United States Forecast Summary
The U.S. economy took a half step backwards in the fourth quarter, with GDP growth receding below three percent after two four percent plus quarters. Some of the weakness was one-time factors; some was more worrisome. However, the labor market continued to produce strong results, and we continue to expect 2015 to be the strongest year of the current expansion.
The advance report on total output for the fourth quarter of last year was about what we had forecast last November, but the details were different and overall the report fell short of our expectations. Real GDP growth was put at 2.6%, compared with our November outlook figure of 2.4%.
Unfortunately this accuracy reflected large offsetting errors at the disaggregate level. Consumption, of both goods and services, was much stronger than we expected, while business investment spending especially on equipment, but also on structures, was significantly below our forecast. The trade balance showed a sharp deterioration, instead of the small improvement we expected. This was due mostly to a surge in imports. As is often the case the movement in imports was matched by a parallel change in inventory accumulation. The increase in inventories means that final demand growth (at just 1.8%) was significantly below both GDP growth and our forecast. Government spending reversed most of its third quarter surge.
Some of our errors can be traced to the dramatic drop in oil and gasoline prices. When we prepared our November forecast West Texas crude was a little over $80 per barrel. Our forecast had the price remaining at about that level during the fourth quarter. Instead by year-end it was approaching $50, and gasoline was headed for $2 per gallon.
These changes pulled the economy in both directions. For households lower gas prices meant a boost in discretionary income north of $100 billion, more than enough to account for the strong fourth quarter consumption numbers. But the gain for consumers was a loss for producers. At current prices much of the “fracked” oil is a losing proposition. While it makes sense to continue production from existing wells, new drilling (and all its associated investment spending) is quickly being cut back. Some of this was probably in the fourth quarter data, and more will show up during 2015.
Our takeaway from the new data is that the economy entered 2015 with moderate momentum. However, this momentum is coming mainly from the household sector. Business investment remains on hold, or in the energy sector in retrenchment mode, and exports face significant headwinds.
Recent Monthly Data
Monthly data are consistent with these conclusions. Data relating to the household sector look solid, while those for business suggest caution.
On the household side, consumer sentiment was up sharply in January, to the highest levels since 2007. This showed in auto sales, which were strong again in January. It is underpinned by rising real income, due in large part to falling gasoline prices. The latter pushed overall consumer prices down in November and December.
On the business side, industrial production was weak in December as were purchases of capital goods. The ISM index for manufacturing was down in both December and January, while non-manufacturing was flat in January after a decline in December.
Finally the labor market data continue to be positive. Job creation for January was put at 257 thousand, and there were upward revisions to the previous two months. [Actually there were revisions to all of the past five years of data. In total these added almost a quarter million to the employment estimate for December.] With the revision, the economy has added a monthly average of 336 thousand jobs over the past three months. The January data also contained an increase of 0.5% (monthly rate) in both average hourly earnings and average weekly earnings. All this is good news for households. For business it can be seen in two ways. From a “glass half full” perspective, it says business has enough confidence about the near term to be willing to add to payrolls, even at the expense of higher wages. From the “glass half empty” view, it can be seen as adjustment to current demand with a variable input, but without the confidence to make the more long range commitment that investment in new capital would imply.
The household survey had mixed news. The unemployment rate rose a tick to 5.7%, but this was due to strong growth in the labor force. The January participation rate increased two ticks (to 62.9%), while the employment rate was up one tick (to 59.3%).
Our current forecast for total output, compared with three months ago, is slightly weaker for the current quarter, but then a little stronger for the rest of 2015. In the current quarter we now expect growth of 3.0%, 0.2% down from our November outlook. For all of 2015 we expect growth to be 3.2%, compared with 3.1% in November. These numbers actually underplay the strength we see in the economy. In the current forecast we have some inventory drag during the first half as the fourth quarter increase is worked off. This cuts about 0.2% from GDP. In our current forecast final sales come in at 3.4% for both the first quarter and the year as a whole. In November these values were 3.1% and 3.0%, respectively.
At a disaggregate level the forecast has changed in a way that reflects our earlier discussion of the data. Consumption is substantially stronger in our current outlook. Housing is also stronger, especially in comparison with the actual data for 2014. On the other side, our current outlook for business investment is weaker, as is our expectation for exports.
In the labor market we now see employment growth averaging above 270 thousand per month for 2015, about 50 thousand above our November forecast. There is, however, some deceleration as the year proceeds and the economy begins to approach “full employment.” At year end the unemployment rate is down to about 5.3%.
Our new forecast is pretty much in line with the recent behavior of the U.S. economy. Over the past six quarters output growth has averaged 3.0%. Taking into account the effects of last years brutal winter, the difference from our outlook for 2015 is negligible. Yet the forecast could easily prove to be overly optimistic. There are a lot of uncertainties in the current environment, most of which have downside potential.
To begin with there is the rapidly evolving situation in the energy markets. In our forecast we assume that the WTI crude price will average in the low $50 range for the first half of this year, rising to about $61 over the second half and to about $70 by year-end 2016. So far this seems okay, but it implies that the boost to household budgets is mostly past. If the impact on consumption has also peaked, our numbers for this sector could be too high. At the same time, these prices would not be high enough to re-stimulate the runaway production boom of the past few years.
Beyond energy, we have three concerns. First, there are only faint signs of the housing surge that our model sees for this year. Second, our model expects that higher interest rates from the Fed will have little impact on the real economy. But there is no real basis for this expectation (or any other) since the financial situation is without precedent. Finally, the international situation seems to be going from terrible to worse.