The Outlook for the U.S. Economy National Association of Credit Union Supervisory and Auditing Committees Annual Conference and Expo Louisville, KY

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1 The Outlook for the U.S. Economy National Association of Credit Union Supervisory and Auditing Committees Annual Conference and Expo Louisville, KY Kevin L. Kliesen Business Economist and Research Officer June 15,

2 Disclaimer The views I will express today are my own and do not necessarily reflect the positions of the Federal Reserve Bank of St. Louis or the Federal Reserve System. 2

3 DATA HEAVEN RESIDES HERE! 3

4 The Big Picture The business expansion is now 9 years old. The average expansion lasts about 5 years. The record is 10 years. Real GDP growth during this expansion has averaged about 2.25% per year. The historical norm is about 3% per year. Inflation has finally reached the FOMC s 2% target, after mostly remaining below the target since January Monetary and fiscal policies are boosting growth, but the Fed is in the process of gradually normalizing monetary policy. 4

5 Forecasting Basics Joke of the Day! Economic forecasting is an imprecise exercise. Forecasters have a lot of hurdles to overcome: Imperfect data and models, assumptions about economic policy, unexpected developments (shocks) can t be accounted for. So, we largely assume that the past is prologue, but recognize that households, firms, and governments can change their behavior. Incentives matter! Bottom line: Look at long-run trends and then attempt to assess where the economy is currently relative to trend. 5

6 Key Ingredient #1: Labor Input The Labor Force Participation Rate and the Employment-to-Population Ratio, 1984 to Present Percent Participation Rate Employ/Pop Source: Bureau of Labor Statistics. Data through May

7 Key Ingredient #2: Productivity Growth of Labor Productivity, 1948 to 2017 Percent change, annual data (2.8%) (1.5%) (2.6%) (1.2%) SOURCE: Bureau of Labor Statistics and Haver Analytics. NOTE: Labor productivity is output per hour in the nonfarm business sector. 7

8 Final Product: Real GDP Growth Average Real GDP Growth During Post-WWII U.S. Business Expansions Percent change, annualized rate Q2 - Present SOURCE: BEA and author's calculations. 8

9 So Many Questions! Is 2.25% economic growth still the norm? Or, will tax reform boost the economy s short- and long-term prospects? How should we think about the increase in the budget deficit arising from tax cuts and increased spending? How will potential disruptions to the international trading framework affect the U.S. and world economies? Will inflation continue to move higher? If so, what does that imply for the economy and monetary policy? 9

10 Digging a Little Deeper 10

11 Global Economic Growth is Solid. U.S. is forecast to grow faster, but with higher inflation, than most of our key international trading partners. Projected Real GDP Growth: The U.S., the Euro Area and Canada Percent changes Projected Inflation: The U.S., the Euro Area and Canada Percent changes U.S. Euro Area Canada Mexico U.S. Euro Area Canada Mexico SOURCE: Blue Chip Economic Indicators Economic Activity SOURCE: Blue Chip Economic Indicators Inflation 11

12 Momentum Building for U.S. Growth Solid labor market conditions and low inflation. Good fundamentals support spending on autos and other bigticket items. House prices continue to increase. Businesses are also optimistic especially in the aftermath of tax and regulatory reform efforts. Financial market conditions are supportive of growth. Healthy forward momentum in the first half of 2018 bodes well for second half of 2018 and

13 Fiscal Stimulus Spurs Forecasters to Boost Their Near-Term Outlook Where do you expect to see the largest positive effects? Capital spending M&A activity R&D activity Compensation Employment 13

14 Two Key Barometers Looking Good Total Economy ISM Index, 50+ = Expansion (May) 35 Jan.2005 Jul.2007 Jan.2010 Jul.2012 Jan.2015 Jul.2017 Source: Author's calculations based on data published by Institute for Supply Management and the Bureau of Economic Analysis. Index of Leading Economic Indicators 2004= Jan.2005 Jul.2007 Jan.2010 Jul.2012 Jan.2015 Jul.2017 Last actual observation is April

15 The Movement of Goods is Picking Up Cass Freight Index, Shipments, 2012 to Present Index, Jan = University of Louisville/OSU Logistics and Distribution Activity Index Values above 50 indicates healthy economic activity (June 2018) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec May.2008 Nov.2009 May.2011 Nov.2012 May.2014 Nov.2015 May.2017 SOURCE: St. Louis Fed (FRED), the University of Louisville, and Oklahoma State Univ. The LoDi measures national activity in the rail, barge, air, and trucking industries. 15

16 Current Economic Conditions WHAT BUSINESSES ARE SAYING (ISM REPORTS) We are currently overselling our forecast and don t see an end to the upswing in business. We are very concerned, however, about the tariffs proposed in Section 301. (Transportation Equipment) Very difficult to hire skilled and unskilled labor. (Food & Beverage) Sales over the last month have been very strong. We are still struggling with the fluctuation in commodity costs and the weakening U.S. dollar. (Retail Trade) The supply chain is shuttering because of a lack of drivers and equipment causing delays in multiple modes of transportation. We are increasing inventory levels in anticipation of worsening conditions. (Wholesale Trade) 16

17 Construction Outlook Continues to Brighten Dodge Momentum Index for Commercial Construction Year 2000 = SOURCE: Dodge Data and Analytics (May) National Home Builders Housing Market Index Index, All Good = Average, Jan.2010 Jul.2011 Jan.2013 Jul.2014 Jan.2016 Jul.2017 Source: NAHB Last actual observation is May

18 Nationally, Most Housing Markets Appear in Good Condition 18

19 U.S. Job Growth has Outpaced Growth of the Labor Force Growth of Nonfarm Payroll Employment and the Labor Force Percent change from 12 months earlier Private Labor Force S&L Last actual observation is May

20 U.S. Unemployment Rates are Low, Regardless of How Measured The U-3 (Official) and U-6 Unemployment Rates and ther Long-Run Median Unemployment Rates Percent (Dotted Lines are Long-Run Medians) U U Source: Bureau of Labor Statistics. Data through May

21 A Broader Measure Suggests Were at Full Employment St. Louis Fed Labor Market Index Indexed Value (>0= Above-Average Labor Market Conditions) Recession 1986 to Present Current (May 2018) SOURCE: Federal Reserve Bank of St. Louis 21

22 Where are Job Openings the Most and Least Plentiful by Industry? Change in Job Openings Over the Past Year Percent change, April 2017 to April 2018 Professional Business Services 22.9% Trade, Transportation & Utilities 21.0% Manufacturing 20.9% Leisure & Hospitality 11.0% Education & Health Care Services 9.1% Government 6.8% Construction -0.4% SOURCE: Bureau of Labor Statistics Total Job Openings and Total Unemployment Thousands of Jobs 16,000 13,000 10,000 7,000 4,000 1, Last actual observation is April (Openings) or May (Unemployed)

23 A Larger Percentage of Small Businesses are Raising Wages Percent of Small Businesses Raising Labor Compensation Over the Past Three Months Last actual observation is May

24 Nationally, Wage Growth has Picked Up and Inflation Remains Below 2%. The Atlanta Fed Wage Growth Tracker and Headline Inflation Percent change from a year earlier Wages Inflation -2.0 Jan.2005 Jan.2007 Jan.2009 Jan.2011 Jan.2013 Jan.2015 Jan.2017 Last actual observation is April A widening gap is good because it signals improving purchasing power of households (inflation-adjusted wages). 24

25 Are Households Too Optimistic? Consumer Confidence Index Jan.2000 Jan.2003 Jan.2006 Jan.2009 Jan.2012 Jan.2015 Jan.2018 NOTE: Avg. of Michigan and Conference Board surveys. Last monthly observation is May Personal Saving Rate Percent of disposable personal income SOURCE: BEA Last actual observation is April

26 Are Households Too Optimistic? Yes, if you factor in future taxes. Federal Budget Surplus and Deficit (-) as a Percent of GDP, 1960 to 2028 (P) Billions of dollars Actual Projected SOURCE: FRB St. Louis, Haver Analytics, CBO, OMB. Federal Debt-to-GDP, 1940 to 2047 (P) Percent of GDP Actual CBO Projection Mar SOURCE: FRB St. Louis, Haver Analytics, CBO, OMB. 26

27 Federal Entitlements and Net Interest: A Growing Issue. Federal Mandatory Outlays Plus Net Interest on the Debt as a Share of Federal Revenues Percent Federal Spending (Left) Projection NOTE: Fiscal years. SOURCE: CBO, OMB, and Haver Analytics 27

28 Turning to Inflation 28

29 Is Inflation Moving Higher? The Fed's Preferred Inflation Measure Percent change from a year earlier 4.0 Long-Term Inflation Expectations (Inflation expectations based on TIPS) Inflation Expectations FOMC Inflation Target (2%) FOMC Inflation Target (2%) 2.00 (May) 0.0 Jan.2010 Jul.2011 Jan.2013 Jul.2014 Jan.2016 Jul.2017 NOTE: Inflation calculated from the personal consumption expenditures price index. Last observation is April Source is the Bureau of Economic Analysis. 0.0 Jan.2010 Jul.2011 Jan.2013 Jul.2014 Jan.2016 Jul.2017 NOTE: Inflation calculated from the personal consumption expenditures price index. Inflation expectations are 5-year, 5-year forward break-even inflation rates. 29

30 Rising Price Pressures at the Firm Level ISM Manufacturing and Nonmanufacturing Prices Indexes Index, 50+ = More respondents reporting higher than lower prices Manufacturing Nonmanufacturing 0 Jan.2005 Jan.2008 Jan.2011 Jan.2014 Jan.2017 Last actual observation is May 2018 NABE Survey: CapEx, Profit Margins, & Materials Costs Four-quarter moving averages 80 Wages Profit Margins Materials Costs NOTE: Percent reporting rising less percent reporting falling. Last actual observation is 2018:Q1 30

31 Oil Prices Fall; Global Supply Increasing Spot Oil Prices and EIA Forecasts Dollars per barrel $80 $70 $60 $50 $40 $30 Spot Brent Spot WTI Brent Forecast, June 2018 WTI Forecast, June 2018 World Petroleum Supply-Demand Balance: Actual and Forecast Millions of barrels per day Supply Less Demand 6-mo MA Forecast, June 2018 $20 07/29/15 03/29/16 11/29/16 07/29/17 03/29/18 11/29/18 07/29/19 SOURCE: U.S. EIA and Haver Analytics. NOTE: Last actual observation is June 13, Jan.2014 Oct.2014 Jul.2015 Apr.2016 Jan.2017 Oct.2017 Jul.2018 Apr.2019 SOURCE: U.S. Energy Information Administration, June

32 Inflation Forecast to Remain Near Target Headline PCE Inflation: Actual and Forecast Year/Year Percentage Change 3.0 Actual Inflation May forecast (April data) 2.5 April forecast (March data) 2 % target Jan-12 Oct-12 Jul-13 Apr-14 Jan-15 Oct-15 Jul-16 Apr-17 Jan-18 Oct-18 Source: BEA; Jackson, Kliesen, Owyang. 32

33 A New Normal for Inflation? Some economists believe that inflation behaves differently than in the past. For example, the fracking revolution in the United States seems to have permanently lowered the price of crude oil ( shale band ). Others wonder whether the Amazon effect has exerted similar effects on retail prices. Regardless, most people have confidence that the Fed will keep inflation under control. That s important! 33

34 Turning to Monetary Policy 34

35 The labor market continues to strengthen and economic activity has been rising at a solid rate. Growth of household spending has picked up, while business fixed investment has continued to grow strongly. Overall inflation has moved close to 2%; indicators of longterm inflation expectations are little changed. The Committee decided to raise the target range for the federal funds rate to 1.75% to 2%. 35

36 The Fed s Near-Term Outlook June 2018 FOMC Economic Projections Percent (A) Longer run Real GDP Unemployment Rate Inflation NOTE: FOMC Projections are the median estimates of FOMC participants. The unemployment rate is the average of the fourth-quarter for the year indicated. 36

37 The FOMC: We re Bullish on the U.S. Economy! The Actual and Projected Federal Funds Target Rate Percent Fed Funds Rate FOMC SEP, June 2018 Long-Run Median FFR The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective over the medium term. [FOMC Statement, June 13, 2018] 37

38 A Modest Projected Rise in Interest Rates Blue Chip Consensus Treasury Yield Curve Forecast Percent Treasury bill, 3-mo. Treasury note, 10 yr. Yield Curve Forecast Blue Chip Consensus Forecasts: 30-Year Mortgages and LIBOR Percent Forecast Home mortgage rate LIBOR, 3-mo Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q SOURCE: Haver Analytics and Blue Chip Financial Forecasts (June 2018) SOURCE: Haver Analytics and Blue Chip Financial Forecasts (June 2018) Risk-Free Rates Risky Rates 38

39 Commercial Bank Lending is Increasing Growth of Bank Loans, Year-to-Date 2018 vs. Year-to-Date 2017 Percent 3.0% 2018, Year-to-date: 2.4% 2.5% 2017, Year-to-date: 2.1% 2.0% 1.6% 1.5% 1.6% 1.5% 1.3% 1.0% 0.9% 0.5% 0.0% Total Loans & Leases 0.0% C&I Real Estate Consumer Loan Growth Net Interest Margin 39

40 Credit Union Performance Looks Solid Growth Rates (%) Asset Quality (%) Mar ROA Trends bp of Average Assets Mar 18 Loan Growth Savings Growth 60+ Day Dollar Delinquency (right) Net Chargeoffs (left) Mar 18 Loan Growth Credit Risk Trends Earnings SOURCE: U.S. Credit Union Profile, 2018:Q1 40

41 Small Business Lending Picks Up. Small businesses are benefitting from a host of tailwinds, including strong international growth and reduced regulatory and tax burdens. Small business delinquencies and defaults have edged up in recent months, though this is expected at this stage of the business cycle and does not signal an imminent deteriorations in credit conditions. SOURCE: PayNet/Thomson Reuters (June 2018) 41

42 Financial Market Conditions Remain Supportive of Growth The St. Louis Fed's Financial Stress Index Weekly data Jan 2006 Jan 2008 Jan 2010 Jan 2012 Jan 2014 Jan 2016 Jan 2018 Last observation: Week of June 8, U.S. Stock Prices (Wilshire 5000) Weekly data 30,000 25,000 20,000 15,000 10,000 5,000 Jan 2006 Jan 2008 Jan 2010 Jan 2012 Jan 2014 Jan 2016 Jan 2018 Last observation: Week of June 8, St. Louis Fed Financial Stress Index Stock (Equity) Prices 42

43 Why You Should be Optimistic... Cuts in marginal tax rates, coupled with increases in household wealth, should keep consumer spending and housing construction growing at healthy rates. Deregulation and tax law changes will encourage firms to boost capital spending, hiring, and repatriate foreign profits. All else equal, these developments will tend to raise productivity, real wages, and economic growth. Unless inflation ramps up, the FOMC will be patient in withdrawing monetary stimulus. 43

44 And Why You Might Worry. Productivity growth, the key ingredient to rising living standards, remains lethargic. Fiscal stimulus could produce faster-than-expected real GDP growth (a good thing!). But this could raise inflation expectations. Larger-than-expected budget deficits could also cause a spike in inflation expectations and thus interest rates. International trade disruptions could roil markets, raise business uncertainty, and lead to lower growth. 44

45 Kliesen s Forecast Projected averages, 2018 to 2020: Real GDP growth: 2.5% to 3.0% Unemployment rate: 3.5% to 4.25% Headline inflation: 2% (some upside risk) Punchline: Policy changes will boost economic growth. Inflation fears have crept into the market, so the Fed will need to remain vigilant. 45

46 QUESTIONS? 46