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October 2016, Comerica Economic Outlook

October 11, 2016
By Daniel Sanabria

Firmer U.S. Forecast Ahead of an Interesting End of the Year

By the end of the year we know that we will have a new president-elect, and we think we will have higher interest rates courtesy of the Federal Reserve. We also think that we will see stronger real GDP growth for the second half of the year after lackluster growth through the first half of 2016. A key lever on GDP in 2016H2 will be inventories. The GDP component graph on page 2 shows that inventories have been a drag on GDP growth for the previous four quarters (the recently completed third quarter is still a forecast quarter until the Q3 GDP data is released at the end of this month). We expect the reduction in manufacturing inventories that we saw in the first half of 2016 to ease in H2, reducing or eliminating the drag from overall inventory accumulation. Also, international trade looks like it will be more of a positive in Q3, helping to support stronger GDP growth. After a surge in consumer spending in Q2 we look for less growth from consumer activity in Q3, stepping down a little more in Q4. But it will be growth nonetheless, and with a little help from inventories and trade, real GDP growth improves to about 3 percent for the next few quarters. One thing to keep in mind however, is the approach of the dreaded first quarter. Since 2010, real GDP growth for the first quarter of the year has been weaker than the previous quarter six out of seven times even after accounting for seasonality.

With GDP growth improving, we expect job creation to remain reasonably strong through year-end, eventually bringing the unemployment rate lower to around 4.7 percent by the end of 2017, putting more upward pressure on wages. U.S. nonfarm payrolls increased by a net 156,000 jobs in September, a little below expectations. The unemployment rate ticked up from 4.9 percent to 5.0 percent in September. A surge in the labor force in September of 444,000 workers allowed the unemployment rate to tick back up to 5.0 percent, the highest it has been since last April. The strong expansion of the labor force over the summer is a positive for the U.S. economy and should counter concern about the small increase in the headline unemployment rate. In September, average hourly earnings gained a moderate 0.2 percent, and are up by 2.6 percent over the previous 12 months. We expect to see gradually stronger wage growth through next year. This will get the Fed’s attention and keep them on the path of gradually firmer interest rates.

We still expect to see one fed funds rate hike this year, most likely coming at the December 13/14 FOMC meeting. Loretta Mester, President of the Federal Reserve Bank of Cleveland, has voiced her support for a rate hike at the upcoming November 1/2 FOMC meeting. However, a rate hike coming a week before the general election could put the Fed in the middle of a political minefield. We expect the Fed to step gingerly in November and keep the fed funds rate range unchanged until December. The fed funds futures market shows implied odds of only 8 percent for a November rate hike. That increases to 65 percent for December. We have two fed funds rate hikes in the forecast for 2017, one in June and one in December. More pressure on wages and stronger-than-expected overall inflation could accelerate that schedule. However, given the very cautious nature of the Yellen Fed, and their ongoing mantra of data-dependency, weaker-than-expected economic data next year, from either inside or outside of the U.S., could result in an even shallower trajectory for fed funds lift-off.

For a PDF version of the complete Comerica U.S. Monthly with additional commentary, tables, and charts, click here: USEconomicOutlook1016.