U.S. economic outlook: Don't expect liftoff in 2016

Aging, slow-growing population will hinder growth.

Robert Johnson, CFA 30 December, 2015 | 6:00PM
  • We are forecasting 2.0%-2.5% GDP growth in the U.S. for 2016, lower than most other economists predict, mostly driven by the consumer with little help from other areas of the economy.
  • As we lap some of the biggest energy price declines, we suspect headline inflation could easily approach 2.5% by the end of 2016.
  • We think analysts are overestimating starts and underestimating home-price appreciation again for 2016.
  • U.S. population growth has collapsed from 1.8% in the 1950s and 1960s to 0.7% currently, which is closely correlated with slower GDP growth rates.
  • At just over 3.4% year-over-year, slow credit growth is continuing to hold the economy back.

Our economic forecast for the year ahead isn't much different than our forecasts for the prior three years, namely 2.0% to 2.5% real GDP growth for the U.S. economy. That growth will again be driven by the consumer, with not a lot of help from the other major components of GDP. Government spending will be limited by extreme pressures not to raise taxes and being forced to spend more money on transfer payments and less on goods and services that more directly benefit growth.

Shifts away from brick-and-mortar stores and the rethinking of office space, as well as ongoing issues in oil drilling, mean business investment spending won't provide much help, either. Net exports will likely remain a small negative as slow world growth, ongoing issues in the commodity complex, and a strong dollar will all hurt exports, while consumers are likely to snap up ever-cheaper imported goods. Residential spending should continue to add a few tenths of a percent to GDP growth, but our belief is housing growth will not accelerate from current levels.

All in, our 2.0%-2.5% growth rate is lower than the 2.5%-3.0% growth that the Fed and most economists are estimating. Over the past few years, most forecasters have believed that growth would accelerate in the year ahead, with the economy reaching some type of escape velocity and eventually a 3.0%-3.5% growth rate, if not more. However, both slowing population growth rates and an aging population make it extremely unlikely that the U.S. or any developed market can ever reach those types of growth rates on anything but a very short-term basis. That is part of the reason that economists have had to scale back their cheery December forecasts, often as soon as the following March.

Most of our other forecasts fall out of our low GDP growth predictions and the aging population dynamic. For example, employment growth generally trails GDP growth as office and factory workers become more productive. Looking ahead to 2016, we expect employment to grow at 1.9%, which is slower than our 2.25% central tendency GDP forecast for 2016, because of that productivity factor. That percentage converts to the more commonly reported 220,000 jobs per month, or 2.6 million per year. That growth is likely to favour services jobs over manufacturing and government in the year ahead.

Interestingly, because of the dynamics of a shrinking working-age population, the rate of unemployment fell much faster than expected in 2015 to 4.9%, even though most forecasters overestimated the number of jobs per month that would be added. A combination of retiring baby boomers, teens staying in school longer, and skills or wage mismatches have caused some potential workers to drop out of the job market. Those same phenomena are likely to drive unemployment even lower in 2016, even though overall economic and employment growth rates are unlikely to get much better next year.

Core inflation has been relatively tame over the past three years (excluding food and energy), at just under 1.7%, with some pick-up in 2015 to 2.0%, due to rising rents and increased health-care costs. Those same dynamics, plus increased shortages of workers, could push core inflation even higher in 2016, to the 2.2%-2.4% range.

Falling oil prices have largely masked the steady increases in services inflation in 2015. However, as we lap some of the biggest energy-price declines, we suspect headline inflation (food, energy, and everything else) could easily approach 2.5% by the end of 2016. A geopolitical event or OPEC clamping down on production could push overall inflation closer to 3%.

The demographics of spenders and slow growth overall should keep inflation from getting out of hand. Still, 3% inflation could be a bit of shock to some. All in, 4% inflation is usually when big economic problems set it in. Hopefully, things won't get that bad in the short term.

The housing market, though improved, was a disappointment in 2015, with housing starts falling almost 100,000 below the consensus forecasts of 1.2 million units. Weather, worker shortages, and a lack of available land all weighed heavily on housing starts. Lower-than-expected housing starts are why most GDP forecasts were too aggressive for 2015.

The shortage of new homes caused the prices of existing homes to go up almost 6% in 2015, handily outpacing the consensus forecast of under 4% price appreciation. We think analysts are overestimating starts and underestimating home-price appreciation again for 2016. Ramping up housing production is not easy. And where housing demand is high, there are few available lots to build on. That problem is particularly visible in California and New York City.

Although we've had three years of good GDP forecasts, our calls on interest rates have not been as accurate. We have always believed bond yields would be some type of spread above inflation. For example, we believe that the 10-year U.S. Treasury rate should be about 2% above inflation. We thought inflation would be about 1.5% in 2015, for a total forecast of 3.5%. Instead, headline inflation for 2015 will be well under 1%, due to falling energy prices. And the Fed delayed starting interest-rate normalization until the very end of the year (versus March or June expectations) because of an economic slowdown in China and other commodity-related emerging markets. Easy monetary policies in other world economies also kept U.S. rates lower than they would have been otherwise. With the normalization now started (and we expect several more Fed rate increases in 2016), and inflation moving modestly higher, we continue to expect the 10-year Treasury rate to be at 3.0%-3.5% by the end of 2016.

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Robert Johnson, CFA

Robert Johnson, CFA  Robert Johnson, CFA, is director of economic analysis for Morningstar.