This is the first of a series of Macro & Market themes in which a team of lead economist discuss cyclical and structural dynamics that will drive markets next year
1 US is Narrowing Growth Pillar
We see the 2016 U.S. growth as dependent on one pillar of support—the labor market. That is not to say Federal Reserve policy rates will remain stuck at zero. The Fed should start raising rates soon, although the normalization path will be neither aggressive nor linear, but instead one of starts and stops.
Fed forward guidance, indicating a modest pace of normalization, will be the key to broadening the expansion from household spending to business investment via both higher confidence in the recovery and low borrowing rates.
2015: The Year of the Consumer
U.S. consumers came on strong at the end of 2014 and have remained on a bit of a spending spree since then, recovering fully from the early-year soft patch that prompted much unfounded hand-wringing. PCE growth has averaged 3.2% annualized since mid-2014, the strongest pace in a decade.
Accelerating job growth and a historic collapse in oil prices propelled real income growth to 4.5% y/y by the end of last year. Real income growth has since moderated to 3.7% y/y, which is still well above the long-term pace of 2.6% and is therefore sufficient to support above-average consumer spending, for now.
Other typical supports to consumer spending—wealth and credit—have been largely absent. Equities are on track for low single-digit gains this year, the weakest showing since 2012, and home price appreciation has averaged less than 5%, around half the pace seen in the early days of the housing recovery. Consumer credit growth has stayed relatively steady at 7% but, even here, credit availability is largely restricted to auto and student loans (i.e., secured credit).
Even the support provided by the labor market has been confined to a single aspect—jobs. Given weak demand and lingering slack in the labor market, businesses have felt no need to expand the workweek or plump wage packets.
2015 Will Be a Tough Act to Follow
Forces now conspire to slow real income growth and, with that, households must either trim spending or run down savings. Job growth has slowed to under 190,000 per month in the past three months, a steep decline from over 300,000 at the beginning of the year.
The workweek shows nary a sign of rising, despite the steady drop in the unemployment rate to within a hair’s breadth of the Fed’s estimate of the non-accelerating inflation rate of unemployment (NAIRU). A gradual rise in nominal wages, toward 3% y/y from 2.5% currently, as the labor market continues to tighten, will help to slow the decline in real income growth, but not completely offset it. Nominal wage growth would need to accelerate to over 4% to keep real income growth at the current pace.
Moreover, job growth has come at the expense of productivity performance—and profit margins. This year has been another disappointing one for productivity, tracking at just 0.5% compared with 2014—virtually the same pace that has held since 2011. That slim gain in productivity will discourage hiring and wage increases.
Could 2016 Be Year of Capex Breakout?
With profit margins constrained and global growth prospects weak, we do not expect 2016 to be the year businesses finally get down to expanding capacity. Since the global financial crisis, private-sector capex has been constrained by political and regulatory uncertainty, not just the cloudy economic outlook.
Rather than investing in productivity and enhancing capital investment, businesses have generally chosen to redistribute earnings via share buybacks and keep payout ratios steady. Corporate firms prefer to stash their rising profits in cash reserves (perhaps to build a buffer of liquidity) or use them to fund share buybacks or dividend payouts, benefiting high-net-worth households, which tend to have high savings rates. The U.S. is not alone in its reluctance to invest. Globally, we see not just a savings glut, but also an investment slump, weighing on potential growth.
The investment slump has taken a toll on the U.S. capital stock since well before the 2008-09 recession. The average age of non-residential structures is now at a 60-year high, and intellectual property (such as software and R&D) is not far behind, at a 30-year high. If businesses do pick up the pace of investment, the economic dividends would be welcome—but this is unlikely given the economic, financial and political circumstances.