United States

Steady growth, higher interest rates headline the economic forecast

But companies should monitor a wealth of global risks

INSIGHT ARTICLE

The U.S. employment picture continues to improve. Unemployment has dropped from 5.4 percent in the second quarter of 2015 to 5 percent in November, and the U.S. economy should continue to add jobs at a rate of 175,000 to 200,000 a month. In addition, consumers are starting to spend the windfall they've realized from ongoing low energy costs. While energy costs are probably at or near their floor, they are unlikely to rebound significantly any time soon. Combined, these factors are driving improved consumer confidence, reflected in an increase in household consumption of 3.6 percent through the second quarter. That rate may dip slightly in the third quarter, but will likely rebound during the holiday shopping season. Household consumption is a key driver of U.S. economic growth, which will likely be about 2.2 percent for the year as a whole.

The improved employment picture is beginning to present challenges for employers, however. At the height of the financial crisis, there were nearly seven unemployed people for every job opening. Now there are less than two. In addition, the creation of high-wage jobs has, for the first time during the recovery, begun to outstrip that of low-wage jobs. Employers are seeing increased competition for skilled hires and are beginning to experience wage pressure. Employers should expect wage increases to top 3 percent by the end of 2016.

Interest rate hikes—when and how much?

Continued steady growth and improved employment numbers mean that the U.S. Federal Reserve will raise interest rates soon, perhaps as early as December, but almost certainly by March 2016. The Fed has a target inflation rate of 2 percent for the U.S. economy, which has not yet been met. That, combined with global macroeconomic weakness, have stayed the Fed's hand thus far. But the Fed is anxious to begin rate increases so that it will have some latitude to react when the business cycle ends. However, it has sent conflicting messages in recent months. Market uncertainty due to confusion on when the Fed will act may actually be hurting growth. The Fed should consider returning to a rules-based monetary policy instead of its current judgement-based approach that tends to shift with each economic report or market spasm.

Absent some deflationary shock, however, rate increases are coming. The real question is not so much when, but how much. We expect rates to reach 75 basis points by the end of 2016, and 200 basis points in 2018.

These increases will mean a continuing influx of foreign capital to the United States., which will strengthen the dollar. This will make U.S. exports more expensive and will also diminish foreign earnings denominated in U.S. dollars. It will, however, make offshore sourcing options more affordable and could create international acquisition opportunities for globally minded U.S. companies.

5 things that keep me up at night

A stronger employment market and increased consumer spending bode well for continued slow but steady growth. However, here are five major risks that could derail the economy.

  1. Europe. As part of its latest bailout, Greece agreed to an austerity program that sentences current and future generations to an unrelenting decline in their standard of living. Greece's best option may be splitting from the European Union. Greece isn't the only country that may either choose or be forced to leave the Eurozone. Spain and Italy are also at risk. Should one or more of these economies defect, loss of confidence in the European Central Bank and currency could inhibit the ability of the remaining governments to float their debt, spurring a massive crisis. The massive influx of refugees from the Middle East and Africa and Volkswagen's diesel emissions scandal also cloud the outlook.
  2. Syria. The ongoing civil war in Syria is pulling countries like the Unites States and Russia into conflict. Should the unrest in Syria spill over into Saudi Arabia, it could choke off energy supplies to most of the world. Factory production and transportation would grind to a halt, and there would be nothing that the central banks could do.
  3. China. The world's second-largest economy is trying to deflate massive bubbles in real estate, debt financing and equities while avoiding a hard landing in manufacturing and construction. China's central planners need to coordinate fiscal and monetary policy to prevent additional disruptions from capital flight and crashing stock prices. We anticipate a massive fiscal stimulus program in 2016. Should the economic picture in China worsen significantly, though, the drag on global growth would be tremendous.
  4. Productivity. Businesses are not investing enough to boost productivity and spur future economic growth. Tax reform and changes to entitlement programs are needed to channel funds into more productive areas of the economy.
  5. Washington gridlock. Political polarization has stymied the government into inaction. Meanwhile, deteriorating roads, bridges, railways and airports are constraining trade. The United States needs a trillion-dollar infrastructure program to facilitate continued growth.

Overall, the U.S. economy continues to improve. While the global picture holds numerous uncertainties, we still anticipate global growth of about 3 percent for 2015, with a slight uptick next year. Begin now to plan for inflation, currency risk and to manage a tighter labor market.

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