Monday, February 1, 2016

Don't fret about US growth

It has been an angst-ridden start to the year with concerns about global growth the major cause of all the consternation.  For those of you who have read the latest edition of QSO, you already know we think those concerns are largely overdone.  Fourth quarter 2015 US GDP data released last week didn’t help alleviate those concerns, but there was nothing in that report to alter our view that the US economy will enjoy a third consecutive year of above trend growth of 2.0-2.5% in 2016.

Much of the weakness in the low quarterly (annualised) result of +0.7% was for reasons that were well-flagged and that will ultimately prove to be transitory.  Inventories provided a second consecutive quarterly drag on growth while net exports shaved 0.5% off growth in the quarter. Business investment was flat over the quarter but that as largely due to weakness in “petroleum extraction structures” (i.e. rigs), outside of which investment remained solid.

On a more positive note consumer spending was solid (+2.2%) over the quarter, despite the drag from utilities spending given the unseasonably warm weather over the quarter.  Also residential investment (+8.1%) continues to benefit from the increase in household formations and still low mortgage interest rates.

But we don’t completely dismiss the weakness in the economy at the end of last year.  The best indicator of what you might call “core growth” is real final sales to domestic purchasers which came in at an annualised rate of 1.6% in the fourth quarter, down from 2.9% in the third quarter. 

Right now our view is for continued above trend GDP growth of 2.0-2.5% in 2016.  A combination of solid jobs growth, increases in the average working week along with modest wage growth is expected to lead to continued solid gains in aggregate labour income and consumer spending.   Our read of the forward looking labour market indicators remain consistent with this story.  Furthermore we also believe we haven’t yet seen the full benefit of the real income gains that have come from weaker oil prices. 

The biggest risk to our view is weaker than expected jobs growth and any deterioration in the recent trend improvement in consumer confidence.  The weather also appears likely to cause disruption again in the early part of the year.  We will be watching that data closely in the weeks and months ahead.

No doubt the FOMC will also be watching closely.  The Committee’s “dot plot” forecast suggests four hikes this year.  We have been assuming three but acknowledge the risk is biased to less rather than more.  The latest data and market volatility suggests the pause may come earlier than we thought.  Markets are pricing in only a 14% chance of a hike in March which doesn’t seem unreasonable right now.  The Committee will need to see firm evidence the growth weakness at the end of last year is indeed temporary.