Growth in the U.S. economy was weak through the first half of 2016, when fixed investment was in recession, housing starts were at recessionary levels, and industrial production showed year-over-year declines that were consistent with every recession since 1919. However, despite anemic 2016 growth and recessionary data, the economy showed improvements after the midyear.
As for 2017, the outlook for U.S. economic growth is somewhat mixed. Financial market dynamics and sentiment data after the U.S. presidential election showed increased optimism for the New Year. Nevertheless, it is likely to take many months before any changes in fiscal policy could be enacted—and it will take even longer before any changes are likely to have a GDP-level impact on government spending or consumption. In the meantime, the dollar is likely to be stronger and interest rates are likely to be higher—weighing on growth. Given the prospects for stimulative fiscal policies, we expect solid growth by the end of 2017, with especially strong growth likely by the second half of 2018.
We conducted a post-election benchmarking of our clients a week after the U.S. presidential election in November 2016. Clients generally reported more optimism about the economy after the election, with 80 percent of respondents stating they were “more optimistic” or “significantly more optimistic.” In fact, the percent of respondents expecting a recession start by the end of 2017 fell sharply from 89 percent to only 63 percent (see graph). Post-election responses also indicated that our clients expected some potentially significantly later start dates for the next recession. This represents a huge change from what our clients expected just a month earlier—in October 2016.
In our post-election survey, our clients also reported expectations of personal tax cuts, corporate tax cuts, more government spending and reduced regulations. As a compliment to these economically supportive expectations, our clients also reported increases in the level of planned business activity, increases in the level of planned capex, and increases in the level of planned hiring in 2017 as a direct result of the election outcome. These responses reinforce our expectations of improved growth prospects.
Fiscal policy takes time, rate adjustments don’t
A Trump administration could result in tax cuts, an acceleration of deficit spending, more growth, and an increase in inflation. This is already being priced into markets, as reflected by higher interest rates at the back of the yield curve. The risk of more inflation also increases the prospects of higher Fed Funds Rates at the short end of the curve, which has also sent the dollar higher. Increases in rates across the forward curve present some downside risks to growth for the first half of 2017, as does the strong greenback that has accompanied hawkish Fed expectations.
Despite some risks for the first half of 2017, we see upside risks for U.S. growth in the second half of 2017 and in 2018, as fiscal policy stimulus drives GDP growth higher. Of course, our expectations are predicated on some tax cuts and additional government spending that is unlikely to occur within a balanced budget framework. As such, if Trump is unable to enact at least some of the fiscal stimulus he has planned and announced, disappointment could lead to a more significant slowing of U.S. economic growth—including the risk of a U.S. recession—that could drag on, rather than a slowdown that might rebound quickly.
Growth expectations and the Fed
Fed Chair Janet Yellen’s November 2016 testimony to Congress highlighted balanced risks for the economy, with the labor market reflecting solid dynamics, while inflation remains below the Fed’s 2 percent target. However, a Trump administration could result in significantly more growth and inflation in the medium term, since any stimulus is unlikely to occur within a balanced budget framework—and it is likely to require significant additional levels of deficit spending.
Despite downside risks to U.S. economic growth in the first half of 2017, we see risks of significantly higher Fed Funds Rates by the end of 2018. In essence, loose fiscal policy could overstimulate the U.S. economy and engender inflation—a dynamic that would force the Fed to tighten monetary policy to dampen inflation and slow U.S. growth. This dueling dynamic between monetary and fiscal policy could come to fruition quickly, if major stimulative fiscal policies are implemented.