Paul Single
Managing Director
(415) 576-2531

Steven Denike
Portfolio Strategy Analyst
(212) 702-3500

Economic Perspective November

Throughout the current economic expansion, we have seen sentiment oscillate often between pessimism and optimism. Lately, it seems that the tide has ebbed back to the pessimistic side. Weak results in a number of economic releases have once more called into question the strength of the U.S. economy, as well as the likelihood that the Fed will be confident enough to raise interest rates before the end of the year.

The swings in sentiment are understandable, considering underlying U.S. trend growth has been frustratingly slow, while quarterly GDP has been particularly volatile. Yet, through all the ups and downs, the U.S. economy has proven to be relatively durable, especially in the face of ongoing global headwinds.

Much of the resilience is attributable to the considerable improvement over the past several years in domestic economic fundamentals. In our minds, the current growth scare is due to transitory factors and ongoing weakness in manufacturing in response to the rise in the value of the dollar, rather than a more alarming deterioration in broader domestic economic conditions.

For example, the slowdown in third-quarter U.S. economic growth to 1.5% from a very strong 3.9% in the second quarter was disappointing on the surface (Figure 1). However, details in the BEA’s GDP release reveal an economy that is in better shape than what is captured by the headlines. The slower pace of growth was mainly due to a big drag from inventories, largely related to cutbacks from export-oriented manufacturers, which we do not anticipate will be repeated in the fourth quarter.

Indeed, once inventories and trade are stripped out, the data shows that final sales to domestic purchasers (a much better gauge of underlying demand and predictor of future GDP) rose at a healthy 2.9%. This is a good indication that the broader U.S. economy appears to be taking weakness from abroad in stride.

The consumer sector, in particular, continues to be a bright spot. The significant improvement made to consumer finances, along with continuing job and income gains, has for some time now been translating into better spending growth. Since the start of 2014, real consumer spending gains have averaged a healthy 3.1%, which is a sharp pickup over the more modest 2.2% average rate seen since the recovery began.

The other positive development on the home front is that housing continues to boost overall economic activity. Americans are forming new households and buying new homes at an increasing rate. This not only should help support housing demand and overall construction for years to come, but we believe it also bodes well for future overall economic growth.

Against this positive backdrop, the chief cause for concern (particularly for policymakers) has been the slowdown in China and its ramifications for the rest of the world. Still, incoming data continues to indicate that fears about the global economy being in the throes of a broad-based downturn are overstated. The Chinese economy is going through a painful and somewhat messy economic rebalancing process, but its increasingly important service sector has been resilient (we believe a hard landing is still only a low-risk outcome). Meanwhile, recent business surveys suggest that activity in advanced economies has held up well over the last several months.

What all this means for the Fed and the potential of the first rate hike in nearly a decade remains an open question. Market forecasters are now roughly split over the odds of a December rate hike (Figure 2). In our analysis, conditions in larger domestic parts of the economy where monetary policy has the most influence appear strong enough to justify higher interest rates.

The Fed, on the other hand, is not yet entirely convinced and has made it no secret that its decision to raise rates would be “data dependent.” However, should domestic strength persist and continue to outweigh the related weakness in the international markets, it likely will not be long before policymakers decide to start their long-anticipated gradual tightening cycle.


The Federal Open Market Committee (the monetary policymaking arm of the Fed) met in late October and decided to keep short-term interest rates unchanged (interest rates have been at the near-zero level for almost seven years). The Fed hinted to raising rates at its next meeting in mid-December.

The Fed’s overall outlook on the economy is that growth is expanding at a moderate pace, driven by increased household spending and business investment. Inflation continues to trend below the Fed target level of 2%. The Core Personal Consumption Expenditures (core-PCE) Price Index (the Fed’s preferred proxy of inflation) is at 1.3% and has not been above 2% since early 2012. The core-PCE Price Index has been held down by energy prices and other imports. The Fed expects it to move toward the target level as the labor market continues to improve and the energy and import prices dissipate.

For the second meeting in a row, the Fed discussed international events and noted that it is monitoring global economic and financial developments.



Although gains in employment have been on a positive track for five years, the recent employment report was a letdown. Not only did the gain in nonfarm payrolls come in at a disappointing 142,000 (30% below the expected 200,000), but there were notable downward revisions to the August and July releases (a total combined reduction of 59,000). Results are usually lower than expected, due to seasonal quirks or specific events, such as bad weather, occurring during the week that the Bureau of Labor Statics does its survey. However, that did not happen last month. What makes this even more frustrating is that these numbers pulled down the rolling six-month average gain to 199,000. It peaked this past February at 282,000 (Figure 3).

Important to note is that the average hourly earnings were unchanged for the month, keeping the yearly change at just 2.2%. For the past five years, this proxy for wage gains has been averaging just 2%.

In a separate labor report, the unemployment rate held steady at 5.1% for the second month in a row. It has continued to improve; in September 2014 it was 5.9% and in September 2013 it was 7.2%.


The Core Consumer Price Index (core-CPI), which excludes food and energy prices, has ticked up to 1.9%, the highest reading since July 2014. Housing, the biggest component of the index (with a weighting of about half of the index) is up 2.1% over the past year.

There are several CPI calculations, with the most common being the headline CPI, or CPI-U (U stands for urban consumers). CPI-U includes the food and energy components not reported in core-CPI. CPI-U had a 0% change over the past year, due in part to the 18.4% plunge in energy costs. For example, the subcomponent gasoline, which makes up 4.4% of the CPI Index, fell 30% in the past year.

Another inflation proxy is CPI-W (W stands for wage earners and clerical workers), which also registered no change over the past year. This proxy of inflation is used for the cost of living adjustment (COLA) for Social Security benefits. Thus, there will be no increase in 2016 benefits. Ever since 1975, the benefit increase has been COLA adjusted (prior to that, benefit increases were set by legislation). This marks the third time in the past 40 years that there has been no change to this index (Figure 4). All three of those times have occurred since 2010.



American households have turned slightly more anxious in the past month or so, most likely due to the downshift in the pace of job growth, weakness in the manufacturing and energy sectors, and the ongoing policy debates in Washington. Nevertheless, we believe the long-term trend continues to be favorable. Consumer confidence has been moving in an upward direction ever since the end of the recession, more than six years ago (Figure 5). The confidence polls tend to follow employment gains and the stock market – both have been in positive territory for about the same period of time.

The subcomponents of the recent surveys are encouraging and point to a stronger consumer in the future. Overall, this is leading many forecasters to believe that consumption will continue to grow around 3% this year, supporting overall GDP growth. Home purchase plans, which measure the intent to purchase a home in the next six weeks, have moved up in the past two months. This is giving further support to the housing market, which continues to strengthen.

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