Global Economic Perspective: February

US Economic Fundamentals Constructive, But Political Realities Suggest Year of Moderate Growth

For all that political events and speculation about policy direction have dominated news cycles over recent months, the US economy’s key fundamentals have changed remarkably little, in our view. Growth is still range-bound in the 2% zone that has predominated in recent years, though the backdrop appears to us to be constructive, as a healthy level of consumer spending has been increasingly reinforced by a recovery in corporate earnings and investment. With sentiment, particularly among businesses, boosted by the US election result, the economy may pick up a little speed over the rest of 2017, although we feel it will probably not be to the extent some have predicted.

This uptick in sentiment has been clearly reflected in financial markets, as most participants seem to have focused primarily on a possible upcoming boost to growth through fiscal and regulatory initiatives, and do not seem to have allowed for the likelihood of any problems or delays down the road. However, delivering effective policy change is both difficult and time-consuming, which we think makes a significant near-term shift in the US trend growth rate less likely, though there is potential for market volatility to increase as the political process unfolds. Setting aside the multiple scenarios for the paths to be taken by the new administration, we feel confident the US economy is on a solid footing, and well placed to maintain and perhaps slightly increase its rate of expansion over the rest of the year.

Emphasizing the economy’s current range-bound growth, the initial reading for fourth-quarter 2016 gross domestic product growth came in below consensus expectations at 1.9% on an annualized basis. It was again affected by volatility in transitory factors, notably a reversal of a third-quarter surge in overseas demand for soybeans. However, elsewhere the data showed growth in consumer spending—the key driver for the US economy—remained solid at 2.5%. Encouragingly, there was also a reasonably strong rise for business investment in equipment after four consecutive quarters of declines. In part, the rebound reflected renewed opportunities for the energy sector following the recovery of oil prices, which was also evident during the reporting season, as many companies engaged in the location and extraction of oil and gas sharply raised their estimates for capital expenditure during the coming financial year. The pickup in investment may also have signaled wider business expectations for potentially lower taxes and lighter regulation under the new administration.

Meanwhile, January’s labor market report contained mixed signals. The 227,000 jobs added were well above consensus expectations of 180,000, although previous reports at the start of the year have sometimes been affected by seasonal distortions in sectors like retail and construction. A rise of two-tenths in the labor force participation rate to 62.9% underlined how the strong labor market has been attracting new entrants and former workers, and pushed the unemployment rate up slightly to 4.8%. The participation rate has been stuck at an extremely low level by historical standards since late 2013, and of the key data points closely monitored by the US Federal Reserve (Fed) to gauge how much slack still exists in the labor market, it remains the measure most out of kilter with levels seen before the global financial crisis.