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Beneficial Bank August 2014 National Economic Outlook

While the economy is strong enough to absorb a rate hike, it is still not clear when the Fed will start raising rates.


In a Nutshell: "While the economy is strong enough to absorb a rate hike, it is still not clear when the Fed will start raising rates."

Summary:
The national economy grew moderately in the spring and early summer while the labor markets continued to tighten. But wage gains are still lagging, inflation is below desired levels and the Chinese economy is faltering. In the face of these contradictory patterns, the Federal Reserve must decide when to start raising rates.

GDP Growth

  • The spring brought the consumer out of hibernation.
  • Consumers hit the auto showrooms hard and vehicle sales are now back at levels not seen since the housing-bubble driven days a decade ago. Since demand hit bottom in February 2009, sales have nearly doubled.
  • Retail activity picked up with households buying both big-ticket items, including furniture, as well as soft-goods such as clothing and sporting goods. People are once again eating out in droves.
  • Despite the newfound willingness to spend money, consumer confidence is not soaring. Indeed, it is unclear how people really feel about economic conditions as the major measures of confidence have been bouncing around. Still, the labor market is solid and gasoline prices are falling again, so household perceptions are likely to improve.
  • The housing market is also coming back. In June, existing home sales were nearly 10% above the June 2014 level, new home demand was up 18%, housing start soared by 26% and permit requests jumped 30%. Prices are rising faster as supply is scarce but demand is strong. This sector of the economy should lead the way going forward.
  • The rise in energy prices looks to have been temporary and if Iran starts exporting oil again, additional declines are possible. That could cause the oil patch to retrench further. However, firms are adjusting to current price levels, so any the cut backs should be modest.
  • The dollar continues to strengthen and the recent action of the Chinese government to devaluate its currency could put further upward pressure on the U.S. currency. With U.S. goods becoming more expensive overseas and foreign product prices falling here, the trade deficit is should widen, slowing growth.
  • Internationally, China's economy is decelerating more than expected. Europe, though, with the largest economies growing in the spring. That nascent recovery has to be sustained. Lower energy prices should help but the currency war set off by the Chinese devaluation could negatively impact Europe as well.
  • Summary – The labor market is in very good shape. By the end of the year, the unemployment rate should be at, if not below, full employment. That should set off a bidding war for workers, but that remains a hope rather than a reality.

The Employment Picture:

  • When you get to the point that solid job gains are viewed as being disappointing, you know that the labor market is in good shape â€" and it is.
  • For the three months ending July, payroll gains averaged a very solid 235,000 a month. This was an improvement over the first part of the year.
    The employment increases were across the board. Indeed, in July, over 64% of the industries posted increases in employment. The energy sector continues to be the weakest link and the losses are likely to continue for a while.
  • Job openings remain at record levels but the solid hiring is slowing the rise. The large number of open positions appears to be due to a lack of available workers at the going wage rate. As a consequence, firms are hanging on to workers and unemployment claims are at record lows, when adjusted for the size of the workforce.
  • The July unemployment rate of 5.3% in July, a rate it hit in June, was the lowest level since April 2008. The labor force participation rate drop slowed significantly and the July rate was only modestly below the level posted one year earlier. The number of people unemployed was down over 14% over the year. All of these clearly indicate that the labor market is firming.
  • On the compensation front, the data are disappointing. The acceleration we had been seeing slowed in the spring, despite the unemployment rate nearing full employment. Normally, we would see better wage increases by now.
  • Summary – The U.S. economy is starting to hit on most cylinders and should improve going forward. But the challenges that world financial events are creating raises some questions whether growth can accelerate sharply during the second half of the year.

Federal Reserve and Interest Rates:

  • The Fed is positioning itself to begin the rate normalization process, but the lift-off date is still a subject of debate.
  • The Fed has a dual mandate to have solid economic growth with reasonable inflation. The first element of that mandate is clearly in place: The economy is growing solidly enough to absorb a rate hike right now.
  • The second element of the mandate, inflation, is not in sight. Inflation is running well below the Fed's target of 2% and a rising dollar, which lowers import costs, could restrain prices further. However, the Fed members still expect inflation to move back to its desired rate over the next 12 to 24 months, and that patience may be the key in determining if rates are increased sooner rather than later.
  • Strong economic data before the September 16-17 meeting could be enough to allow the FOMC to start the rate hike process then.
  • Summary – The expectation is that the Fed will start raising rates in September, but weak data could push the first hike out to December.

National Outlook:

The economy is growing solidly but we are still missing strong wage gains. The large number of job openings indicates that that firms need to raise compensation if they are to expand their pool of potential workers. However, they remain reluctant to do that. How long firms can operate with so many unfilled positions is unclear, but eventually they will have to break down and start changing their pay structure. Until that happens, consumer spending will remain restrained. However, it is expected that worker compensation will accelerate during the second half of the year and that will propel growth forward at a faster pace.


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