United States

Consumers ready to drive economic growth in second half


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After a disappointing start, the U.S. economy likely experienced a modest rebound in the second quarter, which points to much better performance in the second half of this year. Growth in the second quarter will probably come in above trend at 2.7 percent (trend growth is 2.15 percent) compared with the contraction of 0.2 percent seen in the first quarter. Revised spending and residential investment data both point to better than 3 percent growth in the second half as the economy moves past weaker foreign demand and the transitory impediments that dragged down growth during the first three months.

The risks to that outlook lie squarely in the external sector. The European Central Bank may deem it necessary to flood the euro zone with liquidity to address the aftermath of what appears to be a Greek sovereign default and possible exit from the common currency bloc. As a result, another sharp depreciation of the euro may occur, which would potentially trigger an adverse shock to net U.S. exports and the balance sheets of firms with large international exposure.

Export growth is likely to slow to near 4 percent in the second half while imports should pick up noticeably and experience near 6 percent growth linked to strong domestic demand and increased purchasing power thanks to a stronger dollar. While most large and internationally active firms should already have effective hedges in place against exchange rate volatility, there may be a negative impact on corporate balance sheets under these conditions when coupled with rising wages.

The major policy shift in the United States in the second half of the year will be the long-awaited first step in policy rate normalization by the Federal Reserve. The noticeable improvement in economic data during the past several weeks should result in a 25 basis point rate increase by the Fed in September and another possible 25 basis point increase in December. In the Fed’s September economic projections, 15 of 17 central bankers thought it appropriate to raise rates once this year and another 10 thought two rate increases would be necessary. Again, this is contingent on the crisis in the euro zone remaining relatively well contained. If not, the Fed would likely postpone the start of policy normalization until early next year.

MIDDLE MARKET INSIGHT: RSM’s proprietary Middle Market Leadership Council survey data show that a full one-third of respondents intend to increase the current inventory level, another sign of growing optimism among the fastest growing portion of the economy.

Financial conditions in the United States are improving. The Bloomberg financial conditions index is five standard deviations above normal and our own estimate of the total credit creation by private financial institutions increased by 6.87 percent through the end of the first quarter.

This has clearly improved based on total demand for credit and growing loans and leases to support inventory building among firms. Meanwhile, RSM’s proprietary Middle Market Leadership Council survey data show that a full one-third of respondents intend to increase the current inventory level, another sign of growing optimism among the fastest growing portion of the economy.

U.S. households will be the primary engine of growth in the second half of the year. With wage growth likely to exceed 3 percent, and inflation-adjusted personal disposable income rising at a 3.5 percent rate, there is ample room for growth in spending.

The revised May retail spending data shows Americans are tapping growing nominal income and savings thanks to cheaper year-over-year gasoline prices. On a three-month annualized basis retail sales are up 6.1 percent, and excluding gasoline prices are up 6.7 percent. In our estimation, this provides upside risk to our call for 3 percent growth in the second half.

MIDDLE MARKET INSIGHT: More than half of respondents to RSM’s Middle Market Leadership Council survey indicate they plan to increase capital expenditures.

Meanwhile, the pace of private sector investment should more than double the 2.4 percent pace posted during the first three months of the year. That gain will be driven by a robust increase in residential investment. Forward-looking building permits point toward an increase to 1.275 million housing starts at an annualized pace, up from the current pace of 1.09 million starts. In addition, our propriety Middle Market Leadership Council survey indicates that slightly more than half of respondents plan to increase capital expenditures. Given a tightening labor market, we expect that firms of all sizes will increase outlays on fixed business investment, which places some upside risk on the consensus forecast for a 5.4 percent average increase in capital expenditures in the second half.

Given the political division in Washington locked in until at least 2017, the pace of government expenditures should remain somewhat modest and increase nearly 2 percent during the final six months of the year. Special supplemental bills to support greater defense outlays would not be surprising given ongoing operations in the Middle East and Africa.

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