Last year saw numerous surprise headlines, from January’s US stock market stumble to June’s Brexit vote and the rise of anti-globalization politics
in America that reverberated in November with the election of Donald Trump as president.
Despite all this flux, the economy maintained a pace of forward momentum, bringing above-trend job creation, record-low layoffs and steadily improving household balance sheets. As the economy continues to progress toward full strength, here are seven key trends that will likely shape its development in 2017
Donald Trump’s administration, backed by a Republican majority in both houses of Congress, has unveiled a strongly pro-business, pro-growth agenda. While some initiatives, such as cutting regulations and boosting infrastructure spending, may take several years to impact the economy, the promise of tax reform has already spurred a stock market surge.
Tax cuts for businesses and households stand a strong chance of becoming law in early 2017, as procedural rules make them far easier for Congress to pass than traditional legislation. The GOP has largely coalesced around House Speaker Paul Ryan’s “Better Way” plan, a comprehensive package of reforms designed to encourage investment and promote growth.
The stock market responded to the presidential election by climbing 7 per cent in the fourth quarter of 2016, creating almost $2 trillion in new wealth. This winter’s anticipatory equities surge could be followed by a boost in GDP as the implications of tax reform become clear. Nonpartisan tax economists estimate that the planned stimulus could raise GDP by as much as 1 to 1.5 percentage points.
GDP Growth May Quicken
After years of relatively sluggish growth, the US economy is forecast to grow 2.3 per cent over the course of 2017. While this may be slow compared to previous decades, it represents robust growth in an era of demographic decline.
Due to the retirement of the baby boom generation, the growth of the American workforce has slowed by a full percentage point compared to previous business cycles. The outsized wave of retirees currently leaving the job market may explain why GDP growth has been underwhelming, even in a time of rapid hiring and soaring equities valuations.
But there may well be more to the story than demographics — labour productivity has also been stagnant, at least according to the official measures of GDP. To some observers, this may seem peculiar. Businesses are embracing new technologies — such as mobile commerce, cloud computing and automation — that should boost their employees’ productivity. Yet any improvement has failed to find its way into the official statistics.
This year could bring a surge in labour productivity as the business cycle nears its peak and capital investments in technology begin to pay off. Stable wage growth and low inflation are likely signs that the economy still has room to grow, so a period of strong expansion at the top of the business cycle remains a possibility.
Slowing Job Growth
The labour market has been adding jobs at an above-trend pace for several years, and the nation’s supply of idle workers is nearly exhausted, as measured by the unemployment rate. While the job market still has room to expand, wage growth finally began to accelerate in the fourth quarter, a sign that full employment may be on the horizon. As the ranks of available workers begin to dwindle, hiring activity will likely slow back into alignment with the underlying rate of population growth.
This slowdown in job growth likely won’t be immediate. While the official unemployment rate has returned to normal levels, broader measures still show a considerable amount of slack remaining in the labour market. Millions of discouraged workforce dropouts and involuntary part-time workers need to move back into full-time employment before the labour market truly tightens.
The economy appears on a trajectory to reach full employment soon, quite possibly this year. When the labour market does begin to tighten, job creation will likely slow from today’s above-trend pace. Combined with the emergence of inflationary pressure, full employment could set the stage for the Federal Reserve to normalize interest rates.
Federal Reserve Chair Janet Yellen
Interest Rate Normalization
In December 2015, and again in December 2016, the Federal Reserve hiked interest rates by a quarter point, lifting rates from near-zero. These widely anticipated moves caused very little volatility in markets — interest rates are expected to remain at historically low levels for the foreseeable future, even as the economy makes a full recovery.
The Federal Reserve projects a gradual series of rate hikes in the coming years, and market expectations are beginning to rise into alignment with the Federal Open Markets Committee’s (FOMC’s) median forecasts. Both the futures market and the FOMC anticipate two small rate hikes in 2017, with interest rates ending the year above 1 per cent. Forecasts diverge further in the future, but both private investors and central bankers appear to agree that, eventually, rates will likely climb to the long-term target of approximately 3 per cent.
As always, the Federal Reserve will likely be guided by inflation. All signs indicate modest inflationary pressure in the coming year, and most analysts believe that a gradual process of interest rate normalization should be sufficient to contain rising prices.
The global oil glut began to evaporate in 2016, with crude oil prices rising 45 per cent following a steep reduction in exploration and an OPEC agreement to cut production. As global demand climbs to meet current production capacity, rising oil prices will likely eventually make North America’s shale fields profitable once again.
The Climbing Dollar
With the US economy poised to return to full strength, interest rate normalization underway and other key central banks following up with their own versions of asset-purchase programs, the dollar has been gaining against major foreign currencies. Japan and the eurozone are gradually improving, but their central banks are locked into quantitative easing programs that have effectively pushed down exchange rates, at least for now.
By itself, this has hurt American manufacturers by making their goods more expensive in foreign markets, though consumers have benefited from cheap imports. However, the international policy actions that are contributing to the strong dollar will likely eventually benefit American businesses as they work to strengthen the Japanese and European economies. Furthermore, concern about a strong dollar may be misplaced if its strengthening is due to meaningful tax reform and economic stimulus indicating optimism for growth in the US economy.
Markets are naturally volatile, and it’s important to keep a long-term perspective during periodic corrections. This time last year, the stock market fell sharply in response to slowing growth in China. At the time, the market’s tumble caused widespread alarm, but in retrospect, the downturn hardly seems notable. The market quickly regained its losses, China stabilised at a more sustainable growth rate and the broader US economy kept creating new jobs and greater wealth.
With 2017 underway, the US economy remains on sound footing: household wealth is at an all-time high, the stock market is climbing, monetary policy is strongly accommodative and there is plenty of room for further growth.
Despite these strengths, it’s possible 2017 could bring an unexpected correction at some point. If that happens, remember that the broader trends are overwhelmingly positive — we’re starting the year in a strong position, and reasons for optimism abound.
Jim Glassman is head economist for commercial banking at JPMorgan Chase.