, Annual Data
|
Country/Region
|
2016A
|
2017F
|
2018F
|
2019F
|
|
Japan
|
1.0
|
1.6
|
1.6
|
1.3
|
|
Euro Area
|
1.7
|
2.3
|
2.2
|
1.8
|
|
UK
|
1.8
|
1.5
|
1.3
|
1.6
|
|
China
|
6.7
|
6.8
|
6.5
|
6.1
|
|
India
|
7.1
|
6.4
|
8.0
|
8.3
|
|
Brazil
|
-3.6
|
0.9
|
2.7
|
3.1
|
|
World (incl. U.S.)
|
3.2
|
3.7
|
4.0
|
3.9
|
Source: Goldman Sachs
The real risk to our export forecast and
for that matter the entire forecast is political. In less than a year President
Trump has blown up the Trans Pacific Partnership (TPP) trade treaty and the
global climate accord. The North American Free Trade Treaty (NAFTA) could be
next especially given the hawkish views espoused by Secretary of Commerce
Wilbur Ross and Trade Representative Robert Lighthizer. Although news from the
Mexico City negotiations is not on the front burner, it would be advisable to
pay very close attention. Why? Leaving NAFTA is not so simple because it would
undo countless supply chains among the three countries (U.S., Canada and
Mexico) involved. Just as a reminder the
gross trade volumes among the three NAFTA partners amounts to over one trillion
dollars per year.[ii]
Especially hard hit would be the U.S. automobile industry where parts cross
borders several times in the manufacturing of a single automobile. In our view
should the U.S. leave NAFTA the growth outlook would deteriorate and the chance
of a recession in late 2018 or 2019 would significantly increase.
Conclusion
With our weather forecast analogy for a
title we are hoping to be as accurate as modern weather forecasting. Economics
has a lot to learn from near term weather forecasting. It looks like 2018 is
shaping up to be a pretty good year. There is momentum coming from the recent
strength in 2017, strong equipment spending, the likelihood of a tax cut and a
consumer that is benefiting from higher asset prices and the prospect of
higher wages. Unemployment will drop below 4% and remain there throughout most
of the forecast horizon and inflation will experience an uptick. The Fed will
respond by continuing to normalize short term interest rates with the Fed Funds
rate on a path to 3% by 2019. However as we get into 2019 inflation could be
approaching 3% and the economy will slow as it reaches capacity constraints.
The
risks to the forecast include the unknowable consequences of the Fed reducing
its balance sheet and the potential failure of the ongoing NAFTA negotiations.
All told a sunny 2018 with clouds coming in 2019.
No comments:
Post a Comment