| Economic Outlook: Reflections on 2014 and a Glimpse into 2015 | |
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By James Hotchkiss Jr., Director, Quantitative Analysis, FHLB Chicago The U.S. economy closed out 2014 on drastically different footing than at the start of the year. Despite a very slow start, job creation has picked up dramatically, manufacturing is booming, and GDP growth has strengthened in every quarter of the year thus far. A growing list of signs point to a tightening labor market: job openings at 13-year highs, initial jobless claims at the lowest level since 2000 (when the unemployment rate hit 3.8%), a cycle high in small business plans to increase compensation, and an unemployment rate of 5.6% - now, just 0.1 percentage points away from the Fed’s long-run normal rate. However, despite declining Fed purchases and improving economic data, rates continued to move lower throughout the year, largely driven by U.S. commercial bank buying on regulatory concerns and foreign investors as European and Asian economic growth faltered. Low inflation has remained a concern throughout the year and has quickly become one of the main topics of economic conversation, especially given the collapse in oil prices during the fourth quarter. The housing recovery clearly also fell short of expectations, never fully rebounding from a mid-winter arctic blast that iced sales.  However, housing starts, home sales, and house prices still climbed higher year-over-year throughout 2014, albeit at a slower pace than in recent years.We are entering 2015 with payrolls averaging above 250K for the last six months, an unemployment rate nearing the natural rate, GDP growth of 5%, and manufacturing levels above pre-crisis averages. The only laggards in the economic equation are housing and inflation. And now, after Fed Chairwoman Yellen’s latest post-FOMC press conference, it seems the big economic story of 2015 will not be whether the Fed will raise rates, but rather when in the year they will do it. For more than five years, the Fed’s steadfast commitment to low interest rates has led many households and businesses to assume cheap money will be available for the foreseeable future. It is possible that the normalization of interest rates will spur businesses to borrow before cheap money is gone. Rising rates, coupled with solid consumer sentiment and a strengthening job market, may also support home mortgage lending as potential homeowners try to lock in low rates. However, U.S. economic growth is not immune to global issues, so it is also possible that weak overseas inflation and demand could spill over to the U.S., slowing the economy. Chairwoman Yellen believes the slowdown in inflation is temporary and, in fact, low oil prices will boost consumer income; and thus; spending. Nevertheless, low inflation and expectations will allow the Fed to be patient about the timing of the first rate hike, despite expectations of continued economic strengthening. While the U.S. seems to be diverging from the global economy, it is much harder for U.S. long-term rates to decouple from global rates; rising risk concerns in the rest of the world and low bond yields could create greater demand for U.S. Treasury bonds, pushing yields lower and flattening the curve. Overall, the U.S. remains a relative bright spot in an otherwise gloomy global picture, particularly in the job market which is gaining traction after years of erratic growth. This looks likely to continue into 2015. And, as the economy continues to be driven by domestic consumers and not exports, it’s likely that overseas financial stress could be less of a headwind to growth in the U.S. than what is now feared. | |
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