The 2016 Economic Outlook: Slow but steady wins the race

By Kyle Brandon

SIFMA’s Economic Advisory Roundtable is composed of chief U.S. economists from 19 SIFMA member firms. Twice per year, the Roundtable publishes the results of a detailed survey on the U.S. economic outlook and rates forecasts.

This December, the Roundtable released its “US Economic Outlook End-Year 2015,” forecasting that the U.S. economy will grow at a solid 2.5% rate both this year and next. The following is a Q&A with Kyle Brandon, Managing Director and Director of Research for SIFMA and staff advisor to the Economic Advisory Roundtable.

SIFMA’s Economic Advisory Roundtable increased its 2015 growth forecast from 2.2% to 2.5%. What factors contributed to the forecast?

The Roundtable saw a healthy year for growth this year and going forward. Some of the components driving that growth include strong consumer spending and consumption, as well as ongoing improvements in the labor market.

Real GDP Growth

The median end-year forecast calls for 2015 GDP to grow by 2.5% on a year-over-year basis and by 2.2% on fourth-quarter-to-fourth-quarter basis, stronger than the 2.2% and 1.9%, respectively, predicted in the mid-year survey. Ethan Harris, Co-Head of Global Economics Research at Bank of America Merrill Lynch and 2015 Chair of the SIFMA Economic Advisory Roundtable, characterized the underlying theme of the Outlook as “slow but steady wins the race.”

The Roundtable emphasized improvements in the labor market. Are we finally achieving full employment?
We are finally achieving full employment — an important milestone this many years removed from the 2008–2009 crisis. The Roundtable expects employment will continue to improve, with survey respondents predicting the unemployment rate will fall from an average of 5.3% in 2015 to 4.7% in 2016. This is an even bigger dip than the mid-year forecast of 5.4% and 4.9%, respectively.

Consumer Spending Growth Rate and Unemployment Rate

What does increasing consumption and decreasing unemployment mean for inflation?
We expect inflation to pick up — but keep in mind that this is a sign of a normalizing economy and its underlying health.

Economic slack/unemployment was the dominant factor cited in the core inflation outlooks, as in prior surveys, followed by the strength of the U.S. dollar and commodity price pass through. The forecast for “headline” inflation, measured by the personal consumption expenditures (PCE) chain price index, weakened slightly from the mid-year forecast, with 0.3% percent growth expected for full-year 2015 and 1.4% for full-year 2016.

Earlier this month, the FOMC raised rates for the first time in nearly 10years. What’s next?
Consistent with SIFMA’s Roundtable’s prediction, the FOMC did raise the target fed funds rate range from 0.0–0.25% to 0.25–0.50%, citing “considerable improvement in the labor market conditions this year.” They further stated they are reasonably confident that inflation will rise, over the medium term, to its 2% objective and that monetary policy will remain accommodative after the increase supporting further improvement in the labor market and a return to 2% inflation.

So, what’s next? Approximately 60% of the Roundtable expects the target federal funds rate will reach 1% by the fourth quarter of 2016. There is no perfect time to raise rates and markets will always get nervous, but the underlying health of the U.S. economy points to gradual rate increases over the course of the coming year.

When Will the Lower End of Fed Funds Target Rate Range Rise to 1%?

“The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.”
http://www.federalreserve.gov/newsevents/press/monetary/20151216a.htm

Will there be pressure on longer term rates as the target federal funds rate inches up?
We do expect to see some upward pressure on bond yields, but the Roundtable was nearly unanimous in expecting a flattening yield curve as longer term yields are impacted by a great number of factors. However, it is important to point out that they are still quite low.

Do any pending policy issues have the potential to impact the Outlook?
As in prior surveys, corporate tax reform was cited as the pending policy issue which could have the greatest potential impact on the U.S. economy. It was followed distantly by immigration reform and completion of the Trans-Pacific Partnership.

Interestingly, respondents were more pessimistic than in the mid-year survey that concern or uncertainty about financial regulatory reform would pose a drag to GDP growth.

The rest of the world looks quite different than the recovery we are seeing in the U.S. Are we witnessing a global divergence?
While the U.S. economy is improving, other economies across the globe are struggling with a continued lack of recovery resulting in low and perhaps even falling core inflation. We are indeed seeing a global divergence, where the Fed is moving slowly away from the monetary policy of other central banks.

So, prospects for the U.S. economy look promising?
During a briefing for the media on the Outlook, our Chair Ethan Harris said it best:

“The bottom line here is slow but steady wins the race. I don’t want to overstate it, but this is a bit of a historical moment. After being in one of the deepest recessions in history and one of the slowest recoveries in history, we’re finally at that stage where we can talk about the Fed and talk about inflation. And that’s a world that is much more normal than the one we’ve been living in for the past seven years.”

Download SIFMA’s US Economic Outlook for End-Year 2015:
http://www.sifma.org/eoutlook20152h/

View more from SIFMA Research:
http://www.sifma.org/research

SIFMA’s 2015 Economic Advisory Roundtable:

Bank of America Merrill Lynch, Barclays, Credit Suisse Group AG, Daiwa Capital Markets America Inc., Deutsche Bank AG, FTN Financial Securities Corp., Goldman Sachs & Co., J.P. Morgan Securities LLC, Jefferies LLC, Mesirow Financial, Inc., Moody’s Analytics, Morgan Stanley & Co. LLC, Nomura Securities International, Inc., The PNC Financial Services Group, Inc., Raymond James & Associates, Inc., Société Générale, Standard & Poor’s Ratings Services, UBS Securities LLC, Wells Fargo Securities, LLC

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