The Story: A Mid-Cycle U.S. Economy in a Multi-Speed World
The endogenous growth story for the U.S. economy remains intact. There are two key channels of growth operating within the U.S. economy that have brought us through the recovery and into mid-cycle. One is the re-emergence of the household sector as a stabilizing force. Think of the household sector as a gyroscope that keeps the economy upright. With two-thirds of gross domestic product accounted for by consumer spending, the economic health of households is of paramount importance. Households are rapidly repairing their balance sheets. Rising home prices combined with still-low mortgage rates are allowing households to build equity in their homes at a strong rate. Homeowners’ equity is being augmented by strong job creation and by strong financial market performance. The second key channel for endogenous growth is the domestic energy sector and its impact on the manufacturing sector. Not only is the energy sector still generating strong job growth, it is fueling (literally) growth throughout the manufacturing sector by providing abundant energy at a low price.
Typically, in a mid-cycle economy, credit availability expands and risk appetite increases. We are seeing both now. Increasing credit availability and improving risk appetites will support business investment and bring the lagging edges of the economy into expansion mode. Ominously, we recall that credit expansion and risk appetite combined to fuel a strong expansion in the 2000s that ended in catastrophe. We do not anticipate a return to astronomical leverage ratios in systemically important financial institutions combined with the rapid expansion of complex and toxic financial instruments worldwide.
To sustain the mid-cycle economy into 2015, we look for steady household spending, improved residential and business investment, the end of drag from tight controls on federal spending and improved demand globally for U.S. goods and services.
An important challenge to this sanguine outlook comes from outside the U.S. economy. Global growth remains unsteady. The multi-speed global economy is contributing to a de-coupling of central bank policy. Foreign exchange rates and sovereign bond spreads are vulnerable to the de-synchronization of asset purchases and interest rate policy among major central banks. We expect the Federal Reserve to keep tapering its asset purchase program in measured steps, meaning another $10 billion reduction in QE at the end of July. Even as the Fed loosens its grip on the long end of the yield curve, it will maintain the near-zero fed funds rates through the remainder of this year. We still expect interest rate lift-off to come by the third quarter of 2015.
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