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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.