We expect to see another sub-par GDP report for the recently completed first quarter of 2016 when the first estimate of Q1 GDP growth is released on April 28. Consumer spending has been stable, but uninspired. Business investment has been hurt by the reset in the energy sector. Inventories ran up through last year and are now a drag on growth. Exports have been hurt by subdued global demand and the strong dollar.
The shaky global environment was a key element of FOMC Chairwoman Janet Yellen’s speech at the New York Economic Club last week. Yellen’s somewhat dovish speech reset financial market expectations for fed fuds interest rate hikes this year. According to the fed funds futures market, the implied probability of an April 27 fed funds rate hike is now only 4.6 percent. That might be a bit high given Yellen’s speech. She clearly set the bar high for future rate hikes that appear to be as contingent on global conditions as they are on U.S. conditions. For now, we will maintain our interest rate forecast that shows one 25 basis point increase in fed funds in June and one in December. However, we will need to see a change in tone from Chair Yellen at the upcoming April 26-27 FOMC meeting, or soon afterwards, in order to maintain that view.
We think that U.S. economic data will improve enough to motivate another fed funds rate hike by September, even if the odds of a June rate hike are fading. There is ample upside potential for residential investment. Business investment will firm up as higher oil prices stabilize the energy sector. Higher oil prices will also begin to heat up inflation indicators. Manufacturing conditions are improving. Ongoing strong job creation will be a key support to U.S. households. Wages are going up.
However, global conditions, to which the Yellen Fed are keenly attuned, may be a different matter. Much depends on China and its ability to sustain strong growth through an awkward economic transition. China has made itself the focal point of global concern by being responsible for half the world’s GDP growth, while at the same time being both unpredictable and awkward in its policy responses to an economy that must make a difficult transition in order to avoid a serious stumble. China faces the difficult challenge of reducing productive capacity in many industries, and re-directing labor while trying to maintain political stability.
Higher oil prices will help stabilize the economies of other countries, including Canada, Mexico, Brazil and Venezuela here in the Americas. Firmer commodity prices generally would help other South American countries, Africa and Australia. Europe is facing a different set of issues. The jury is still out on the long-term consequences of negative interest rate policy by the European Central Bank and other central banks. The refugee crisis and the increased potential for terrorism will keep the population on edge and politics contentious. In Great Britain, the Leave campaign (for leaving the European Union) is gaining momentum. According to a recent poll, 43 percent of British voters want to “Leave,” while 39 percent want to “Remain.” The United Kingdom European Union membership referendum is scheduled for June 23. After that, the EU may never be the same, nor stand for the same things.
For a PDF version of the complete Comerica U.S. Monthly with additional commentary, tables, and charts, click here: USEconomicUpdate -04_2016.