Except for the updated GDP data, which were slightly discouraging, the economic data during the past month have been positive. This was in line with our expectation that growth would remain adequate in the near term and consequently produced very little change in our forecast.
The second release of data for final quarter 2016 was unchanged on the top line, but contained composition revisions that were a disappointment. Growth in real GDP remain at 1.9%, with more than half still due to inventory accumulation. In the other half, consumption growth was increased, while that for business investment and government was reduced. This mostly removed the signs of improved balance that we had found encouraging in the advance data. Instead the fourth quarter now appears to have been a continuation of the consumption dependent pattern that has characterized the recent period.
Monthly data, however, suggest a positive turn in the current quarter. In particular, for the first time in a while there are signs of some animal spirits in the business sector. Both ISM indexes rose in February (from already high levels). For manufacturing this marked six months of continuous increase. An index of small business optimism (from the National Federation of Independent Business) was at its highest level since 2004 in January. January industrial production was held down by weather related weakness in the utilities sector, but both manufacturing and mining have risen in three of the past four months. Finally hiring has been strong (more on this below).
Household sector data are more mixed. Adjusted for inflation both income and consumption fell in January, as did consumer sentiment, auto sales and housing starts. But sentiment bounced back in February and auto sales held flat at a healthy level, while building permits rose in January.
The labor market had another very solid month in February. On the demand side, payroll employment rose by 235 thousand, just short of its January rise. These monthly increases are about 30 thousand above the average value implied by our January forecast. In the household survey the unemployment rate declined from 4.8% to 4.7%. This decrease was entirely due to a drop in the number of unemployed job seekers. The labor force rose by a strong 340 thousand, which pushed the participation rate to 63%, matching its highest value since March 2014. The household survey measure of employment rose by 447 thousand. This elevated the employment rate (the ratio of those employed to the over-16 civilian population) to 60%, the highest since early 2009.
Overall, as can be seen in the chart, the new and revised data have had virtually no effect on our forecast relative to a month ago. We expect growth in the first half of this year to average just above 2.4%, followed by slightly over 2.2% through the remainder of the forecast period. Current quarter growth benefits from inventory accumulation. In Q2 the forecast has a slight (and temporary) elevation in consumer spending and in business investment.
After mid-2017 our model has the economy operating at its potential. With our current assumptions, this implies that the nonfarm private sector grows at about 2.5% – 1% from employment growth and 1.5% from productivity increase. Adding the government and agricultural sectors gives overall GDP growth just below 2.3%.
Our updated forecast represents a continuation of the recovery norm of growth a little above 2%. The growth in this forecast closely parallels the underlying growth in potential. This raises a clear problem if the Trump administration is successful in implementing its program of economic stimulus – tax and regulatory reform, plus increase in infrastructure and defense spending. [None of this is yet included in our forecast.] The problem is that unless the policy significantly raises growth in potential output, it would surely be inflationary. Tax and regulatory reform could increase potential. Spending increases (even for infrastructure) not so much. Protectionist trade policy (including border tax adjustment, which strikes us as a bad idea) probably the reverse. It might be a good time to read up on the history of stagflation in the 1970s.