Bank of the West US Outlook Report for May 27, 2016

US Outlook Report: Setting Up for a Better Second Half

Sometimes teams that play a lackluster first-half go into the locker-room at half-time and emerge so energized they play like a completely different team. Now, nearly two-thirds of the way through the second quarter the U.S. economy is about to go into the locker-room for half-time. So what team can we expect to emerge? The U.S. economy is about to enter its eighth year of continuous growth and recent indicators for the second quarter suggest the U.S. expansion isn’t ready to roll over anytime soon.  So what does the second half of the year hold for team USA?


Generally, we expect a modestly stronger advance in the rate of overall U.S. economic growth over the first half of the year at about 2.3 percent. Key drivers will be solid consumer spending growth bolstered by rising incomes and a tightening labor market, and renewed but modest growth in business investment spending. Continued growth in government spending and homebuilding will also add modestly to U.S. growth in the last six months of the year. Nearly all the national housing data released for April beat economists’ expectations.


Also, brace for higher inflation. As oil prices have rebounded sharply, up about 50% over the last three months, the upward pressure on inflation has intensified as the median CPI Index – at 3.4% last month — is at its highest annualized growth rate since the expansion began and is well-above the trend-line.


Our baseline forecast is that the Federal Reserve will raise interest rates for the second time in July and perhaps another rate hike in December, as inflation picks up and labor markets improve further. Undoubtedly, long-term interest rates, such as mortgage rates and auto loan rates, will rise accordingly, but it is expected to be a mild uptick driven by firming aggregate demand and normalizing inflation without major adverse implications on consumer spending, or housing sector growth.


What could go wrong? The list of downside risks includes a strong U.S. dollar that will continue to be a drag on U.S. exports and manufacturing activity. Moreover, the dollar’s strength could be exacerbated by additional Fed rate hikes. Also, rising wages and business costs could further erode corporate profits if businesses are unable to pass along the higher costs to their customers.  If business cost pressures are sustained, businesses could scale-back future business investment plans or start cutting jobs. Let’s hope team USA’s coach has an inspiring half-time speech, the country could really use one right now.


To learn more, check out this week’s Bank of the West report.

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