The 2015 Economic Outlook: U.S. and Global

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THE U.S. ECONOMY

Daniel Cooper, senior economist of the Federal Reserve Bank of Boston, suggested that, while housing is sluggish and wages are stalled, he does see moderate growth in the U.S. economy over the next 6 months to a year.

Cooper pointed out that manufacturing activity is improving. Durable goods orders (excluding aircraft) exceed shipments and industrial production has picked up recently and is forecast to remain strong.

Output growth (GDP) was weak to start the year due to what Cooper called “transitory factors,” but it rebounded in the second quarter of 2014. Cooper forecast moderate GDP growth for the remainder of 2014, along with 2015 and 2016.

“Labor numbers are still down,” said Cooper, “And there are those in the Fed that are concerned about the labor force participation rate. The percentage of those actively looking for work is low, and they worry about people getting discouraged and leaving.”

Wage growth also remains subdued, but inflation is expected to remain modest. One of the biggest issues facing the American economy is that banks are not lending out money.

“The interest rates are very low, so banks have been keeping their reserves on the balance sheet, not lending them out, which means that reserves deposited at the fed are far beyond those required,” said Cooper.

This is thanks in part to the fact that the recent Great Recession was combined with a financial crisis. The failures of major financial firms like Bear Stearns, Lehman Brothers, AIG and Washington Mutual made investors and creditors fearful they would not be repaid so short-term financial markets and interbank lending froze. While monetary policy intervention has spurred lending to some degree, there is still much less money being lent out.

Employment fell substantially and it hasn't come back. The number of people unemployed 27 weeks or more remains elevated. The economy has improved, but the recovery has been slow and signs point to the fact that the U.S. is not going to get back to where it was before. While some economists say there is a reduced ability of the economy to grow, Cooper said he does not think so.

WORLD ECONOMIC OUTLOOK

Simona Mokuta of IHS confirmed much of what Cooper said during his presentation on the state of the U.S. economy, then expanded upon it and compared the post-recession progress of countries around the world.

Countries making a good recovery from the 2008 recession include Australia, which is now nearly 120% of pre-2008 levels, Canada, which is at 110%, and the U.S. is at about 108%. Mocuta pointed out that, historically, advanced countries have grown about 5% slower than emerging markets, but emerging economies are now growing only about 3% faster than established countries and the pace of globalization has slowed.

The United States

Mokuta asserted the U.S. is “steady as she goes,” but below potential. While it has mostly corrected for the recession, the country’s economy has idled since. Mokuta believes that it is not reaching its potential because of the structural shifts that have happened since the recession.

Forces Fighting Against U.S. Growth

Mocuta believes the federal government has focused too intently on deficit reduction, which actually led to a loss in GDP. “But, that is changing,” she said. “Current deficit levels are acceptable now and reduction is behind us. It is still not expansion, but the headwind is backing off.”

Housing: Mocuta said there is a loss in confidence as housing as an investment. While she believes that will change, it will not be for several more years. While loan restrictions are relaxing somewhat, the flat housing is also related to demographics.The younger generation does not see home ownership as the investment previous generations did. Additionally, fewer households are forming, so there is less demand for housing. “Home sales are increasing, but will never reach pre-recession rates,” said Mocuta.

Labor Markets: There is little employment growth in the construction and manufacturing sectors, although slow recoveries are in progress. Service has almost made up some of the loss of jobs, but manufacturing has not recovered even to half of its pre-recession rates. Mocuta sees structural unemployment remaining as a problem. Also, about 3% of the working age population has dropped out of the labor force since the end of the recession. “The labor force participation rate has shown 3 percentage point loss. Something is going on in the economy,” she said. “There is much more of a skill mismatch from what businesses need on one hand compared to what labor seekers have in the other hand.”

Capital Spending: While U.S. businesses are investing abroad, they are still holding onto their liquid assets and Mocuta does not see that changing any time soon. Since the end of the recession, corporate profits have grown much faster than investment. "This is a problem," Mocuta noted. "Real GDP has long surpassed the level prior to the recession, but employment has languished and corporate profits are crazy. The persistence of many of these trends will foster a heightened dependency on consumer spending and international trade as drivers of future growth.”

South and Central America

Europe

The adjustment in wages and austerity programs were painful in Greece, Ireland and Italy, but fiscal deficits in those countries have narrowed and current accounts are now all in surplus. These improvements have allowed a slight policy shift from austerity to growth.

Mocuta shared the forecasts for GDP growth made by IHS, but, she said, “There are factors that can change the trends upward. Among those possibilities is that there is stronger than expected global growth, and that there will be further increased policy focus on growth. The structural reforms put in place by the European Community could have an earlier-than expected impact.”

However, there are also factors that could lower GDP from the forecast. Mokuta suggested that a protracted Ukrainian crisis would weigh down on growth as would an unexpected slowdown in global growth, which could happen with other conflicts around the world. Also, if the euro strengthens significantly, that could have a negative impact on the Eurozone’s growth in GDP.

Asia

While China has experienced a meaningful slowdown, Mocuta sees no “hard landing.” However, there is what she calls a “Three Pronged Challenge” to growth in China.

1. Secular growth downtrend: China is now a mid-income country. This means that its purchasing power is reaching parity with the U.S. dollar, so wages are no longer as competitive as they were.
2. Major cyclical downturn: Support from the stimulus surge has waned, so the economy is naturally going back down. China’s social finance data reveals a surge in lending; its debt buildup highlights the urgency of reforms.
3. Development strategy bottleneck: China is very dependent on exports, and they are falling. They also have an over capacity in certain industries. Restraining policy actions ignited a year-long softening of house prices, so housing sales and construction starts contracted early in 2014.

All of this means that the current slowdown in China is milder, but will be much more protracted than the great recession and rebound will be much weaker. "What happens there will change everything in the world. We must watch that economy carefully," said Mocuta.

Risks to the Global Economy

1. A higher cost of money. There will no longer be near zero interest rates.
2. A hard landing by China would lead to loan defaults by developers and local governments, triggering a banking crisis and a credit squeeze.
3. If Eurozone banking problems intensify, it could lead to a credit crunch that would stall growth and high unemployment, which could lead to social unrest. Another threat to stability is if the Russia-Ukraine conflict cuts gas supplies to Europe.
4. Conflicts in the Middle East and Africa could lead to an oil supply disruption, which would make oil prices soar initially, until markets could adapt.

Projections

• After a 2015 decrease, crude oil prices are expected to rise to $150 /barrel in 2024.
• The Bank of England will lead the upturn in policy interest rates and IHS expects a sharp upturn mid-2015.
• The U.S. dollar’s real exchange value will stay competitive.
• The U.S. Federal Reserve will end quantitative easing this October, but will not raise rates until later.

In summary, the global economy will accelerate modestly in 2015-16. Expect the U.S. expansion to gain momentum, sparked by a pickup in capital spending, a housing market recovery and an energy boom. Europe will continue its slow recovery, as credit conditions improve. But emerging markets will not regain the peak growth rates of the 2000s. It is the Asia-Pacific region that will make the strongest contribution to global economic growth in the decade ahead.

Kate Kunkel is senior editor of VALVE Magazine. Reach her at kkunkel@vma.org.