Economics Group MONTHLY OUTLOOK 

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2-13-2016 12-32-48 PM79


“Don’t lie about it. You made a mistake. Admit it and move on. Just don’t do it again. Ever” 



February 10, 2016.

U.S. Overview International Overview

The Economic Divide Continues to Widen The growing economic divide between domestic demand and global economic influences was the central feature of our annual economic outlook and has figured prominently during the first few weeks of 2016. Growing concerns about slowing global economic conditions have caused businesses, policymakers and investors to become more risk averse. Sales and earnings expectations have been lowered, credit spreads between government and corporate bonds have increased and the S&P 500 has tumbled more than 9 percent since the start of the year. We have slightly lowered our forecast for U.S. economic growth and now look for real GDP to rise at just a 1.8 percent pace this year and a 2.3 percent pace in 2017. The drivers of growth remain the same. Domestic demand is holding up relatively well, with consumer spending and homebuilding growing solidly. Government spending should also make a modest contribution to growth this year. Areas tied to the global economy are weakening even more, however, particularly investment tied to energy and mining. In addition, the widening trade deficit is expected to subtract 0.5 percentage points from growth this year. While expectations for economic growth have been reduced, we continue to look for the Federal Reserve to attempt to normalize short-term interest rates. Falling interest rates overseas will make this a difficult mission for the Fed, however, and the rate outlook will continue to be influenced by global forces beyond the Fed’s direct control.

International Overview

Slow Global Growth to Continue Much of the volatility in financial markets since the beginning of the year has been linked to concerns about the global economic outlook. We expect the global economy grew roughly 3 percent in 2015, marking the fourth consecutive year in which global GDP growth has been below its long-run average of 3.5 percent per annum. In our view, the outlook for global growth in 2016 is for continued weakness. With the notable exception of Brazil and Russia, real GDP growth rates in many developing economies have slowed but they generally have not turned negative. The Indian economy is growing in excess of 7 percent, and we look for real GDP in China to grow roughly 6 percent per annum in 2016 and 2017. Slow economic growth in the developing world does not help growth prospects in the developed world, but it is not likely, by itself, to lead to recession in advanced economies. The expansions that have been in place in most advanced economies should remain in place, although the pace of GDP growth in these major economies likely will be lackluster. The combination of slow growth in real GDP and lack of pricing power means that nominal GDP growth on a global basis continues to slow, and it likely will remain lackluster for the foreseeable future. Consequently, the operating environment for many businesses probably will remain challenging. Furthermore, in an environment of slow growth in nominal GDP, sovereign bond yields in most economies are not likely to rise significantly anytime soon.

Economics Group MONTHLY OUTLOOK 1

A Rough Start to 2016 The central theme highlighted in our 2016 annual outlook—the widening divide between domestic demand and global economic conditions—has clearly played a prominent role during the first few weeks of 2016. Growing concerns about slowing global economic growth and its impact on commodity prices, exchange rates and corporate earnings has led to widening in credit spreads and a slide in equity markets around the world. Yields on government bonds have also plummeted, particularly overseas, where interest rates on the bonds of many developed countries are now negative. The deterioration in financial conditions is a warning sign for the economy and is typically a harbinger of slower economic growth. The growing risk aversion evident from falling share prices and declining “risk-free” government bond yields is also evident at the corporate level, where a growing number of businesses are redoubling cost control efforts and scaling back plans for capital spending and hiring. So far, consumer spending appears to be less affected, but the longer share prices tumble the greater the risk that some sort of negative wealth effect will take hold. While the markets appear to be full of gloom and doom, domestic economic conditions are holding up relatively well. Consumer spending grew at a respectable 2.2 percent pace during the fourth quarter of last year and is expected to rise 2.7 percent in 2016. Consumer spending is being supported by strong job growth, increasing hours worked and rising wages. Nonfarm employment growth has been solid, averaging 215,000 jobs per month over the past six months. The index of hours worked has also ramped up, climbing at a 2.8 percent annualized pace in the fourth quarter. In addition, average hourly earnings have gradually perked up and are now up 2.5 percent over the past year. Homebuilding is another bright spot in the economic outlook. Housing starts rose 10.8 percent in 2015 and are expected to rise 8.0 percent in 2016. While the percentage gain seems large in an economy expected to grow just 1.8 percent, the gain comes off of an extremely low base. We are looking for housing starts to rise to just a 1.20 million-unit pace in 2016, a pace well below what we would expect for an economy six-plus years into an expansion. We are looking for residential construction spending to rise a strong 8.5 percent, reflecting a larger gain in single-family starts relative to apartments. Home improvement spending is also ramping up, benefitting from rising home values and the reduced turnover of existing homes. One of the big questions for 2016 is whether the growth in domestic demand will be enough to help pull along limping global economies. The dollar has strengthened against most major currencies and has soared against currencies of emerging economies and large commodity-driven economies, such as Canada. We are looking for the trade deficit to widen as imports increase and exports decline. Another key question for 2016 is how much of a cutback we see in the energy sector. We expect oil prices to finally find a bottom at some point in 2016, but prices are likely to remain lower for even longer than had been expected and the industry is likely to undergo a major consolidation, particularly among smaller and mid-sized exploration and production firms. Capital spending budgets have also been slashed further, which is evident in our reduced forecast for structures investment. With global economic growth slowing and commodity prices under pressure, the risks to the inflation outlook will remain skewed to the downside. We still see the major inflation measures moving toward the Fed’s 2.0 percent target, however, which will keep the Fed’s goal of normalizing rates in place. We have not changed our forecast for the federal fund rate because we already had the Fed waiting until June to make its next move. We continue to have three quarter-point rate hikes in our forecast for 2016 but that view is contingent on the global economy finding its footing, or at least enough footing, so that is does not pull the U.S. economy down with it.

Economics Group MONTHLY OUTLOOK 2






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