Slow but Steady on the Backs of Consumers

Estimated at 0.9%, real GDP growth in the first quarter is not expected to improve from the slow 1.4% real GDP growth rate in the fourth quarter. High inventories, a generally weak world economy and extreme drops in energy and non-energy commodity prices have slowed overall economic growth in the last half year. However, the American economic expansion has been sustained through this challenging period by modest but gradually rising consumer spending. Despite areas of weakness in manufacturing and mining employment, total nonfarm payroll growth continued at a solid 209,000 average pace in the second quarter, the labor force participation rate showed steady gains, and average wage growth reflected nascent signs of acceleration. Spring also brought some signs of thaw in a manufacturing sector suppressed in 2015 by weaknesses in exports and energy related investment. However, exports still dropped to their lowest levels in January since June 2011, and will detract from economic growth in 2016 as long as the world economy continues to grow at a subpar pace. Capital spending is expected to remain subdued as business investment will not receive the boost it has in recent years from energy related investment. A drop in economy wide corporate profits in the fourth quarter to the lowest level since the third quarter of 2011 will likely also put downward pressure on overall capital investment.

Despite significant impacts on the energy producing sector of the economy, energy price declines have had positive effects on energy users as many consumers have been benefiting from low prices at the gas pumps. As discussed on the upcoming section on inflation, net gains in real per capita disposable incomes in the last 2 years have been primarily the result of declining energy prices. Low gasoline prices have also been generally supportive of auto sales and production. Vehicle sales should continue at a strong pace above 17 million in 2016, matching last-year’s brisk pace for the year overall.

"High Inventories create headwinds to economic growth in goods producing sectors."

The likely continuation of low mortgage rates should also keep the housing recovery on track, with a corresponding increase in housing-related durable goods consumption. Government spending will likely continue to grow as government revenues rise with economic expansion. On the other hand, inventory levels have been generally rising, and probably reflect disappointing sales overall. The Wholesale, Retail and Manufacturing components of Business inventories have continued to climb, and are at their highest since the recession. (Please see the chart below.) Hence, real GDP growth in the first half of the year will likely be restrained until these inventory-to-sales ratios begin to recede. The expected pick-up of GDP growth in the second quarter to 2% should help clear shelves, at least for goods destined for domestic purchasers.

Inventory to Sales Ratio
Economic Outlook April 2016

Overall, real GDP is expected to grow 1.7% in 2016, slower than the 2.4% average annual pace of the last 2 years, but still sufficient to continue to add jobs to the economy, albeit at a slower pace than during the last 2 years. However, these anticipated job increases may not be sufficient to absorb all the new labor force entrants. General declines in the U.S. unemployment rate during recent years are expected to slow significantly in 2016, and the unemployment rate is forecasted at 5.0% in the fourth quarter, equal to its rate in March. Goods intensive areas of the economy are likely to underperform service areas of the economy until overall goods markets return to greater balance. Hence, interior portions of the country, which tend to have relatively high industry concentrations in manufacturing, energy and agriculture, will likely grow more slowly than coastal states in 2016.

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