quarterly update

As 2016 begins to unfold, economists and forecasters are putting together their perspectives on what will drive economic growth for domestic and global (developed and emerging) economies. The consensus seems to be that the most dominant issues will be the prices of oil and other commodities, along with the pace of economic growth in China. Additionally, there is concern about the potential ripple effects that may occur both domestically and around the world in reaction to the decisions of the Federal Reserve as it continues to raise short-term interest rates back to a “normal” level.

The price of oil was $37.13 per barrel at the end of 2015. That was a drop of 30.6% for the year, and came on the heels of an even sharper decline (45.5%) in 2014. This has created a massive global transfer of wealth from oil producers to consumers. In the long run, this is a good thing for the United States, because consumption accounts for two-thirds of our economy. The extra disposable income gained from lower energy prices will allow households to increase their spending. However, in the short term, lower oil prices have reduced the incentive to invest in drilling and exploring, which in turn has acted as a drag on domestic GDP. On a global level, reduced revenues are squeezing the budgets of many oil-producing countries, which could lead to even higher levels of political instability.

It is not just oil. Prices of many other commodities, from food to industrial metals, have also fallen to near-record lows. In recent years, many emerging economies (China, Russia, Brazil, Mexico, Chile, etc.) spent heavily to develop the infrastructure needed to deliver their products to customers around the world. Now that the demand for these products has fallen, this has left many emerging nations with enormous debt loads, as much of their infrastructure development was financed by borrowing (frequently in dollars). Rising interest rates and less-favorable currency exchange rates have further increased the financial pressures on these countries, which need to continue producing in order to generate revenue to service their debts, even if they are producing below cost. The result is continued supply in an already weak market that is keeping prices low. This also applies to oil, but the dynamic is different this time. In the past, when prices fell, supply was curtailed in response, thereby bringing the supply/demand equation back into equilibrium

As for the U.S., we anticipate the pace of economic growth to increase somewhat in 2016 (reaching the range of 2.2% to 2.7%) due in large part to increased consumer spending. We expect inflationary pressures to move up ever so slightly, held down in part by low commodity prices, which account for about one-third of most inflation measurements. We also believe the Fed will raise short-term interest rates (50 or 75 basis points in 2016), which is below its forecast of 100 bps.

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