The 2017 Economic Outlook
Change in Economic Growth Leadership in Early 2017
Our outlook for 2017 has not changed significantly since the beginning of the year, but we are seeing the underlying sectoral trends come into clearer focus. After a 2 year slump the goods producing areas of the economy are experiencing renewed vitality. The goods producing areas of manufacturing, mining and construction created 75,000 net new jobs in February – the most since March 2000. Exports grew 7.4% year-over-year in January, signaling the end of the downturn in the international economy. Stagnant world economic growth in the last 2 years had been a primarily source of weakness in world goods and commodity markets. Manufacturing indicators have also shown a pick-up in activity since late 2016. New orders for capital goods have shown nascent signs of recovery. Business inventory-to-sales ratios have continued to recede from peaks experienced during mid-2016.
In conjunction with the goods recovery and in some regards a result of it, inflation has accelerated in early 2017. This trend is expected to continue throughout 2017 as the rising price of goods, except for autos, joins persistent trends in services inflation to bring total annual inflation to a 2.7% annualized growth rate, upwardly revised from 2.4% in the previous publication. Higher inflation will likely translate into higher interest rates for 2017. The 10-year Treasury yield is forecasted to reach 3.0% by year-end. In response to rising inflationary pressures, the Federal Reserve is forecasted to raise the Fed Funds rate target 3 times in 2017 instead of twice as forecasted at the beginning of the year. The net stimulatory impact of potential fiscal policy changes by the new Administration and Congress is still unknown. Hence, forecast uncertainties remain high, but potential is probably tilted to the upside as the year progresses.
In contrast to the recovery in the goods-producing areas of the economy, consumer spending started the year on a soft note. After a strong fourth quarter, consumers reigned in spending in January on goods and especially on services. The outlook for consumer spending this year is mixed. On one hand, a strong job market, improved consumer finances and rising consumer confidence should support continued overall growth in consumer spending in 2017. On the other hand, rising inflation and interest rates will likely temper consumer spending growth to a slower pace than experienced during most of the economic recovery. The early disappointments in consumer spending this year confirm our view that pent-up demand is no longer a major source of continued consumer spending.
Although little has changed in the overall outlook for 2.1% real GDP growth in 2017, only slightly lower than the 2.2% initial forecast, the year started with surprises to both the upside and to the downside. We expect an interesting year in the economy in 2017 overall in which the goods side of the economy experiences above average growth while the consumer-led areas of the economy slow somewhat relative to past years of the economic recovery. It may be a prelude to a reversal in economic growth leadership from consumer spending to the goods-producing business sectors of the economy. (Please see the table on page 12 for the Huntington Wealth and Investment Management forecasts.).
Virtually all aggregate measures of inflation surged in January. The Consumer Price Index (CPI-U) rose 0.6% in January for its largest one month advance since August 2012. Inflation was more modest in February, but the annual growth rates are clearly rising. (Please see the chart.) Energy led the early year increase, but measures of inflation excluding energy and foods have been holding firm. The CPI-U excluding food and energy was up 0.3% in January followed by 0.2% in February. More price increases for consumers are probably in the pipeline. The Producer Price Index for Final Demand rose 0.6% in January for its largest increase since February 2013. Producer prices continued to rise 0.3% in February for a 2 month increase of 0.9% in total. The Personal Consumption Expenditures price index from the GDP accounts (referred to as PCE inflation) rose 0.4% for its largest one month increase since February 2011. The so-called core PCE, which excludes food and energy, rose 0.30% in January for its largest one month percentage gain since January 2007. Core PCE inflation is the measure favored for policy decisions by the Federal Reserve. In its March 15th FOMC statement, the Federal Reserve explicitly targeted 2.0% in Core PCE as its intermediate and long-term inflation objective. After the January surge this measure was at 1.74% -- on the doorstep of the Federal Reserve’s target.
The robust gains across a wide spectrum of inflation measures brought annual inflation rates into line with what they were prior to the deflationary commodity declines of the last 2 years.