July 2019 U.S. Economic Outlook

July 8, 2019 by Robert A. Dye, Ph.D., Daniel Sanabria

Between Scylla and Charybdis (First Pass)

According to Homer, Scylla was a six-headed sea monster and Charybdis was a whirlpool. They occupied opposite sides of the Strait of Messina near modern Italy and are sometimes evoked when a person, or an organization, must navigate through a difficult passage. The Federal Reserve is on such an odyssey as it contemplates its next monetary policy move ahead of the July 30/31 Federal Open Market Committee meeting. 

Financial markets have been pushing hard on the Fed to begin easing monetary policy this year. The probabilities implied by the fed funds futures market for at least one 25 basis point rate cut this year are overwhelming. Pressure on the Fed is also coming from outside the U.S. Other central banks are easing. Mario Draghi, outgoing president of the European Central Bank has telegraphed what may be his final policy move before Christine Lagarde takes over (pending her final approval). With other central banks easing, the Fed will effectively tighten if it stands still and this would put pressure on the already strong dollar. 

The Fed’s “data dependence” is more complicated than ever. Recent U.S. data has been mixed. Job growth in May was soft, then it bounced back in June. Manufacturing indicators have been easing but auto sales were surprisingly strong in May and June. Global growth has cooled, in part due to international trade uncertainties. However, trade wars could be resolved quickly, or they could linger for years, if not decades.

The other dimension of the Fed’s data dependence is also ambiguous. In his speech at the Fed’s annual symposium in Jackson Hole last August, Fed chair Jay Powell noted the data “stars” by which the Fed navigates. R-star is the neutral rate of interest. Pi-star is the inflation objective. U-star is the natural rate of unemployment. A year later we wonder whether those stars are fixed beacons, or do they drift? The upcoming Jackson Hole Conference may provide more clues about how the Fed views its guiding stars. 

Political pressure on the Fed by the Trump Administration has been intense, compounding the potential for a lose-lose-lose-lose policy announcement by the Fed on July 31. With respect to interest rates, the Fed has four choices in front of it. The first possible outcome is that they raise the fed funds rate by 25 basis points. This is a very low probability event and would instantly trigger a financial market reset and intense pushback from many directions. The next choice is to do nothing with interest rates. The probability of doing nothing is also low, but it is higher than the zero probability assigned to it by the fed funds futures market. Again, the Fed would be courting financial market volatility and intense pushback if they leave the fed funds rate unchanged. The third option is to lower the fed funds rate by 25 basis points. This is not a win for the Fed in terms of financial market reaction because that move is already priced in. Further, it would disappoint those who favor a stronger move by the Fed. The fourth option is a 50 basis point rate cut. This would give the strongest jolt to the economy, and likely win praise from interest rate doves. But the Fed would risk using up a big chunk of its rate cutting potential for an uncertain upside gain at a time when the data is ambiguous. 

We believe that the Fed’s least bad policy choice is to make a 25 basis point rate cut at the end of July and then do nothing through at least the next FOMC meeting (over September 17/18) in order to gauge the response of the economy to marginally lower interest rates. A key risk of the least bad move is that a 25 basis point reduction at the end of July is not enough and leaves the Fed in a position later this fall that is similar to where it is right now. 

For a PDF version of this report, please click here: July 2019 U.S. Economic Outlook 

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June 2019 U.S. Economic Outlook

June 10, 2019 by Robert A. Dye, Ph.D., Daniel Sanabria

The L4L Economy

The title of our January 2018 U.S. Economic Outlook was 2018: Out of the Shadow of the Great Recession.  We began that article with the generalization from Carmen Reinhart and Ken Rogoff that it takes about 10 years for an economy to recover from a severe financial crises. 2018 marked the 10 year anniversary of the Great Recession for the U.S. economy. Obviously, the generalization begs the question…what’s next? Approaching the halfway point of 2019 we will hazard a guess. We will call this the L4L economy. 

L4L is a tactic defined by former Federal Reserve chairman Ben Bernanke as a monetary policy tool. It stands for lower for longer. In his October 2017 paper titled Monetary Policy in a New Era, Bernanke discusses ways that the Federal Reserve may seek to influence the economy in this new post-crises era. In Bernanke’s framework, lower for longer means that the Federal Reserve may need to signal that it will keep interest rates lower for a longer period than the current conditions and other policy tools (such as Taylor rules) may indicate. By announcing that the Federal Reserve will keep rates lower for longer, businesses will feel emboldened to take on cheap debt in order to finance expansions, thus stimulating the economy. 

We believe that the lower for longer concept also applies more broadly to the overall U.S. and global economies. L4L also describes overall economic growth, inflation and interest rates generally, beyond the specific application of monetary policy. In the L4L economy, real GDP growth rates are lower than what many people think is normal. Inflation is also lower than expected. Indeed central banks globally, including the Federal Reserve, are asking themselves how to conduct monetary policy in an era of persistently low inflation. Weaker growth, and demand for capital, plus weaker inflation, mean that interest rates are also going to be lower for longer than many of us feel is normal. 

For example, normal real GDP growth in the 1950s and 1960s centered around 4 percent, sometimes higher and sometimes lower. During the 1980s and 1990s that central tendency dropped to about 3 percent. Lately, during the 2010s, normal real GDP growth looks closer to 2.5 percent. Potential GDP growth is a useful concept for analyzing the step down in GDP growth over recent decades. It is driven by productivity growth and by labor force growth. In an era of lower-than-expected productivity growth and lower-than-expected growth in the working age population, potential GDP will also be low.  

Inflation has also stepped down. The Consumer Price Index increased at double digit annual rates in the 1970s, pushed hard by the energy price shocks caused by the OPEC oil embargoes. During the 1980s, 1990s and 2000s, the CPI tended to increase at around a 3 percent annual rate. In the 2010s, that number is closer to about 1.8 percent. 

Interest rates have also trended down. We expect the 10-Year Treasury bond yield to fall back below 2 percent by early next year, well below the double digit peak of the early 1980s.

In the L4L economy, Federal Reserve monetary policy is more constrained by the zero lower bound for interest rates. Also, we believe that the economy is susceptible to mild recessions of the type that occurred in 2001. The buildup of downside risk factors that appears to coalesce at the end of this year and into early 2020 is a concern. With deft monetary and fiscal policy, we believe that a recession can be avoided, and that is our forecast. However, we believe that in the L4L economy, we are flying closer to the treetops, and the downdrafts matter.

For a PDF version of this report, please click here:  June 2019 U.S. Economic Outlook

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations.  The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team.  We are not offering or soliciting any transaction based on this information.  We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation.  Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed.  Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.  

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May 2019 U.S. Economic Outlook

May 6, 2019 by Robert A. Dye, Ph.D., Daniel Sanabria

It’s Complicated...

    U.S. economic data are indicative of a somewhat nuanced U.S. economy. GDP growth in the first quarter of 2019 was much stronger than we anticipated, however, some of the underlying data was weak. April job growth was also stronger than expected, yet two major indexes capturing much of the U.S. economy declined in April.

    Real GDP increased at a 3.2 percent annualized rate in Q1. Three out of the last four quarters have posted real GDP growth above 3.0 percent, buoyed by the tax reform of early 2018. When we look at the components of Q1 GDP, the message is more complicated. Several important components of GDP were weak in Q1. Real consumer spending was soft, increasing at a 1.2 percent annualized rate, well below the 3.3 percent average of the previous three quarters. Real business fixed investment (excluding inventories) increased at a modest 2.7 percent annualized rate, the second weakest expansion in that category over the last nine quarters. Real residential investment continued to slide, contracting at a 2.8 percent annualized rate. Residential investment has declined for five consecutive quarters. Real federal government spending, which was very strong from 2017Q4 through 2018Q3, was unchanged in 2019Q1.

    The components that pushed headline Q1 GDP stronger than expected in Q1 all showed unsustainable growth. The U.S. international trade gap narrowed considerably in Q1, adding just over 1 percentage point to headline real GDP growth. Trade flows have been very lumpy recently as companies schedule shipments with one eye on the timing of new tariffs. Even with an unratified trade deal in place for Canada and Mexico, and a U.S.-China trade deal imminent, U.S. trade faces the twin headwinds of a strong dollar and a softer global economy. We expect the trade gap to revert to being a small drag on U.S. GDP very soon. Inventory accumulation added about 0.7 percentage points to headline real GDP growth in Q1. Inventories have been building up strongly over the last three quarters. Boeing’s recent problems have added to inventory accumulation. Automakers are also building their inventories in anticipation of a potential contract dispute with the UAW later this year. We expect inventory accumulation to flip from a positive for GDP back to a negative soon. Finally, real state and local government spending was unusually strong in Q1, increasing at an unsustainable 3.9 percent annualized rate.

    Most labor-related data looks strong after payroll job growth faltered in February. U.S. payrolls increased by just 56,000 net new jobs in February, the weakest monthly gain since September 2017. March payrolls bounced back, showing a solid 189,000 job gain. April payrolls surged, up 263,000, while the unemployment rate fell to 3.6 percent, the lowest rate since December 1969.
    Both the ISM Manufacturing Index and the ISM Non-Manufacturing Index declined in April and have been on a declining trend since late 2018. Fortunately, both indexes remained above 50 in April, indicating improving conditions. However, the pace of improvement for these broad-reaching indexes has clearly cooled.

    Separating the transitory from the fundamental is a key challenge in this complex economic environment. Adding to the complexity is the challenge facing the Federal Reserve. How the Fed executes monetary policy and how it thinks about inflation are both in question by monetary policy theorists. Inflation has been cooler than expected. The core-PCE price index showed a 1.6 percent year-over-year gain in March, and has been running below the Fed’s 2 percent target since last August. We still expect the fed to keep the fed funds rate range unchanged at 2.25-2.50 percent through the remainder of this year.

For a PDF version of this report, click here: May 2019 U.S. Economic Outlook

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information. 

 

 

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April 2019 U.S. Economic Outlook

April 9, 2019 by Robert A. Dye, Ph.D., Daniel Sanabria

Our job is to remind everyone why they call economics “the dismal science.” So as downside risks to the U.S. economy increased through the end of 2018 and into early 2019, we felt compelled to incorporate them in our U.S. economic forecast and to communicate about them. As a result, our real GDP forecast for the U.S. shows growth slowing significantly in 2020 and beyond. We have also increased our subjective probabilities of recession to show that there is a meaningful danger to this very long economic expansion lurking nearby. We hope that the downside risk story is no longer headline news, but something that is recognized in your planning process.

While we have covered the downside risk story for the U.S. economy in recent editions. There are two other important alternative stories. One alternative story describes an ongoing weak-to-moderate economic expansion. A key element of this potential outcome is the stabilizing power of the U.S. household sector. Wages and salaries account for about half of U.S. personal income. We know that the employment rate (the inverse of the unemployment rate) now stands at 96.2 percent. There is always some frictional unemployment in the system as available labor seeks its best opportunity, but it is fair to say that hiring conditions remain very favorable and almost everyone who wants a job has a job. Because of the general scarcity of available labor, wages in most occupations are being bid up. The yearly rate of change of average hourly earnings was 3.4 percent in February, well above the yearly change in the Consumer Price Index of 1.5 percent for the month. So most households are seeing real gains in earnings. At the same time homeowners’ equity in their homes is increasing and the personal saving rate remains elevated well above pre-recession rates. Overall consumer debt remains manageable. The household financial obligations ratio, debt payments as a percent of income, is still well below the historical average from 1980 through 2010.

There is also an upside story waiting to unfold if conditions allow. A resolution to the U.S./China trade war could be a catalyst for improved business confidence and investment. A long pause, or even a rate cut by the Federal Reserve would keep a lid on the cost of capital for businesses. The recent dip in home mortgage rates could provide a reset for the housing market. If earnings remain strong and corporate profits stay robust, then equity markets could stage another rally, generating significant wealth.

Our monthly U.S. forecast seeks to balance the upside and downside risk factors for the U.S. economy and show what we believe is the most likely near-term outcome. We expect to see ongoing economic growth this year after a very weak first quarter. We expect growth to moderate toward the end of this year and into early 2020 as the current economic expansion establishes a new record duration of more than 120 months.

The low-growth economy beyond 2019 will be vulnerable to downdrafts and may fall into technical recession without replaying the catastrophic cliff dive of 2008-2009. Barring a dramatic correction in global debt markets, the next recession could look more like the on-again-off-again pattern of 2001 than the classic V-shaped recession pattern.

We saw a bit of this this zag-zag pattern in GDP growth through 2011 and again in the second half of 2012 into early 2013. A revolution in oil field technology spurred a sustained peak in drilling activity, well servicing and investment in production and distribution systems that provided enough of a boost to business investment that we avoided a follow-on recession after the Great Recession. Without the Shale Gale we might have fallen into the Recession of 2011/2012. The current expansion cycle would then be dated much differently, with perhaps more potential to continue.

For a PDF version of this report, click here: April 2019 U.S. Economic Outlook.

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information. 

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March 2019 U.S. Economic Outlook

March 13, 2019 by Robert A. Dye, Ph.D., Daniel Sanabria

Flatlining the Fed

We have removed the one fed funds rate hike for 2019 that we had previously shown in our interest rate forecast. In our February interest rate forecast, we had one fed funds rate hike coming at the June FOMC meeting. Now, in our March interest rate forecast we show the fed funds rate range remaining at the current 2.25-2.50 percent through 2021.  This reflects our uncertainty about both the timing and the direction of the Fed’s next move. 

In his 60-Minutes interview from March 5, Fed Chairman Jay Powell again emphasized the Fed’s “patient” stance. Powell said, “Patient means that we don’t feel any hurry to change our interest rate policy.” Powell’s chief justification was a cooler global economy and he highlighted downside risks emanating from weaker demand in China and Europe and from the Brexit process in the U.K.

The flattening of the Treasury bond yield curve early this year is consistent with the view that the Fed is at the top of its rate tightening cycle. Also, the fed funds futures market shows a strong implied probability, 77.6 percent, that the fed funds rate range will remain at the current 2.25-2.50 percent through January 2020. 

Flatlining the fed funds rate is also consistent with our view of cooler U.S. economic growth through the remainder of this year. We now expect U.S. real GDP growth to ease from 2.9 percent in 2018, to 2.5 percent in 2019, and ease further to 2.2 percent in 2020. While we are forecasting continued U.S. economic growth through the near term, we also recognize that the odds of recession for the U.S over the next two years have materially increased. 

Finally, we can say that a flat fed funds rate forecast is consistent with expectations for overall lower interest rates in this expansion cycle. R-star (or R*) is the terminology that the Fed uses to denote the “natural “ rate of interest. It is more tightly defined as the real (inflation-adjusted) short-term interest rate expected to prevail when the U.S. economy is at full strength and inflation is stable. R-star is not directly measurable. It is only a theoretical construct. But the concept shows how the Fed’s thinking about interest rates has gradually changed over recent decades. The Fed’s estimates for R-star have dropped significantly from about 3.5 percent in the late 1980’s, to about 0.8 percent at the end of 2018. This estimate of R-star at 0.8 percent, plus inflation in the neighborhood of 2.0 percent, gives us an estimate of about 2.8 percent for a “neutral” fed funds rate. This is why the Fed thinks it is already close to neutral and is concerned about overshooting neutral if the global economy cools down and inflation falls. 

Inflation is now the key variable in the Fed’s policy calculation. The Fed’s preferred measure of inflation, the 12-month trimmed mean PCE price index has been hovering near 2 percent since last June. Even though oil prices have firmed early this year, they will likely exert little upward pressure on the trimmed mean PCE because big pushes and pulls in inflation are dropped out of the index so that it represents a “core” reading on prices. 

We expect overall inflation to remain calm, near 2 percent, for the remainder of this year, effectively removing the rationale for further rate increases. Wages are still going up due to the tight labor market, and there is still some upside risk to inflation from the Phillips Curve effect, that higher wages will eventually result in hotter inflation. However, to date, that remains a risk and not a fact. Further, the potential resolution of the U.S./China trade war this year represents a key downside risk for inflation. 

On March 20, the Fed will release a new dot plot showing the FOMC’s expectations for the fed funds rate over the next few years. We expect to see the March dot plot flatten compared to the dot plot from last December.

For a PDF version of this report, click here:  March 2019 U.S. Economic Outlook 

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations.  The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team.  We are not offering or soliciting any transaction based on this information.  We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation.  Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed.  Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.  

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February 2019 U.S. Economic Outlook

February 7, 2019 by Robert A. Dye, Ph. D., Daniel Sanabria

A Downshift in the Global Economy Adds Risk 

There is never a good time, but the recently ended partial federal government shutdown came at a bad time. As the global economy appeared to downshift, the shutdown put sand in the gears of the U.S. economy, and resulted in a partial economic data blackout at a critical time. The Census Bureau and the Bureau of Economic Analysis were closed through January, leaving a big gap in economic reporting. Their reopening is shedding some light on the U.S. economy, but the lighting may be inconsistent in the near term as data procedures and schedules get reassembled.

Inconsistencies in data can be seen in the January employment report from the Bureau of Labor Statistics, which was not shut down but was still impacted by the shutdown. The BLS jobs report is based on two separate surveys. The establishment survey shows employment by place of work and gives us data on employment in specific industries. The household survey shows employment by place of residence and is the source for the unemployment rate. The establishment survey showed that January payrolls increased by a very strong 304,000. December payrolls, which were previously reported as up by 312,000, were slashed to now show a gain of 222,000. Furloughed federal workers were counted as employed in the establishment survey in January because they will eventually get paid. The household survey showed a major drop of 251,000 jobs in January. Furloughed government workers were counted as not employed in the household survey. As a result, the unemployment rate increased from 3.9 percent in December, to 4.0 percent in January.

The bulk of U.S. labor-related data points to ongoing strong hiring through January. However, business and consumer confidence fell at year end 2018, and some marquis companies announced that they were beginning to lay off significant numbers of workers. We believe the hiring story is more nuanced than “full speed ahead.” We expect the blistering pace of hiring through December and January to slow down in the months ahead, reflecting more cautious behavior from U.S. businesses as U.S. and global conditions cool in early 2019. 

While U.S. economic data has been inconsistent, recent data from China has been consistent in a bad way, showing slower growth in the world’s largest single economy. The Caixin Composite PMI for China for January dropped to a barely positive 50.9, with a big drag coming from the manufacturing sector. The Caixin China Manufacturing PMI dropped to a contractionary 48.3 in January. Likewise, the IHS Markit Eurozone Manufacturing PMI fell to a barely positive 50.5 in January, showing that the world’s largest trading bloc is losing momentum. Weaker economic growth is putting pressure on tax collections in Germany according to a recent Finance Ministry report. Japan, the world’s third largest economy, is also losing momentum. Global trade is clearly cooling, crimped by the U.S.-China trade war.

In addition to pressure from the U.S.-China trade war, the global economy is feeling pressure from the Federal Reserve due to higher U.S. interest rates. The Fed has responded to increased downside economic risk by emphasizing “patience” in recent announcements, speeches and press conferences. At the conclusion of the Federal Open Market Committee meeting over January 29/30, Fed Chairman Jay Powell sounded like he was in no hurry to continue raising rates. We expect the next dot plot, to be released by the Fed on March 20, to show reduced expectations for rate hikes, compared to the dot plot from December 19. In our February U.S. forecast, we have only one 25 basis point increase in the fed funds rate this year, coming at mid-year. We believe that the Fed is already very close to the top of its interest rate cycle for this expansion. Also, we expect the Fed to gradually wind down asset runoff this year, settling at a balance sheet of about $3.5 trillion.

For a PDF Version of this report, please click here: February 2019 U.S. Economic Outlook

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.

 

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January 2019 U.S. Economic Outlook

January 7, 2019 by Robert A. Dye, Ph.D., Daniel Sanabria

Two Stories, One Economy

There are two believable but contrasting stories for the U.S. economy as we turn the page into 2019. One story focuses on the majority of economic data, which indicate very positive current conditions. Labor-related data in particular is stellar. December payrolls were much stronger than expected, expanding by 312,000 jobs. October and November payrolls were revised up significantly. Wages were up 3.2 percent in December over the previous year. Job openings exceed the number of unemployed. Unemployment insurance claims remain extremely low. The unemployment rate ticked up inconsequentially in December, to just 3.9 percent. We expect it to tick back down in the months ahead. Also, inflation is benign and corporate profits have been strong.

The other story is forward looking, focusing on increasing downside risks for the U.S. economy in 2019 and beyond. The list of downside risk factors for the U.S. economy has grown appreciably in recent months. Equity markets sold off in October and again in December. Bond yields have dropped as investors shift toward quality. The middle part of the Treasury yield curve has flattened, raising concerns about yield curve inversion. U.S. housing data is underperforming. Housing affordability remains a critical issue for many new buyers. Support from the rest of the world is faltering. Economic growth in China and in Europe eased in the second half of 2018 and looks set to ease further in 2019. The quality of corporate debt markets is a growing concern.

Trade policy is another major source of uncertainty for 2019. Increased tariffs on imports from China and restrictions on U.S. exports to China would add further strains to supply chains and corporate balance sheets. Higher input prices would be passed through and ultimately add to inflationary pressure. More inflation could require the Federal Reserve to raise interest rates more than expected. Conversely, a resolution to the trade war and a roll back in trade friction could be significant positives for both the U.S. and China in 2019.

In this uncertain environment, the Federal Reserve executed its fourth 25 basis point rate hike in 2018 on December 19, pushing the fed funds rate range to 2.25-2.50 percent, 100 basis points above where it was a year ago. The Fed believes that the fed funds rate is getting closer to “neutral” where it is neither stimulative nor restrictive for the overall economy. The problem is that a “neutral” fed funds rate is a theoretical concept that is very difficult to determine in advance. It may be the case that “neutral” is found only by going farther than neutral.

The combination of higher interest rates and high wage rates could start to squeeze corporate profits later this year. Weaker corporate profits are often the trip wire for corporate restructuring and layoffs. General Motors and Tata Motors have recently announced restructuring plans which highlight the uncertainty in the global auto industry. Verizon’s recent layoff announcement shows stress in the telecom sector.

Lower oil prices and reduced business confidence could impede business fixed investment in late 2018 and into 2019. After a strong first half of 2018, growth in business fixed investment cooled to just 2.5 percent (annualized) in the third quarter. The fourth quarter GDP data will tell us if the cooler Q3 numbers were just in response to faster growth earlier, or if the Q3 cool down in investment spending growth was a true inflection point for the economy.

Finally, the U.S. political climate is likely to be contentious in 2019, raising the possibility of lurching fiscal policy by late 2019. The now two-week-long partial federal government shutdown suggests that federal budget negotiations later this year will be difficult.


For a PDF version of this report, click here: January 2019 U.S. Economic Outlook

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.

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December 2018 U.S. Economic Outlook

December 11, 2018 by Robert A. Dye, Ph.D., Daniel Sanabria

U.S. Conditions are Good, but a Canary has Coughed

The majority of U.S. economic metrics look positive early in the fourth quarter. Many metrics are at multi-decade bests. The unemployment rate stayed at 3.7 percent for the third consecutive month in November, the lowest it has been since December 1969, when it dipped to 3.5 percent. It didn't stay there for long. The next recession started in January 1970. By the end of 1970, the unemployment rate had increased to 6.1 percent.

A quick look at the history of the U.S. unemployment rate since January 1948 reveals a simple consistent pattern. Since 1948, the unemployment rate has always been cyclical. Lows are followed by highs and highs are followed by lows. The U.S. unemployment rate has never taken a random walk. The average gain from valley to peak in the unemployment rate is 3.7 percentage points over the last 10 cycles. The largest gain since World War II came during the Great Recession when the unemployment rate increased by 5.6 percentage points over the course of 31 months from 4.4 percent in March 2007, to 10.0 percent in October 2009. The smallest cyclical gains were 2.5 percentage points.

The unemployment rate is considered to be a lagging economic indicator, telling us where we have been, not where we are now. But a related metric is considered to be a leading indicator. Initial claims for unemployment insurance are a key component of change for the unemployment rate. Gains and losses in the weekly initial claims data are well correlated with gains and losses in the unemployment rate. Initial claims dipped to a low of 204,000 for the week ending September 8, 2018 when the unemployment rate first hit 3.7 percent. Since then the trend in initial claims has been up. It is too early to say if the uptrend will be sustained. It may be an artifact of this year’s hurricane season. However, initial claims are like the canary in the coal mine, often signaling when conditions are changing, and the canary has coughed, so we should keep an eye on it.

GM added some dust when it announced 5 plant closures for 2019, totaling about 15,000 jobs in the U.S. and Canada. Verizon has just announced that it will eliminate 10,400 jobs in 2019.

The Federal Reserve’s last policy meeting of 2018 will be an important one. Over December 18 and 19 the Federal Open Market Committee will debate the merits of another fed funds rate hike. We expect that the FOMC will approve the fourth 25 basis point fed funds rate hike for the year. The implied probability of that outcome has eased to about 76 percent. Normally, when there is a broad expectation of a rate hike this close to an FOMC meeting, the probabilities implied by the interest rate futures market would be somewhat higher. However, ongoing volatility in financial markets generally is keeping the rate hike short of a sure thing. In addition to the policy announcement, we will also see a new “dot plot” from the Fed on December 19, plus a new set of economic projections and a post-meeting press conference by Fed Chair Jay Powell.

We expect 2019 to be a pivotal year for the U.S. economy. Some metrics may start to show the early signs of deterioration. Others will point more clearly to cooling conditions. Amongst those, housing data is especially worrisome. New and existing home sales have been on downtrends since both series peaked in November 2017. The Fed’s rate hike next week will put additional upward pressure on mortgage rates, eating into housing affordability. The FHFA’s effective mortgage rate has increased about 130 basis points from its low of 3.49 percent in December 2012, to 4.82 percent in October 2018. Over that time span, housing affordability has dropped by 23 percent according to Moody’s Analytics Housing Affordability Index.

For a PDF version of this report, click here: December 2018 U.S. Economic Outlook

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.


 

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November 2018 U.S. Economic Outlook

November 5, 2018 by Robert A. Dye, Ph.D., Daniel Sanabria

U.S. Economic Metrics Continue to Impress, Reinforcing Higher Interest Rates

U.S. economic metrics continue to be impressive. The economy added 250,000 net new payroll jobs in October, putting the average monthly gain for 2018 through October at 212,500. It will be increasingly difficult to maintain that strong pace of job growth going forward because the pool of available labor is getting smaller. Increased competition for labor is pushing wages up. Average hourly earnings for private sector workers were up by 3.1 percent in October, over the previous 12 month period. This is the strongest year-over-year gain in wages since April 2009. The Federal Reserve Bank of Atlanta’s wage growth tracker is stronger at 3.5 percent wage growth.

U.S. businesses are enjoying strong demand growth. Real GDP expanded at a 3.5 percent annualized rate in the third quarter, after growing at a 4.2 percent annual rate in Q2. Industrial capacity utilization appears to be closing in on a cyclical high. The cyclical high points in overall capacity utilization have been trending down since the late 1960s, so 78 percent capacity utilization in September 2018 may be on par with 88 percent capacity utilization from early 1967.

With labor markets tight, and industrial capacity utilization high, there is relatively little slack in this economy. In a low slack economy the potential for demand-pull inflation is higher. We believe that the Federal Reserve will respond to the increased potential for demand-pull inflation with more interest rate hikes over 2019. We expect the Fed to leave interest rates unchanged at the Federal Open Market Committee this week over November 7/8. We look for the next fed funds rate hike to come at the conclusion of the December 18/19 FOMC meeting. We have three more 25 basis point fed funds rate hikes on our interest rate forecast for 2019, beginning on March 20, 2019. The implied odds of a December 19 rate hike have fallen in recent weeks due to the sell-off in U.S. and global stock markets. According to the CME, they are down to about 73 percent. We expect the implied odds to increase quickly after the stock market stabilizes and the dust settles after the mid-term election.

With wages going up, interest rates going up and import prices going up, it is fair to say that corporate profits are facing some headwinds. Fortunately, corporate tax reform came at an auspicious time and helped to boost corporate profits when they otherwise would have been squeezed. As of 2018Q2, after-tax corporate profits were up by 16 percent over the previous year. However, the support to corporate profits from tax reform will fade in 2019. Meanwhile, the pressure from wages and interest rates will increase. Import price pressure from tariffs could go either way depending on trade negotiations between the U.S. and China.

Global economic growth is slowing. The European Union posted weak Q3 GDP of just 0.2 percent over the previous quarter. Some of that can be blamed on a hiccup in German auto production due to new emissions tests. Italian GDP was unchanged in Q3 over Q2. China’s manufacturing sector is barely expanding. The Caixin China Manufacturing Purchasing Managers Index inched up from a flat 50 in September, to a faintly positive 50.1 in October. China’s service sector is also showing reduced growth. The trend in China’s economy looks ominous with likely spillover effects on other Asian economies. Japanese industrial production fell by 1.1 percent in September. South Korea posted a 2.5 percent decline in industrial production in September.

So even with current strong U.S. economic metrics, we believe that downside risk factors for the U.S. economy are increasing. Cooler U.S. and global economic growth in 2019, combined with higher interest rate and higher labor costs could start to put pressure on corporate profits and increase stress on corporate debt markets.

For a PDF version of this report, please click here: November 2018 U.S. Economic Outlook

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.

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October 2018 U.S. Economic Outlook

October 10, 2018 by Robert A. Dye, Ph.D., Daniel Sanabria

U.S. Households Are in Very Good Shape     

The U.S. economic expansion reached 112 months in October and it is in no immediate danger of ending. We expect this expansion to go into the record books as the longest U.S. economic expansion ever when it reaches 121 months next July. While the near-term outlook is good, we will be in unknown territory if and when this becomes the longest expansion in U.S. history.

The number of economic metrics that are at multidecade bests (highs or lows) is remarkable. Many of these “bests” are labor market metrics. The U.S. unemployment rate, at 3.7 percent in September, is the lowest since December 1969. Likewise, unemployment insurance claims are the lowest since 1969. July job openings were at 6,939,000, the highest level since that series started in December 2000. The National Federation of Independent Business’s Business Optimism Index was at a 45-year high in September.

Other metrics are very good. The ISM Manufacturing and the ISM Non-Manufacturing Indexes combining in September to exceed 120 is a very positive signal.

Payroll job growth in September eased off the near-200,000 jobs per month pace of the first eight months of 2018, to hit 134,000 for the month. This is not a bad number at all given how tight the labor market is. We have gotten used to robust job growth but that is going to change. We simply cannot keep that pace up given that we have only about 6 million unemployed workers according to the U3 labor force count. Wage growth continues to be moderate, up 2.8 percent over the last year.

Hurricane Florence may have been a small negative weight on the September job numbers. The timing of the hurricane suggests that most of the jobs data was collected before the hurricane struck the Carolina coast. Hurricane Michael may prove to be a bigger drag on October economic data than Florence was on September data.

U.S. households are in great shape. Jobs are plentiful. The personal saving rate has rebounded after bottoming out in June 2005 at 2.2 percent, to a fairly steady near-7 percent range. Homeowners are continuing to generate equity in their homes, and for the most part, they are not spending it out. So even if we hit some bumps, households are not overextended on credit and they have much more padding to protect themselves from adverse economic conditions than they did in late 2007.

The Conference Board’s Consumer Confidence Index in September surged to 138.4, within striking distance of its all-time high of 144.7 from January 2000. With the mid-term elections coming up consumer confidence may be vulnerable, especially if a flip in the House or Representatives and/or Senate significantly alters the political landscape. However, history suggests that consumer confidence tends to increase after the mid-term election. In 2014, the Consumer Confidence Index was higher in December after the mid-term election than it was in October before the mid-term election. The same was true in 2010, 2006, 2002, 1998 and 1994. 1990 breaks the pattern, but it holds in 1986 and 1982.

Federal Reserve Chairman Jay Powell has doubled down on “gradualism.” We still believe that gradualism, as defined by a 25 basis point fed funds rate hike every other FOMC meeting, will change in late 2019. But for now, the Fed’s familiar cadence will continue. According to the CME Group, the implied odds of the fourth rate hike for 2018, coming on December 19, are about 81 percent. The odds of the next rate hike after that coming in cadence on March 20, 2019 have increased to about 56 percent.

For a PDF version of this report, please click here: October 2018 U.S. Economic Outlook

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.

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September 2018 U.S. Economic Outlook

September 10, 2018 by Robert A. Dye, Ph.D., Daniel Sanabria

Fed’s Gradualism Will Gradually Change

Recent fedspeak has featured the word “gradual” to describe the Fed’s approach to monetary tightening. In his speech at Jackson Hole, Wyoming on August 24, Fed Chairman Jerome Powell described the two key risks of raising interest rates in an expanding economy; (1) moving too fast and shortening the expansion, and (2) moving too slow and letting inflation get out of control. Powell said, “I see the current path of gradually raising interest rates as the FOMC’s approach to taking seriously both of those risks.” Dallas Fed President Rob Kaplan wrote in his essay from August 21, “..we should be removing accommodation (by raising rates) in a gradual manner to get to a neutral policy stance.”

So far in 2018, gradualism has meant a 25 basis point increase in the fed funds rate range every other meeting, beginning in March. After the March rate hike came the June rate hike. We expect that cadence to continue on September 26, and again on December 19 for a total of four rate hikes in 2018 over a period of eight FOMC meetings.

In looking ahead to 2019, we encounter the problem with gradualism. The problem with gradualism is that it is only a description of the pace of rate hikes. It is not a justification for rate hikes, and it offers little guidance about what will happen when conditions inevitably change. Moreover, even as Powell and the rest of the Federal Open Market Committee seek to define what they are doing, the conditions that justify gradualism are already changing.

As economist Herb Stein said succinctly, “If something can’t go on forever, it will stop.” What Stein’s Law intuited is that the U.S. economy does not run at steady state. A quick review of historical GDP growth shows expansions and recessions. Even in long expansions, quarters of faster growth are followed by quarters of slower growth. The U.S. economy accelerates and decelerates. It does not run at a steady state.

We are concerned that after the current period of acceleration, featuring 4.2 percent real GDP growth in 2018Q2, the U.S. economy will decelerate sometime in 2019, and the Fed’s gradualism will have to be redefined.

Strong job growth has fueled the economy’s recent acceleration. The U.S. economy has created an average of 207,000 net new payroll jobs per month this year, through August. It is unlikely that that pace of job growth can be sustained into 2019. This year we see that there are currently more job openings than there are unemployed workers. This is the first time that has happened since the Job Openings and Labor Turnover Survey was initiated in 2000.

With available labor becoming scarce and capacity utilization running high, businesses will have to spend more on capital in order to keep expanding production. This would lift productivity growth and help alleviate the inflationary pressure from increasing wages. We saw some pickup in the rate of business investment early this year after the corporate tax law was changed. However, we have not seen a sustained industry-wide acceleration in bank lending to fund capital expansion. Rather, we are concerned that both labor and capital may eventually constrain the economy, particularly as capital becomes more expensive after two more fed funds rate hikes this year. This could be similar to what is happening in the housing market now as the limited availability of houses for sale, and their decreasing affordability appears to be keeping the market in check despite pent-up demand. Slower rest-of-world growth and U.S. fiscal contraction are also downside risks for late 2019 and early 2020.

We expect the Federal Reserve to slow the every-other-meeting pace of rate hikes next year. The adoption of a press conference after every FOMC meeting will give Powell more flexibility to change the cadence of rate hikes as the Fed approaches the peak fed funds rate for this cycle by the end of 2019 or early 2020.

For a PDF version of this report, please click here: September 2018 U.S. Economic Outlook

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.
 

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August 2018 U.S. Economic Outlook

August 6, 2018 by Robert A. Dye, Ph.D., Daniel Sanabria

After a Strong Q2, A Return to Normalcy in H2

    The U.S. economy was strong through the second quarter and at the start of the third quarter. Real gross domestic product accelerated at a 4.1 percent annualized rate in Q2, the fastest growth since the 4.9 percent growth rate from 2014Q2. Business decisions are usually based on nominal numbers, and in the nominal GDP numbers we see a year-over-year gain of 5.4 percent over the 12 months ending in Q2. This is the strongest year-over-year growth in nominal GDP since 2006Q3, before the Great Recession. Real consumer spending was healthy in Q2, expanding at a 4.0 percent annualized rate, juiced up by job growth and tax reform. Tax reform also contributed to a good quarter for real business fixed investment, which grew at a 7.3 percent rate. Inventories were an unexpected drag in Q2, shrinking by $28 billion ($2012), and subtracting a percentage point from real GDP growth.

    In the current quarter, we expect to see less help from consumer spending. July unit auto sales eased from the 17.2 million Q2 average sales rate, to a 16.8 million unit rate. Residential real estate markets look like they are cooling in many areas, keeping a lid on consumer spending and residential fixed investment. We expect business investment to continue to expand, but many businesses are complaining about price pressure and uncertainty due to the trade wars. Inventories are a big question mark for Q3. After the Q2 drag, it is reasonable to expect a bounce back in Q3. We look for a moderate increase in Q3 inventories, possibly adding more than a percentage point to Q3 real GDP growth. All in, it looks like the U.S. economy will expand moderately in Q3, stepping back from a strong 4.1 percent annualized growth rate for real GDP in Q2, to a moderate 2.5-3.0 percent real growth trend over the remainder of this year.

    Job growth was good in July, just not quite as good as most were expecting. 157,000 net new payroll jobs were added and the unemployment rate eased back to 3.9 percent. Private-sector average hourly earnings increased by 0.3 percent in July, and were up 2.7 percent over the previous 12-month period. Wages are simply not moving up quickly, even though virtually all labor market indicators are indicating tight supply. The ongoing retirement of baby-boomers, and their replacement with lower-paid younger workers, is a factor in the suppression of the total wage bill.

    To date, it is hard to find numerical evidence of a significant impairment to overall U.S. economic activity due to increased trade tariffs and other measures related to the current trade wars. However, there are numerous anecdotal comments complaining about trade in the Federal Reserve’s Beige Book, both the ISM Manufacturing and Non-Manufacturing Reports on Business, and in other reports. We look at trade conflicts across three dimensions. The breadth of the trade tariffs is a concern, as they expand to include more and more products. The height of the tariffs is a concern, placing significant burdens on both importing and exporting companies. The duration of the trade measures is a concern. The longer they are in place, the more the drag is passed on to other parts of the economy. Tensions with China still appear to be increasing. The recent visit by European Commission President Jean-Claude Juncker to the White House increased hope for a wind-down of U.S. trade tensions with Europe. The U.S. and Mexico appear eager to finalize a trade deal this month.

    The Federal Reserve remains on track with gradualism. We expect to see a 25 basis point increase in the fed funds rate range, to 2.00-2.25 percent, announced on September 26. The CME calculates implied odds of 94 percent for a September rate hike. We expect the Fed to skip a rate hike at the November 7-8 FOMC meeting, and then raise again on December 18. The CME Group reports a 67 percent chance of a December rate hike.

For a PDF version of this report, please click here: August 2018 U.S. Economic Outlook

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.

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July 2018 U.S. Economic Outlook

July 10, 2018 by Robert A. Dye, Ph.D., Daniel Sanabria

The Risk of Trade Wars 

The Trump Administration is resetting U.S. trade policies, much to the consternation of our key trading partners. Some economists fear a return to the “beggar thy neighbor” trade policies adopted during the Great Depression, which are thought to have deepened and extended the Great Depression. A Reuters survey this spring showed that 80% of 104 economists believe that steel and aluminum tariffs would harm the U.S. economy. However, the U.S. economy is currently strong and the drag from trade disruption is still relatively small. We do not expect trade tensions to escalate to the point where the U.S. economy is fundamentally impaired. But any move away from the global status quo will be disruptive, generating costs and benefits. Somebody's ox gets gored somewhere. 

It is a very complex analysis to determine how the costs and benefits from the short-term disruptions that are occurring are weighed against medium and longer-term costs and benefits. The costs and benefits are themselves complex. Some can be measured in economic terms on specific industries and companies and may have geographic components. Some can be measured in terms of national welfare. Some are strategic, including those related to national defense, and some are purely political. 

Downside effects that are already happening are: higher prices for some imports, reduced demand for some exports, increased uncertainty, businesses reducing leverage, delayed investment, lots of planning for alternative supply chain strategies, inventory management and uncertain pricing strategy. Some businesses may already be delaying hiring. However, overall labor market indicators, including the recent June jobs report from the BLS, remain strong. 

In our view, it is beyond the capabilities of economic analysis to develop a conclusive cost-benefit analysis of the current trade policy changes, accounting for both short-term and long-term effects. Simplified assumptions may be fed into macroeconomics models, but the results of simulations will be shaped by the assumptions themselves and by the inherent biases of the models. The Great Recession taught us that much of economics is nonlinear, meaning that relationships between variables and actors change over time. Complex events with nonlinear interactions are inherently unpredictable. However, we should heed the guidance that economics can provide. Economic theory tells us that free and fair trade is efficient and improves the welfare of the trading countries. However, it does not tell us the best route to get to free and fair trade from where we are now. 

In the near-term, a significant trade war would result in higher import prices and reduced demand for U.S exports. This could put the Federal Reserve in a dilemma if the U.S. economy faced higher inflation as uncertainty and business stress increases. It resonates with the stagflation scenario that some economists, including Alan Greenspan, fear. In this scenario, the Federal Reserve could feel the need to raise interest rates to fight inflation when economic growth is cooling, just as the positive effects of the tax reform wind down. A measured, proportionate and agile approach to trade policy could help to mitigate against potential adverse consequences. 

We expect to see Q2 real GDP growth in the neighborhood of 4.0 percent. This may be the strongest GDP growth this year. Productivity growth has been historically weak, but it may jump in Q2, to about 3 percent. Stronger productivity growth is essential in order to keep the now 108-month-long expansion going. Stronger productivity growth would also mean that wage growth, due to very low unemployment, would not necessarily be inflationary. This could give the Federal Reserve extra maneuvering room in setting interest rates in 2019.

For a PDF version of this report, please click here:   July 2018 US Economic Outlook

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations.  The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team.  We are not offering or soliciting any transaction based on this information.  We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation.  Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed.  Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information. 

 

 

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June 2018 U.S. Economic Outlook

June 5, 2018 by Robert A. Dye, Ph.D., Daniel Sanabria

The Economy That We Do Not See

After a step down in real GDP growth in the first quarter of 2018, to 2.2 percent, we expect to see stronger real GDP growth in the second quarter, up to about 3.6 percent. The first estimate of Q2 GDP is due out on July 27. We look for stronger business investment in Q2, aided in part by federal tax reform. We assume that federal government spending will increase in line with the new budget agreement. After a stronger second quarter, we bring real GDP growth down, closer to 3.0 percent for the second half of the year, and then lower in 2019 and 2020. In making the case for cooler GDP growth later, it is important to note what we do not see when we look down the list of GDP components. We do not see a  positive trend in U.S. auto sales. Auto sales in early 2018 are essentially in the same range that they occupied in all of 2016 and 2017. Flat to declining auto sales will be a weight on overall consumer spending. We do not see a robust trend in home sales and construction. Both sets of housing-related indicators have been flat since early 2017. Residential investment is clearly not an accelerator in this economy. We do not see a push from inventory accumulation. Inventory growth over the last two years has been below average and is contributing only modestly to GDP growth. Finally we do not see strong state and local government spending. State and local government spending is about 50 percent larger than federal government spending. Even if we see more spending on the federal ledger, overall government spending remains subdued. 

May employment data was better than expected. The U.S. economy added a net 223,000 new jobs, with positive net revisions to the previous two months. The manufacturing sector continues to add jobs, posting an 18,000 job increase in May. The average workweek was unchanged at 34.5 hours. The U.S. unemployment rate ticked down to 3.8 percent in May, the lowest since April 2000. What we still do not see in the labor data is evidence of accelerating wage gains. Average hourly earnings were up 2.7 percent over the 12 months ending in May. This is about where the rate of change has been since early 2016. 

There are good things that we do not see. We do not see an increase in credit-related stress that is often associated with the end of a business cycle. Both business bankruptcy and personal bankruptcy filings are still trending down.  Charge-off rates for all commercial banks remain very low as a percentage of total loans. The household financial obligations ratio, as a share of total disposable income, remains very low. 

We expect to see another 25 basis point fed funds rate hike at the upcoming Federal Open Market Committee meeting over June 12/13. This will put the fed funds rate in the range of 1.75-2.00 percent. The Fed may choose to raise the interest rate on excess reserves by only 20 percent (instead of moving it up 25 basis points in lock-step with the target fed funds rate range). This will allow the Fed to better manage the fed funds rate in the middle of the target range. In addition to a fed funds rate hike on June 13, we will also see a new set of economic projections and a new “dot plot” from the Fed, showing FOMC members’ expectations about the economy and about appropriate interest rate policy. 

We have been moving toward making the call for a fourth fed funds rate hike this year in December, after the third rate hike in September. However, economic uncertainty has increased in the last two weeks. International trade issues have become more contentious. Downside risks for European economic and political outcomes have increased. The price of oil dropped swiftly in late May. Until June 13, we will go with a 45 percent subjective probability for a December 19 fed funds rate hike. 

For a PDF version of this report click here: USEconomicOutlook_0618.

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.

Featured photo by Olu Eletu via Unsplash

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May 2018 U.S. Economic Outlook

May 7, 2018 by Robert A. Dye, Ph.D., Daniel Sanabria

Warming Inflation May Push the Fed to a Fourth Rate Hike in 2018 

In the first quarter of 2018, many U.S. economic metrics were strong, but real GDP growth was soft at just 2.3 percent. In the second quarter, we may see the mirror image of that picture. Economic metrics that are at or near their cyclical peaks can either go sideways or down in Q2. At the same time, some of the factors that kept Q1 GDP growth in check, including net exports and residential investment, look like they will strengthen in Q2.

Job growth in April was moderate, with payrolls up by 164,000 net new jobs for the month. Revisions to payrolls for the previous two months were +30,000, bringing the three-month average for payroll gains to 208,000 per month, a strong number at this stage of the business cycle. Average hourly earnings were up by 0.1 percent for the month and 2.6 percent over the previous 12 months, so wage pressure was light even though we are seeing more evidence of wage pressure in other reports. The unemployment rate fell to 3.9 percent, the lowest it has been since December 2000. The average workweek was unchanged at 34.5 hours, about where it has been since early 2012.

Inflation remains a hot topic. Headline inflation metrics warmed up this spring. In March, the 12-month change in the Consumer Price Index hit 2.36 percent. The Producer Price Index for Final Demand was up by 3.04 percent over the previous 12 months. The Federal Reserve’s preferred measure of inflation, the Trimmed-Mean PCE Inflation rate, is also warming up. It is a more stable measure, eliminating volatile components, but the 12-month Trimmed-Mean PCE Inflation Rate was up to 1.77 percent in March, and is expected to trend higher in the months ahead, closing in on the Fed’s near-2-percent inflation target. Commodity costs are under pressure. Transportation and distribution costs are too, with trucking capacity very tight. Labor costs are going up. The Employment Cost Index, which measures both wages and benefits, was up 2.7 percent in Q1, compared to a year earlier.

We are revising our forecast for year-end oil prices. Last month we had a $63 per barrel average for West Texas Intermediate crude oil in 2018Q4. This month we are showing $75 per barrel. Supply/demand fundamentals are shifting in the global oil market. On the supply side, there are key developments. Venezuela, a key global oil producer, is imploding politically and this has resulted in a significant deterioration of its oil production capacity. Venezuelan oil production will be down nearly a million barrels per day in the second half of this year compered with just a few years ago. OPEC is maintaining production discipline. This is reducing the global oil inventory overhang. U.S. production is strong and expected to continue to increase, but there are infrastructure bottlenecks making it difficult to expand export volumes quickly. Finally, on the supply side, President Trump appears to be positioning himself to withdraw from the Iran Nuclear Deal. This could result in new sanctions on Iranian oil exports. On the demand side, the global economy is growing, requiring more oil. Also, the Trump Administration appears likely to freeze fuel economy standards from 2020 through 2026, coming after U.S. auto demand has shifted toward less fuel efficient SUVs and light trucks. Higher oil prices will keep inflation metrics warm this year, adding to the probability of a fourth fed funds rate hike at the end of this year.

The Federal Open Market Committee did as expected last week, voting to keep the fed funds rate range unchanged at 1.50-1.75 percent. Solid U.S. economic indicators and warmer inflation metrics justify the strong expectations for a second 25-basis-point fed funds rate hike this year at the next FOMC meeting over June 12-13. A third rate hike, at the conclusion of the September 25-26 FOMC meeting, is also looking likely. As we move toward mid-year, financial market attention will increasingly focus on the possibility of a fourth rate hike this year, coming at the end of the December 18-19 FOMC meeting. We place the odds of a fourth rate hike in 2018 at about 50/50.

For a PDF version of this report click here: USEconomicOutlook-0518.

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.

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April 2018 U.S. Economic Outlook

April 10, 2018 by Robert A. Dye, Ph.D., Daniel Sanabria

Adding Up the Economy, It Looks Like 2018 Q1 GDP May Disappoint

In the March edition of the U.S. Economic Outlook, we talked about the strong start for 2018. We stand by that statement, as corroborated by several economic indictors that were strongly positive in early 2018. Among them are both the ISM Manufacturing and Non-manufacturing Indexes. If we take a quarterly average of these two series and add them together, the combined reading of 119.1 for the first quarter of 2018 was the highest combined reading for those two indexes since 2004Q1. Likewise, unemployment insurance claims have been historically low, and the February payroll gain of 326,000 net new jobs was the biggest gain since October 2015. 

However, when we look at how 2018Q1 GDP is shaping up, some components are looking weaker than expected. We have revised down our 2018Q1 real GDP growth forecast to just a 1.6 percent annualized rate. This is about two full percentage points below where some forecasts were at the start of the first quarter. We will get the first estimate of 2018Q1 real GDP growth from the Bureau of Economic Analysis on the morning of April 27. Even if there is a weaker-than-expected first estimate of Q1 GDP, we believe that the U.S. economy is still strong and that will show up in better second and third quarter GDP numbers. 

In order to understand how many economic indicators can be strong while GDP is not, it is useful to deconstruct GDP. GDP was designed to be a measure of the flow of production from the U.S. economy. There is no single observable flow of production that we can say is representative of GDP. Instead, GDP is the summation of several different flows within the economy, that can all behave differently at different times. Mathematically GDP = C + I + G + X. That is to say, GDP is the sum of consumer spending, investment, government spending and net exports. 

Consumer spending is the largest component of GDP, and is divided into consumer spending on durable goods, nondurable goods and services. In our April forecast we show real consumer spending growing at a fairly weak 1.2 percent annualized rate, after a strong 4.0 percent growth rate in 2017Q4. The main culprit behind the surge and slowdown in consumer spending growth from 2017Q4 to 2018Q1 is auto sales, which show up in consumer spending for durable goods. In 2017Q4, we saw strong auto sales as a result of the damage wrought by Hurricanes Harvey and Wilma. In the first quarter of 2018, unit auto sales declined at a 12 percent annualized rate, normalizing to the pre-storm trend.

Investment is divided into business fixed investment (on buildings and machinery), business investment on inventories, and residential investment (on new houses and improvements to existing houses). Residential investment  looks like it will be a weak link in 2018Q1. Three sets of housing-related data look like they will be soft in 2018Q1. In January and February, the value of new residential construction was flat. Single-family housing starts for January and February were flat. Also, single-family home sales for January and February were well below the November peak, pointing to a quarter-to-quarter decline.

Finally, net exports are expected to be a drag on real GDP growth in 2018Q1. Net exports equals the value of exports minus the value of imports. Imports have exceeded exports for the U.S. since 1981Q4, meaning that the U.S. has been running a trade deficit since then, which subtracts from GDP. For the first quarter of 2018, we estimate that imports grew faster than exports, due in part to the television coverage of the Winter Olympics. The roughly $1 billion in television royalties paid to broadcast the games in the U.S. reduced 2018Q1 nominal GDP by a billion dollars.

For a PDF version of this report click here: USEconomicOutlook-0418.

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.

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March 2018 U.S. Economic Outlook

March 13, 2018 by Robert A. Dye, Ph.D., Daniel Sanabria

Regime Change, Risk Factors, and a Really Strong Start for 2018

St. Louis Federal Reserve Bank President Jim Bullard is talking about regime change. Not political regimes, but economic regimes. Bullard is focused on the factors that drive monetary policy, but his broad concept of regime change is very useful now when thinking about the overall U.S. economy.

Within the world of monetary policy it is easy to see that we are in a new regime. The Federal Reserve went into crisis mode in late 2006 when it dropped the fed funds rate to near zero. It took until the end of 2015 to change that. In the meantime, the Fed initiated three rounds of asset purchases and expanded their balance sheet from about $1 trillion, to $4.5 trillion. Not only did the Fed press short-term interest rates to historical lows during that nine-year period, they also exerted significant influence over the long-end of the yield curve through asset purchases. In the new regime, the Fed is pushing up short-term rates with increases in the fed funds rate, at the same time that it is winding down its balance sheet, putting some upward pressure on the long end of the yield curve.

In addition to the U.S. Federal Reserve trying to normalize U.S. monetary policy, the European Central Bank is also gradually winding down its extraordinary policy. As the ECB further reduces their asset purchases this year, they too will put upward pressure on bond yields.

The fiscal policy regime has also changed. The recently signed two-year federal budget deal, along with tax reform, is expected to push out the federal budget gap. Most neutral sources estimate that the new fiscal regime will widen the federal deficit over the long term. This would require the Treasury Department to issue more bonds, putting upward pressure on interest rates as bond supply increases.

Inflation indicators are warming up gradually. As they do, financial market volatility is increasing. The historically low financial market volatility of 2017 may already be a thing of the past.

The Trump Administration is also disrupting trade regimes. A more assertive trade policy from the Trump Administration may yet bring countermeasures by our trading partners.

Finally, as we discussed previously, we are now more than 10 years out from the start of the Great Recession. Historically, that demarcation is associated with a regime change toward improved economic performance.

Even with a strong start to 2018, economic risk factors remain. By this May, we will be in the second longest U.S. economic expansion ever as we reach 107 months. By many metrics, this feels like a mid-to-late cycle economy.

However, the labor market is not cooling off. For a few years now, the consensus view among macroeconomists was that labor demand would gradually ease by this point in time, to something on the order of 100,000 to 120,000 net new jobs per month, or less. In the February labor data we saw the opposite. Payroll job growth was robust, up 313,000 for the month. Net revisions to December and January were +54,000, to bring average payroll job growth for the last three months to over 242,000 per month. Sizeable increases in the household employment survey and in the labor force kept the unemployment rate at 4.1 percent for the fifth consecutive month. We still expect the unemployment rate to drop below 4 percent this year, but the pace of declines appears to be slowing, yet another sign of economic regime change. Wages increased only moderately, by 0.1 percent in February, after jumping by 0.3 percent in January.
 

For a PDF version of this report click here: USEconomicOutlook-0218

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.

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February 2018 U.S. Economic Outlook

February 5, 2018 by Robert A. Dye, Ph.D., Daniel Sanabria

Jay Powell Takes the Helm at the Fed as U.S. Economy Enjoys a Tailwind

U.S. economic momentum was good through 2017 and may be better in 2018. Real GDP growth increased through the first three quarters of 2017, reaching a 3.2 percent annualized rate in 2017Q3. Real GDP growth then eased a little in 2017Q4, to a 2.6 percent annualized rate. Three key factors that pushed and pulled on GDP growth in 2017Q4 may be reversing themselves in 2018Q1, and this could lead to a stronger growth in the current first quarter. Real consumer spending was a positive in 2017Q4 as consumers, many from hurricane ravaged Texas and Florida, bought new cars and trucks. We expect the push from consumer spending on durable goods will ease significantly in 2018Q1. We have already seen unit auto sales throttle down from a 17.9 million unit rate last December, to a 17.2 million unit rate in January. Auto sales could ease further in the months ahead. However, even as consumer spending was strong in Q4, adding to GDP growth, both inventories and net trade were weak, together pulling nearly 2 percentage points off of Q4 real GDP growth. Those two key levers could reverse in early 2018, pushing real GDP growth in 2018Q1 back above 3 percent despite the drag from cooler auto sales. Average real GDP growth for 2017Q4 and 2018Q1 could push back above 3 percent, expending the run of solid GDP growth from 2017 into 2018.

Jay Powell was sworn in on February 5th as the new Chairman of the Federal Reserve. His comments after the ceremony were brief but positive, highlighting the current strength of the U.S. economy and of the U.S. financial system. The Powell Fed faces the challenge of appropriately communicating and executing Federal Reserve interest rate strategy at a time when inflation-related metrics are sending mixed signals. The January employment report showed that wages are warming up. Higher wages tend to put pressure on corporations to increase their prices, stoking higher inflation. However, the Fed’s favored measure of inflation, the trimmed mean PCE price index, has been running consistently below the Fed’s symmetric near-2-percent inflation target for the past several years.

The Powell Fed is also expected to increase the amount of maturing assets that it will allow to roll off the balancing sheet, in line with the schedule announced last summer. This will put marginal upward pressure on interest rates along with the push from an increasing fed funds rate.

Powell’s first meeting as Chairman of the Federal Open Market Committee, scheduled over March 20/21, will be an interesting one. Financial markets currently expect another fed funds rate hike on March 21, to a range of 1.5-1.75 percent. The fed funds futures market shows that the implied probability of a March 21 rate hike is about 78 percent. The Fed’s last dot plot, from December 13, 2017, is consistent with thee rate hikes in 2018. This could result in a pattern of a rate hike every other FOMC meeting, March, June and September, and then a pause at the end of the year. The cumulative implied probability of a second rate hike on June 13 now stands at a fairly high 60 percent. The cumulative implied probability of a third rate hike on September 26 stands at a not-insignificant 39 percent.

However, if the Fed is concerned about increasing inflation and increasing inflationary pressure coming from higher wages, it may not make sense to raise rates three times in 2018 and then pause for four months, from the end of September through the end of January, before raising rates again in January 2019. So, we look forward to seeing the new version of the Fed’s dot plot on March 21 to see if it gets steeper than the last dot plot from December 2017. A steeper dot plot could imply a total of four rate hikes in 2018 and not three. It could also imply a higher peak value for the fed funds rate in this business cycle.

For a PDF version of this report click here: USEconomicOutlook_0218

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.

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January 2018 U.S. Economic Outlook

January 8, 2018 by Robert A. Dye, Ph.D., Daniel Sanabria

2018: Out from the Shadow of the Great Recession

With the end of 2017 came a noteworthy anniversary. December 2017 marked ten years since the onset of the Great Recession. One generalized conclusion from Reinhart and Rogoff’s masterpiece, This Time is Different: Eight Centuries of Financial Folly, is that it can take about 10 years for an economy to recover from a severe financial crisis. While there is no calendar to check off milestones of crisis and response, that ten-year time span feels about right. So we can think about the U.S. economy in 2018 less in terms of recovery from crisis, and more in terms of what can foster positive momentum, what is sustainable and what is not.

As we look ahead to 2018 and beyond, we see that the U.S. economy is generating more consistent momentum. We still have a good shot at three consecutive quarters of 3 percent or more real GDP growth beginning in 2017Q2. It would be the first such winning streak in this expansion. We will get the first estimate of 2017Q4 real GDP growth on January 26. In addition to more consistent U.S. momentum, global economic demand is improving. Europe and Japan are both gaining momentum after years of underperformance. With the recent passage of tax reform, U.S. fiscal policy is stimulative. If Congress can cobble together an infrastructure spending program as promised, that could add to fiscal stimulus later this year. Although interest rates are gradually rising, monetary policy remains accommodative. The Federal Reserve has so far raised short-term interest rates from exceptionally low, to merely very low. Also, the crisis-driven regulatory response is easing. We expect to see more examples of regulatory rollback this year.

Productivity growth is key to sustaining a long expansion. We define productivity as real output per hour of all nonfarm private-sector employees. It tends to be cyclical, often peaking at the end of recessions after labor has been shed and output starts to ramp up. It often declines ahead of recessions as businesses hire more workers to keep up with growing demand. So far in this expansion, productivity growth has been weaker than expected. However, through the first three quarters of 2017 productivity growth improved, with 2017Q3 registering 1.5 percent year-over-year productivity growth -the strongest since 2015Q2.We expect the recent reforms to the corporate tax code to be positive for business investment, and therefore positive for productivity growth. Productivity growth is the key lever that will determine if wage growth is inflationary or not. Strong productivity growth allows businesses to pay higher wages with-out raising their prices. Otherwise, wage growth can lead to higher inflation which could cause the Federal Reserve to raise interest rates more than expected, which can eventually lead to the next recession.

What is not sustainable? Reinhart and Rogoff offer a master class in the dangers of rapid debt accumulation. Also, financial bubbles are non sustainable. The recent rallies in both the U.S. stock market and in Bitcoin add to the “wall of worry.” Mismanaged government finances are not sustainable. The Soviet Union, Greece and Zimbabwe are modern examples of self-imposed fiscal crises that led to collapse and chaos.

We expect to see an ongoing economic expansion for the U.S. in 2018, helped by rest-of-world growth, expansive fiscal policy and restrained monetary tightening. Productivity growth will be a key sustaining element of the U.S. expansion. By mid-year we will see the second-longest U.S. expansion ever, reaching 107 months in May.

For a PDF version of this report click here: USEconomicOutlook_0118

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.

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December 2017 U.S. Economic Outlook

December 11, 2017 by Robert A. Dye, Ph. D., Daniel Sanabria

2017 Policy Moves Will Spur Economic Growth in 2018 and Budget Battles 

This year saw important changes in both fiscal and monetary policy. The tax reform initiative will have a major impact on federal spending and federal budget deficit management for years to come. Both the House of Representatives and the Senate have passed versions of tax reform. The committee process to reconcile the two bills is being launched this week. A reconciled bill must still be approved by final votes in the House and Senate before being signed into law by the President. We expect that to happen before the end of this year. Even under dynamic scoring, which allows feedback loops in the scoring models to increase tax revenues over time, both the House and the Senate versions of the tax bill will tend to increase the federal budget deficit according to various scoring models. This in turn may reduce maneuvering room on any spending initiatives that the Trump Administration may propose in 2018, including infrastructure spending and spending on the proposed border wall with Mexico. Next year, the Trump Administration may push for entitlement reform before it pushes for new legislation on infrastructure spending because entitlement reform has the potential to free up some funding for infrastructure. 

In both the House and Senate bills, the largest economic benefits from a new federal tax code will accrue to corporations, less so to households. U.S. corporations will benefit from tax reform as effective tax rates are lowered and overseas profits are more easily repatriated. This will be a support to corporate profits coming at a critical time when corporate profit margins are being squeezed by higher operating costs in a late-cycle economy. Equity prices may also be supported by share buybacks funded with repatriated dollars. We expect most households to see a small-to-moderate reduction in their federal tax bills once the final legislation is passed. However, that may be countered by the loss of the state and local tax deduction, especially for residents of high tax states such as California and New Jersey.  We expect that the net short-term effects on the U.S. economy from a new tax code will be moderately positive, resulting in increased business investment and consumer spending. However, if there is too much pressure on the federal budget deficit from reduced tax revenues, then there is at least some potential for increased federal taxes later on. Also, if states and local governments feel less support from federal revenue sharing, then there is potential for the tax burden to shift downhill to state and local governments, requiring them to raise taxes later.

Federal Reserve monetary policy also changed significantly this year. In October, the Federal Reserve began to reduce the amount of maturing assets that it is reinvesting. A decrease in the amount of assets being reinvested will gradually reduce the size of the Federal Reserve’s $4.5 trillion balance sheet. The Fed has not issued a final target for the size of its balance sheet. That may be in the range of $2  to $3 trillion. The shift away from reinvesting maturing assets will gradually reduce the demand for Treasury bonds, putting a small amount of upward pressure on Treasury bond yields. Also, we expect the Fed to increase the fed funds rate range for the third time this year at the conclusion of the Federal Open Market Committee meeting on Wednesday, December 13. As the Fed puts upward pressure on interest rates, there is potential for higher interest rates to increase the borrowing costs of the federal government, adding to the federal budget deficit already under pressure from tax reform.

For a PDF version of this report click here: US_Economic_Outlook_1217.

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.

 

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November 2017 U.S. Economic Outlook

November 6, 2017 by Robert A. Dye, Ph.D., Daniel Sanabria

Debts and Taxes

The globally synchronized economic expansion will continue through year-end 2017. U.S. real GDP grew at a 3.0 percent annualized rate in the third quarter of 2017, or 0.7 percent quarter-over-quarter. The European Union increased real GDP by a similar 0.6 percent quarter-over-quarter in Q3. China claims 6.8 percent real GDP growth in Q3 on a year-over-year basis, roughly consistent with a strong 1.7 percent growth quarter-over-quarter. Japan is expecting about 0.5 percent quarter-over-quarter real GDP growth for Q3. Commodity countries are doing better as commodity prices increase. As the global expansion continues, so does concern about debt accumulation, which is both a symptom and a cause of the current benign economic environment. Rising debt levels in Asia have drawn warnings from global economic institutions, including the World Bank and the International Monetary Fund.

Accompanying the synchronized global expansion, there is a synchronized monetary policy normalization. The U.S. Federal Reserve looks all but certain to raise the benchmark fed funds rate range again on December 13. It has begun the process of reversing the substantial crisis-driven increase in its balance sheet. We expect the Powell Fed to raise rates again in 2018. The Bank of England just raised its benchmark bank rate for the first time in a decade, while the European Central Bank will reduce its asset purchases in January, but have not yet proposed a tapering strategy.

For most developed countries, including in the U.S., inflation remains weaker than expected. Oil prices have firmed recently, but remain well below earlier expectations. In the U.S., tighter labor markets are expected to lead to further wage gains, potentially stoking more inflation later. But the global forces of disinflation and outright deflation remain strong. Among these are lower population growth, better agricultural production, globalized trade, ever-cheaper computing power and the ever-increasing zero marginal cost economy. 

The U.S. awaits tax reform. The House of Representatives bill is now in the hands of the Senate, which will use the reconciliation process to try to pass something before the end of this year. There has already been pushback on limiting the mortgage interest deduction and eliminating the state and local tax deduction. Some experts warn that the proposed 20 percent corporate tax rate is too low and will destabilize the federal budget deficit, potentially making our federal debt unsustainable. We believe that the Senate will be under enormous pressure to do something and that the final tax bill will retain the broad contours of the House plan. Failure of tax reform could result in a reset of current high business and consumer confidence. 

An infrastructure bill for 2018 remains on the Trump Administration’s wish list. The final infrastructure bill will be dependent on tax reform. We expect to see something featuring public-private partnerships and possibly asset sales.

For a PDF version of this report click here: US_Economic_Outlook_1117.

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.

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October 2017 U.S. Economic Outlook

October 11, 2017 by Robert A. Dye, Ph. D., Daniel Sanabria

U.S. Economy Shows Good Momentum Despite Recent Storms

We are seeing the disruptions caused by a very active hurricane season in some of the economic data for Augustand September. We expect to see more evidence of storm effects in the data for October, and perhaps in the data for November as well. Despite the local and regional economic disruptions, the catastrophic damage and the loss of lifefrom the recent hurricanes, the U.S. economy remains in good shape and looks set to end the year with moderate positivemomentum. This speaks volumes about the resiliency of the U.S. economy.

Labor data for September was muddied by the storms and beyond that it was simply quirky. September payrollsdropped by 33,000 due to business interruptions from Hurricanes Harvey and Irma. Payroll data is collected during theweek of the month that contains the 12th. Harvey made landfall in South Texas on August 25. Flooding in the Houstonarea kept some business shuttered for weeks. Irma struck South Florida on Sunday, September 10, disrupting businessesthroughout the South Atlantic region right before the payroll survey data was collected. If there were no storm effectsto talk about in the September payroll data, we would be discussing the huge and inexplicable 906,000 worker increasein the household survey of employment. Strange spikes occasionally happen in the household survey for no economicreason. The result of the huge increase in the household employment survey for September was a drop in the unemploymentrate to 4.2 percent, despite the weak payroll numbers for the month.

In contrast to the quirky labor data for September, both the ISM Manufacturing Survey and the ISM Non-Manufacturing survey had very good results for the month, increasing to 60.8 and 59.8, respectively. These two surveyscapture economic conditions for the bulk of the U.S. economy. Near-60 readings for both surveys at the same time is arare occurrence that bodes well for the U.S. economy in the second half of 2017.

As Janet Yellen completes her term as chairwoman of the Board of Governors of the Federal Reserve, monetarypolicy is evolving as expected. At the conclusion of the September 19/20 Federal Open Market Committee meeting, the Fed announced that they were keeping the fed funds rate range steady at 1.00 to 1.25 percent. They also announcedthat they would begin to gradually reduce the amount of maturing assets that they would reinvest. By not reinvestingmaturing assets, the Federal Reserve will allow its $4.5 trillion dollar balance sheet to shrink at a controlled and predictablepace. Not reinvesting by the Fed also marginally shifts the demand curve for Treasury bonds, slightly lowering bondprices and increasing bond yields. The Fed will keep the fed funds rate stable through the upcoming October 31/November 1 FOMC meeting. We look for one more fed funds rate hike this year on December 13.

Fiscal policy is also in play. On September 27, the Trump Administration released broad details of its tax reformpackage. Key proposals include a reduction of the corporate tax rate from 35 to 20 percent and the simplification of thepersonal tax code. There are many economic positives that may come with tax reform, including encouraging the repatriation of significant overseas corporate assets, encouraging business investment and encouraging spending by households. However, the political climate is challenging and the constrained fiscal realities mean that there is limited maneuveringroom in budget negotiations. The final details will emerge as a reconciliation budget agreement later this fall.

For a PDF version of this report click here: US_Economic_Outlook_1017.

 

The articles and opinions in this publication are for general information only, are subject to change, and are not intended to provide specific investment, legal, tax or other advice or recommendations. The information contained herein reflects the thoughts and opinions of the noted authors only, and such information does not necessarily reflect the thoughts and opinions of Comerica or its management team. We are not offering or soliciting any transaction based on this information. We suggest that you consult your attorney, accountant or tax or financial advisor with regard to your situation. Although information has been obtained from sources we believe to be reliable, neither the authors nor Comerica guarantee its accuracy, and such information may be incomplete or condensed. Neither the authors nor Comerica shall be liable for any typographical errors or incorrect data obtained from reliable sources or factual information.

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June 2017 U.S. Economic Outlook

June 7, 2017 by Daniel Sanabria

An Important Summer is Shaping Up in Washington

They say “Sell in May, and go away.” However, if you do that this year you are likely to miss a lot. The upcoming June 13/14 Federal Open Market Committee meeting is shaping up to be eventful. Also, the Trump Administration is sharpening its pencils and getting to work on tax reform. National Economic Council Director Gary Cohn expects to deliver a detailed plan to Congress by the end of summer. We also look forward to seeing more details of the President’s infrastructure plan in the coming months.

Despite the clunker of a jobs report for May, we expect the Federal Reserve to raise the fed funds rate range by 25 basis points for the second time this year on June 14. Most recent U.S. and global economic data have been positive, and the weaker-than-expected 138,000 jobs increase in May looks like a fluky number. As of June 6, the fed funds futures market views a June 14 rate hike as nearly a sure thing, with an implied probability of 96 percent. In addition to a rate hike on June 14, we expect to learn more about the FOMC’s thinking about future rate hikes, both for the remainder of 2017, and also for 2018. This could come in the form of forward guidance in the monetary policy announcement on June 14, added details from Janet Yellen’s post-FOMC meeting press conference, and from the updated “dot plot.”

In the near term, we expect the Fed to raise the fed funds rate one more time this year after June 14, for a total of three, 25 basis point rate hikes in 2017. The two leading candidates for the dates of the third rate hike this year are September 20 and December 13, which coincide with scheduled press conferences by the FOMC chairwoman Janet Yellen. There is an FOMC meeting over October 31/November 1, but that meeting does not coincide with a press conference. Given the need for the Fed to communicate clearly about interest rate policy and balance sheet reduction, the odds of a significant move coming from the Fed on November 1 appear to be low.

The timing of the third rate hike in 2017 will be coordinated with the Fed’s plans for balance sheet reduction. The Fed will likely take a pause from interest rate hikes to begin balance sheet reduction, which is expected to be equivalent to a marginal tightening of monetary policy. We look for the Fed to provide some more information about balance sheet reduction on June 14. So far, they have said that they would like to start reducing the pace of reinvestment of maturing assets this year (this will begin to reduce the size of the Fed’s balance sheet). They would also like to gradually ramp up caps on reinvestments until they reach their targets, and hold the caps constant until they reach the desired size of their balance sheet. We still need to know the start date of the reinvestment caps, the scale of the caps, the mechanisms of asset roll-off and the desired final size of the Fed’s balance sheet. Right now, we are expecting to see about a $1.5 to $2 trillion reduction in assets by the Fed, to occur over about a five-year period. We need further insight into the mechanisms for Treasury bond roll-off and for mortgage-backed-security roll-off in order to understand how new Fed policy will impact financial markets and bank financial flows by the end of this year.

The Trump Administration may begin to fill some of the vacant seats on the Board of Governors this summer. Janet Yellen appears to be heading toward retirement next February. Her replacement may be vetted this fall.

For a PDF version of the complete Comerica U.S. Monthly with additional commentary, tables, and charts, click here: June 2017 U.S. Economic Outlook

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January 2017, Comerica Economic Outlook

January 10, 2017 by Daniel Sanabria

Global Reflation and the Trump Swerve

Commodity prices accelerated in the early 2000’s, encouraging the development of new supply and feeding capital investment globally. Very high commodity prices and the global financial market crisis led to significant demand destruction through the early years of this decade. With demand destruction came a downward reset in commodity prices, making high marginal cost production unprofitable. The stall in business investment fed back into demand destruction, pushing the U.S. economy to the brink of recession by the end of 2015. With commodity markets gradually rebalancing, in the presence of still highly accommodative monetary policy, the world is now reflating. U.S. demand upshifted in the third quarter of 2016, and looks set to continue in a higher gear for at least a few more quarters. China is catching a second wind. After revision, Japan GDP data looks better. European economies look stronger despite the ongoing political stress. The U.S. money supply, M2, is surging, up 7.8 percent in November on a year-ago basis.

Commodity prices are once again on the upswing. Wages are going up. Interest rates are still low as central banks respond to new conditions slowly. The global economy is reflating after a catastrophic loss of cabin pressure eight long years ago. The weak global economic recovery contributed to a rejection of the political status quo on both sides of the Atlantic. Now, as President-elect Trump prepares to take office under a mandate of change, the U.S. economy is already under the influence of the Trump Swerve. Equity markets jumped in November, and have not looked back. Measures of business and consumer confidence have surged. Anecdotal evidence suggests that businesses are set to accelerate capital spending in 2017.

The incoming administration has promised a lot. Healthcare reform, tax reform, fiscal stimulus and regulatory rollback are all expected, and soon. Major corporations have altered significant investment decisions under threat of tweet. Most policies expected of the Trump administration will support near-term growth and tend to increase inflation. With wages climbing, commodity prices up and very low inflation expectations threatening to unhinge, the Federal Reserve has ramped up the dot plot, showing upwardly revised expectations for interest rates. The dots now signal three rate hikes for 2017. If inflation warms up quickly, there may be more than three. So there is potential for a monetary offset to the Trump Swerve, in the form of higher interest rates. Fortunately, with interest rates still ultra low, the threat of interest rate drag on the U.S. economy is distant. Another key downside risk comes from rapidly inflating expectations for the stock market. The Trump Bump may morph into the Trump Slump if the administration fails to deliver this spring on the supercharged rhetoric of the 2016 political season. Trade is also a downside risk for 2017, both from the strong dollar and from the apparent potential for heavy-handed deconstruction of trade agreements.

Timing is everything. We believe that the Trump Swerve will position the U.S economy to catch a favorable tailwind from global reflation. As the threat of a near-term U.S. led recession recedes, businesses will recalibrate and extend the current expansion into the history books. At 90 months, the business cycle catches its second wind. Stronger growth, more inflation, higher interest rates and slower job creation are in store for 2017.

For a PDF version of the complete Comerica U.S. Monthly with additional commentary, tables, and charts, click here: USEconomicOutlook0117.

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December 2016, Comerica Economic Outlook

December 5, 2016 by Daniel Sanabria

After a Weak Start, U.S. Economy Set to Finish 2016 on a Stronger Note

The recent upward revision to Q3 real GDP growth, to 3.2 percent, is a look in the rear-view mirror, but it does suggest that the U.S. economy entered the soon-to-be-complete fourth quarter with more momentum than previously thought. Inventories remain a key factor in the GDP calculation. Inventory accumulation was strong in 2015 and supported a moderate 2.6 percent real GDP growth for the year. In 2016, inventory accumulation was much weaker. In fact in the second quarter of 2016, inventories declined by $15 billion (nominal), the first decline in inventories since 2011Q3. Oil inventories were part of the story, as were manufactured goods. We expect U.S. oil stocks to continue to decline through 2017, but at a slower rate than they did this summer. Also, with firmer oil prices, and firming drilling activity, we expect that manufacturers who supported the oil and gas industry will have better control over their inventories in 2017 than they have for the past two years. In our U.S. forecast, inventories contribute positively to GDP growth from 2016Q3 through 2017Q4. This is a major assumption, and it could prove to be wrong, but if it is correct, it will result in above-potential GDP growth through 2017. There are several significant risks to our inventory outlook. U.S. crude oil inventories may fall through 2017 faster than expected. Lower oil prices could result in weaker-than-expected drilling activity. A strong dollar could stifle U.S. exports, as could the fallout from any challenges to existing trade deals. Finally, the auto sector is in play. We expect U.S. auto sales to gradually ease through 2017. If auto sales are worse than expected, auto-related manufacturers could reduce their inventories significantly.

Beyond GDP, other U.S economic metrics improved late in the year. The ISM-Manufacturing Index increased from a mildly contractionary 49.4 in August, to a moderately positive 53.2 in November. Despite the concern about the strong dollar and adverse consequences of trade negotiations, U.S. manufacturers are finishing the year with some momentum. The ISM Non-Manufacturing Index is also showing more momentum, having increased from its August low of 51.4 to November’s strong 57.2. Taken together, the two indexes are consistent with real GDP growth in the neighborhood of 3 percent or more in the fourth quarter.

Add a post-election stock market rally and rising consumer confidence into the mix and 2016 looks to end on a good note, which should carry over into early 2017. As the incoming Trump Administration launches its 100-day plan, we expect to see policy measures designed to boost economic growth, including some form of fiscal stimulus and corporate tax reform. These should help to sustain economic momentum through 2017. With stronger GDP growth and a widening federal deficit, inflation expectations should firm up through 2017. Oil markets will also factor into inflation expectations. The recent OPEC agreement to cut production is more marginal than radical, but it should support slightly higher prices. Stronger inflation, in turn, is an upside risk factor for our interest rate outlook. We continue to expect the Federal Reserve to increase the feds funds rate range by 25 basis points on December 14. We have maintained our call for two more interest rate hikes in 2017. However, we recognize that there is increasing upside risk to our interest rate forecast for 2017 and 2018, which needs to be balanced against the probability of recession in a late-cycle economy.

For a PDF version of the complete Comerica U.S. Monthly with additional commentary, tables, and charts, click here: useconomicoutlook1216.

 

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Florida Economy Gains Momentum Heading into 2017

November 15, 2016 by Daniel Sanabria

The Florida economy continues to run hot in the second half of 2016, supported by an acceleration in employment growth in the third quarter. Employment growth for most major Florida metro areas continues to outpace the national average and gains are being seen across most major sectors. In particular, Florida manufacturing has been surprisingly strong. While the U.S. has seen stagnant to declining manufacturing employment growth over the past year, Florida manufacturing employment increased, up 4.4 percent in the 12 months ending in September. Earlier this year the state legislature passed House Bill 7099 in support of state manufacturers, which made existing sales and use tax exemptions of eligible industrial machinery and equipment permanent. The state tourism sector is weathering the drag from the strengthening U.S. dollar, which makes Florida vacations more expensive for international visitors. Year-over-year employment growth in leisure and hospitality remains above 4 percent. While the U.S dollar has appreciated by 24.4 percent against the U.K. pound in the 12-months ending in October, accelerated by the U.K.’s vote to leave the E.U., the U.S. broad trade weighted dollar has begun to stabilize, up just 3.2 percent. The housing sector began to cool off a bit with slower construction employment growth and a tick down in multifamily construction in the third quarter. However, we expect a rebound in residential housing due to strong home demand, supported by a robust labor market and population growth. The Florida economy will be firing on “most cylinders” heading into 2017.

For a PDF version of the complete Florida Economic Outlook, click here: FL Outlook 112016.

 

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Arizona Addresses Poverty and Education

November 15, 2016 by Daniel Sanabria

Arizona’s economic rebound in the second half of the year has been more muted than originally thought. Arizona job growth continues to move in the right direction, but recent data has us dialing back our expectations for next year. Construction employment continued its win streak with above-trend growth, up 9.2 percent in the 12 months ending in September. This is following strong new home construction throughout Arizona. The much larger services sector is growing at a more moderate pace. Arizona economic growth will outpace the U.S. average over the next few years. However, we expect Arizona, much like the rest of the nation, to experience slower growth in the quarters ahead than historical averages.

Hurdles for the Arizona economy in the long run are household income and education attainment, which impact the propensity to spend and the access to qualified workers. According to the Census Bureau, Arizona had the eighth highest poverty rate in the nation in 2015, with 17.4 percent of people in the state living below the poverty level. The state legislature is attempting to address these issues. In November, voters passed Proposition 206 which incrementally increases the state’s minimum wage from the current rate of $8.05 per hour to $12.00 per hour by 2020, increasing with the U.S. Consumer Price Index thereafter. The law also guarantees paid sick leave to workers of non-exempted businesses and is expected to impact around 700,000 workers. Earlier this year, Arizona also passed Proposition 123, increasing education funding by $3.5 billion over the next 10 years.

For a PDF version of the complete Arizona Economic Outlook, click here: AZ Outlook 112016.

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Navigating California Growth into 2017

November 15, 2016 by Daniel Sanabria

After a rocky start to 2016, the California economy has picked up momentum in the second half of the year. Stronger job prospects have drawn people into the state labor force at levels not seen in over a decade. California has pulled in an additional 379,000 potential workers into the state labor force in the 12 months ending in September, the strongest pace since January 2001. The improving California labor market has supported our expectations of moderate state economic growth this year. We expect California real gross domestic product to grow by 2.5 percent in 2016, outpacing our forecasted U.S. average growth of 1.6 percent.

While we expect California’s economy to continue to outpace the U.S. average in 2017, there are a number of uncertainties to our outlook over the next few years. At the local level, we are already seeing moderating year-over-year employment growth, off of 2015 highs, across the California major metropolitan areas. This is to be expected as the economic cycle matures. A tighter labor market can both limit the pool of job applicants and increase labor costs through upward pressure on wages, slowing down the pace of hiring. At the national and international level, the strong rhetoric on trade policy throughout the 2016 presidential election increases the uncertainty for industries tied to California imports and exports. Mexico, Canada, China and Japan are the top four markets for California exports, respectively. Therefore a shift in trade policy for NAFTA or future trade with China and the resolution to Trans-Pacific-Partnership could have a material impact on California regional economies.

For a PDF version of the complete California Economic Outlook, click here: CA Outlook 112016.

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Firmer Oil Prices Help Texas, But Recovery in Houston Will Be Slow

November 15, 2016 by Daniel Sanabria

The price for West Texas Intermediate crude oil appears to be stabilizing in the range of $45 to $50 per barrel, providing a floor for drilling activity in Texas. The rig count for the state has bounced off the mid-May low of 173 active rigs, up to 268 by mid-November. Oil producers continue to gain efficiencies, pushing the marginal cost of production lower and so we expect to see ongoing moderate gains in the rig count and associated oil field activity through the end of this year and into early 2017. However, even as we write this, the spot price for WTI has slipped below $45, and there remains a worldwide glut of oil that may take a year or more to absorb, keeping downward pressure on prices. Oil storage in the U.S. is falling off its record peak from this past spring, but progress has been slow. Stronger-than-expected storage numbers in late October through early November brought prices down to $43 by mid-November. Fortunately for Texas, the state economy is fueled by more than just oil. Job growth over the last two years has been remarkably resilient, with just two months, March 2015 and March 2016, showing net job losses. This September the state added 38,300 jobs on net, which is above the monthly average for 2012 and 2013. The contrasting patterns in the state economy are seen in the comparison of the Dallas/Fort Worth metropolitan area and the Houston metropolitan area. Job growth in North Texas remains strong, up 3.8 percent in September over the previous 12 months. Job growth in the Houston MSA has slipped to just 0.5 percent year-over-year as of September. We look for a slow turnaround in Houston in 2017.

For a PDF version of the complete Texas Economic Outlook, click here: TX Outlook 112016.

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Michigan Growth to Ease as Short-Term and Long-Term Drags Align

November 15, 2016 by Daniel Sanabria

A key challenge in describing and forecasting the current Michigan economy is how to make comparisons relative to pre-recession performance. The reason for the difficulty is that Michigan did not “just” have to endure the Great Recession of 2007/08. The recession in Michigan started in the summer of 2002 and lingered through 2009. With the pace of job growth currently levelling off, it appears that Michigan has “recovered” from the Great Recession, but total employment remains about 360,000 jobs shy of the April 2000 peak. With the cooldown in job growth visible in 2016, the state has entered a post-recovery phase. The auto industry has restructured and national auto sales are cresting in the vicinity of an 18 million unit annual rate. Going forward it looks like both short-term and long-term forces will keep growth in check for Michigan. In the short-term the state’s key auto industry is looking at stable-to-declining sales over the next few years. Also, both Ford and GM are moving small car production out of Michigan. GM has just announced 840 lay-offs at the Lansing Grand River plant in response to the expected cooler trend in sales. Over the long-term, Michigan’s demographics are a fundamental constraint to growth. By 2005, Michigan’s population growth had slowed to zero. Recent estimates show state population for 2015Q2 to be about 134,000 below the peak from 2004Q3. Since 2000, when job growth began sliding, net migration for Michigan has been persistently negative. We expect the negative trend in net migration to continue as retirees move south and job growth eases with a maturing auto industry cycle.

MIStateOutlook11.16

For a PDF version of the complete Michigan Economic Outlook, click here: MI Outlook 112016.

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