Quarterly key points
- U.S. GDP growth rebounded to a solid +3.5% pace in Q3, aided by a rebound in inventory building and a spike in agricultural exports. Personal consumption
grew at a strong 3.0% pace during the quarter.
- The labor market remained robust. Employers added an average of 165,000 jobs per month in Q4, and the unemployment rate fell to 4.7% in December.
- Donald Trump’s surprise win in the Presidential election raised the prospects for significant fiscal stimulus in 2017, including tax cuts and infrastructure
- As expected, the Fed raised its policy rate by 25 basis points (0.25%) at the December FOMC meeting, to a target range of 0.50% to 0.75%.
- The U.S. economy likely expanded at a 2.0% pace in 2016. The prospect for significant fiscal stimulus in 2017 means GDP growth could accelerate anywhere
from 2.5% to 3.0% next year.
- With the U.S. economy already running close to capacity, fiscal stimulus seems likely to add to already building inflation pressures.
- The incoming Trump administration has signaled the potential for sweeping changes in foreign and domestic policy, raising the likelihood of “fat tail”
outcomes for the global economy and financial markets.
- The Fed may feel pressure to quicken the pace of rate hikes in response to fiscal stimulus in order to keep longer-term inflation expectations in-check.
Third quarter GDP growth rebounds, incoming data suggests solid growth continued into year-end
U.S. GDP rebounded to a solid +3.5% pace in Q3, a significant improvement over the anemic 1.1% growth rate of the first half of 2016. Growth in Q3 was bolstered by a rebound in inventory building and a spike in agricultural exports. Personal consumption grew at a strong 3.0% pace during the quarter. Incoming survey data suggests Q4 growth remained solid, giving the economy significant momentum heading into 2017. The Institute for Supply Management’s (ISM) monthly survey of business activity showed gains in both manufacturing and service sectors during Q4.
The labor market remained strong during the quarter. Employers added 165,000 jobs per month on average over the quarter and the unemployment rate fell to 4.7% in December. Reduced slack in the labor market appears to be driving more substantial wage gains: unit labor costs rose at a 3% pace in Q3, and monthly data from employment report (avg. hourly earnings) suggests wages grew at a similar pace in Q4. Consumer confidence jumped to a 15-year high reading of 113.7 in December. Recent growth in real wages, the further decline in the unemployment rate and, notably, post-election optimism for President-elect Trump’s pro-growth policies all contributed to the rise in consumer sentiment.
Headline inflation measures continued their rebound in the fourth quarter as energy prices firmed. Core inflation measures fell modestly during the quarter, although price pressures in shelter, healthcare, and transportation services remained elevated. As of the November data release, headline CPI rose at a 1.7% annualized pace while core inflation excluding food and energy rose at a 2.1% annualized pace. Notably, the breakeven inflation level priced into 5-year Treasury Inflation Protected Securities (TIPS) jumped to 1.86% at the end of December from 1.49% at the start of the quarter.
Figure 1 | GDP Growth and Weighted ISM Index1
Trump’s surprise win has significant implications for fiscal policy – and beyond
Donald Trump’s surprise win in the Presidential election raised the prospects for significant fiscal stimulus in 2017, including tax cuts and infrastructure spending. Both tax reforms and an infrastructure spending package appear to have broad support among Republicans, who control both houses of Congress. While estimates vary, conservatively Trump’s proposals could be worth $150bn per year – 0.8% of GDP – or more, once fully phased-in2. Beyond fiscal expansion, however, President-elect Trump and his senior advisors have outlined an agenda representing sweeping changes in foreign and domestic policy. From regulatory changes to monetary policy, to immigration, trade and international relations, the scope of policy uncertainty as Mr. Trump prepares to take office is on a scale not seen since the end of World War II. In our opinion, this degree of uncertainty creates the potential for “fat tail” outcomes for the global economy and financial markets.
Post-election optimism for tax cuts, a more friendly business environment, and the potential for faster growth lifted U.S. stocks. Energy, financials, and construction-related industries saw the greatest bounce. Interest rates jumped and the yield curve steepened, with yields on longer maturities rising most. The yield on the 2-year U.S. Treasury note rose 43 basis points, or 0.43%, during the quarter to end at 1.19%. The 10-year U.S. Treasury note yield rose 85 basis points, ending the year at 2.44%. The U.S. dollar rose over 7% on the quarter versus other major currencies, reaching a 14-year high. As expected, the Fed raised its policy rate by 25 basis points (0.25%) at the December FOMC meeting, to a target range of 0.50% to 0.75%. The median of Fed officials’ forecasts calls for three hikes in 2017.
Figure 2 | Consumer confidence and personal consumption expenditures (% change YoY)3
With fiscal stimulus likely – growth and inflation set to accelerate amid profound policy uncertainty
We expect the U.S. economy likely expanded at a 2.0% pace in 2016, and built solid momentum in the final quarter which should carry into 2017. The underlying strength in consumer demand seems to be well supported by steady job growth and real wage gains, as well as increasing home prices and the stock market at a record high. The prospect for significant fiscal stimulus in 2017 means GDP growth could accelerate anywhere from 2.5% to 3.0% next year.
With the U.S. economy already running close to capacity, any fiscal stimulus seems likely to add to already building inflation pressures. In turn, the outlook for higher inflation and faster growth should put further upward pressure on interest rates. The strength of the U.S. dollar, however, may restrain inflation somewhat. Similarly, continued global flows into U.S. dollar assets may keep interest rates from rising too quickly. Based on solid growth momentum and the potential for real wage growth to sustain consumer spending growth, it is reasonable to expect the Fed to hike rates 2-3 times in 2017. The larger the fiscal stimulus, the more the Fed may feel pressure to quicken the pace of rate hikes in order to keep longer-term inflation expectations in-check. In light of the considerable uncertainty surrounding the incoming Administration’s policy priorities, increased caution and respect for the possibility of “tail outcomes” is warranted.
Figure 3 | U.S. Treasury yield curve change4
1. U.S. Bureau of Economic Analysis, Bloomberg, The Institute for Supply Management
2. Source: Goldman Sachs Economic Research. U.S. Economics Analyst, November 19, 2016. “2017 Outlook: Under New Management.”
3. Source: Bloomberg, The Conference Board, U.S. Bureau of Economic Analysis
4. Source: Bloomberg
The information contained herein reflects the views of Galliard Capital Management, Inc. and sources believed to be reliable by Galliard as of the date of publication. No representation or warranty is made concerning the accuracy of any data and there is no guarantee that any projection, opinion, or forecast herein will be realized. The views expressed may change at any time subsequent to the date of publication. This publication is for information purposes only; it is not investment advice or a recommendation for a particular security strategy or investment product. Graphs and tables are for illustrative purposes only. FOR INSTITUTIONAL INVESTOR USE ONLY. © Copyright Galliard Capital Management, Inc.