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Source: Euromonitor International Macro Model
We have kept the forecast for the US economy stable since February with 2% annual GDP growth in 2017-2018. Private sector confidence measures are significantly above average, and stock market prices have continued rising. With a 4.4% unemployment rate, labour markets also appear healthy on the surface. However, the actual performance of the economy in the first quarter of 2017 was below expectations. Output barely increased, up by less than 0.2%, and consumer spending stagnated. First estimates of GDP growth are notoriously noisy, especially for the first quarter when they tend to leave in negative seasonal effects. Therefore, we expect a rebound in the next quarters, allowing the economy to sustain 2% growth for the whole year.
On a more positive note, uncertainty around the outlook has diminished since February. The Trump administration seems to be shifting towards more mainstream Republican policy positions, with growing power of more moderate advisors. If current political trends hold, Trump could become much closer to a standard Republican president, combining a strong pro-business stance and more moderate positions on trade. In the latest G7 finance ministers’ meeting, US treasury secretary Steven Mnuchin emphasized that the US does not want to be protectionist, but it could impose some trade restrictions on a case-by-case basis if it perceives trade “is not free and fair”. The US will not pursue or encourage further global trade liberalisation under the Trump administration, and more protectionist measures against specific industries are likely. But the risks of high general tariffs on certain countries or a trade war have declined substantially since the beginning of 2017.
In the other direction, recent legislative failures have reduced the scope for fiscal stimulus in 2017. The Republican Congress failed to reach an agreement on replacing Obamacare, and their proposed AHCA (American Healthcare Act) had to be withdrawn without a vote in March. Without the Obamacare repeal, there are another USD 100 billion annually in expenditures to finance. The Republicans could raise deficits to finance tax cuts, but to pass Congress with a simple majority, this would require the cuts to expire within 10 years, diminishing their impact. The US House of Representatives ended up approving a revised version of the AHCA in early May. However, the victory was narrow by a 217 to 213 vote. And the bill could be easily blocked or severely delayed in the Senate, where the Republicans only have a 4 Senators majority.
Despite this setback, President Trump announced his initial objectives for tax reforms in April. Key parts include a renewed promise to cut the corporate tax rate to 15%, and a reduction in the number of income tax brackets and top tax rate. The tax reform blueprint does not specify how the plan would achieve the revenue neutrality required to make the cuts permanent. The general lack of details in the plan makes it difficult to assess its economic impact and viability once it hits all the expected legislative hurdles.
We have reduced the level of uncertainty surrounding our forecasts since February. We now assign the baseline forecast a 20-25% probability over a one-year horizon. In the most likely pessimistic scenario, the Trump administration imposes moderately higher than expected import tariffs on certain industries, and fiscal stimulus plans disappoint with much smaller tax cuts than expected. Private sector confidence and the stock market decline. US GDP growth drops to 1.7% in 2017 and by 1.1% in 2018. We assign this scenario a 15-20% probability over the next year. The most likely optimistic scenario features a bigger and more effective fiscal stimulus package, accompanied by further increases in private sector optimism and stock market prices. GDP would increase by 2.4% in 2017 and 2.9% in 2018. We assign this scenario as well a 15-20% probability over the next year.
President Trump’s protectionist and anti-immigration tendencies still pose significant risks, despite the recent strength of more moderate factions in his administration. A full blown trade war with several Asian countries and with Mexico would reduce US annual GDP growth over three years by 0.6%. In a more extreme Adverse Policies scenario, combining a trade war with significant restrictions and expulsions of illegal immigrants and a significant stock market correction, US annual GDP growth would decline by up to 1.8% in 2017-2019. Over a two-year horizon, we assign the Trade War scenario a 15-25% probability, and the Adverse Policies scenario a 10-15% probability.
Source: Euromonitor International Macro Model
Private sector confidence measures have stabilised in the first quarter of 2017, but they remain significantly above long-term averages. Stock market prices have also continued rising, backed in part by high corporate profits forecasts. Financial analyst surveys project S&P500 firms’ operating income to increase by 11% in 2017. However, these expectations could prove over-optimistic given the difficulties of passing President Trump’s big corporate tax cut plans through Congress.
The high average consumer confidence hides significant dispersion in household expectations. The gap between consumer confidence among the rich and poor in early 2017 was the highest since 2009. Similarly there are big differences in confidence between Trump supporters and people who voted against him. According to the latest University of Michigan consumer sentiment survey, Republicans expected 3% income growth one-year ahead, while Democrats expected just 1% growth. Republicans expected on average faster than average growth over the next five years, while a majority of Democratic respondents expected a downturn sometime over the next five years. Consumer spending is likely to be more sensitive to negative expectations than to positive ones. Therefore, higher dispersion in sentiment is likely to cause lower spending than would be predicted by the average measure of consumer confidence.
Consumer spending has grown faster than its long-term trend growth of 1.8% in recent quarters, though decelerating in the beginning of 2017. Growth at the end of 2016 was robust across categories, though it was slower in services and much faster for durable goods. Recent hard measures of spending are lower than what would be expected given the high average consumer confidence and improving labour market conditions, in part due to the strong variance in confidence levels across households. According to the preliminary estimate, consumption increased by less than 0.1% in the first quarter, but year-on-year growth was still 2.8%. First estimates of GDP growth are notoriously noisy, especially for the first quarter. Furthermore, much of the first quarter slowdown in consumption was due to unusually warm winter weather that reduced spending on heating and other utilities. This suggests that a combination of upwards revisions and a rebound in subsequent quarters is likely. Therefore, we are still forecasting US consumption to increase by around 2.4% annually in 2017 and 2018, down from 2.7% in 2016.
Business investment growth turned positive at the end of 2016, but year-on-year growth remained close to zero. Capital spending indicators for early 2017 suggest a continuing recovery in investment. According to the preliminary estimate, first quarter business investment expanded by 3.1% year-on-year. In the most recent Business Roundtable CEO survey, 46% of CEO’s expected their companies to increase capital expenditures over the next 6 months (compared to 35% at the end of 2016), with only 13% expecting a decline in capital expenditures (down from 21% at the end of 2016). Business investment is forecast to rise by around 3.5% annually in 2017-2018, reflecting expectations of significant corporate tax cuts and lower regulation together with a recovery in the energy sector. However, investment growth is especially vulnerable to difficulties in passing fiscal stimulus measures through congress.
The unemployment rate declined to 4.4% in April 2017. By this measure, the US labour market is essentially at full employment. Alternative indicators such as the non-employment rate of prime age (25-54 year-olds) workers indicate a moderate amount of remaining labour market slack, though they also show a marked improvement. Looking across sectors, employment growth remains concentrated in the services sector with a 2% year-on-year increase in the first quarter of 2017. Manufacturing employment has accelerated, but growth remains sluggish at 0.5% year-on-year during the first quarter.
Wage growth has increased in nominal terms, but this mainly reflects higher inflation. Real wage growth has remained weak, in line with continuing low labour productivity growth. Nominal wage growth in April was 2.5% year-on-year, but in real (inflation-adjusted) terms it was only 0.3%. Overall disposable income growth has been above 2% in real terms due to faster employment growth. However, with almost full employment, job growth is bound to slow down. Sustaining the current pace of household income growth will require more robust wage increases. In turn, this will require labour productivity growth to increase from the current slow pace. Our current baseline forecasts assumes both labour productivity and real wage growth increasing towards 1-1.5% by 2018-2019, though downside risks of continuing stagnation in productivity remain significant.
US inflation is now solidly anchored above 2%. This has been true of core inflation (excluding food and energy) since late 2015, but now even inflation including fuel costs is above the Federal Reserve’s target. Bond market yields imply annual inflation expectations for 2017-2021 close to 2%, rebounding from earlier forecasts of continuing low inflation. Based on recent price pressures and expectations of a modest fiscal stimulus, we have raised US inflation forecasts to 2.5% in 2017 and 2.4% in 2018, staying above 2% for the rest of this decade.
Rising inflation, together with the continuing improvements in labour markets and private sector confidence, allowed the Fed to raise the federal funds rate to 0.75-1% in mid-March. The Fed did not announce any policy changes in its early May meeting, but it reaffirmed its commitment to further interest rate increases despite the weak first quarter GDP growth. We expect monetary policy tightening to continue at a moderate pace, with the federal funds rate reaching 1.1-1.4% at the end of 2017, and 1.7-2.1% at the end of 2018.
US long-term interest rates have increased significantly since November 2016, in line with higher inflation expectations. Real interest rates that adjust for expected inflation have also increased by around 0.5 percentage points. However, their level is still quite low by historical standards, and they are unlikely to rise above 1% in the next decade.
Euromonitor International strategy briefing Global Economic Forecasts: Q2 2017 offers further insights on the global economy and provides the latest global macroeconomic projections.