- Stronger consumption helps GDP growth
- Confidence surges among small businesses
- Economic reports coming in above expectations
The U.S. economy appears to be in an upward swing following three consecutive quarters of sub-1.5% growth. Third-quarter growth came in at 3.5%, with the help of robust consumption. Fourth-quarter growth is expected to be 1.9%, which should place yearly growth at 1.6%. Although this is matching the weakest yearly growth rate since the financial crisis ended, the focus is clearly on the strength of the past two quarters and the outlook for 2017.
One of the most exciting developments has been increased confidence among small businesses. There are about 29 million small companies in the U.S. (according to the Small Business Administration), and they account for almost half of the workforce. The respected Small Business Optimism Index, published monthly by the National Federation of Independent Business (NFIB), surged 10.9 points in November and December, breaking above its 42-year average for only the third time since 2007.
In another exciting development, economic reports have been coming in stronger than expected. The Citibank Economic Surprise Index measures the variation between forecasts regarding key economic releases and what the releases show when actually published. When positive, it means the data is “surprising” to the upside.
These developments, along with a low and stable unemployment rate, and gradually increasing inflation, gave the Fed confidence to raise rates in December. This was only the second rate hike in this seven-and-a-half-year expansion, and it places the median rate at 0.625%. The Fed's current projection is for three more rate increases in 2017, which would put the Fed Funds rate at 1.375%. Even then, that rate would still be stimulative since it would be below the so-called “natural” interest rate.
The most important factor behind the Fed's more hawkish view on rates has been inflation. The Fed is more confident that inflation (which has been below its target rate of 2.0% since 2012) will surpass that rate in the medium term. There are a number of reasons for this, most notably the strong labor market. The unemployment rate has been hovering around the “full” employment rate of about 5.0% for more than a year. As the economy continues to expand, companies are likely to increase hiring, which will put upward pressure on wages. Furthermore, the fiscal stimulus planned by the new administration would occur when the economy is already near full capacity. This is expected to add further upward pressure on prices.
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The Standard & Poor’s (S&P) 500 Index represents 500 large U.S. companies. The comparative market index is not directly investable and is not adjusted to reflect expenses that the SEC requires to be reflected in the fund’s performance.
The Small Business Optimism Index is compiled from a survey that is conducted each month by the National Federation of Independent Business (NFIB) of its members. The index is a composite of 10 seasonally adjusted components based on the following questions: plans to increase employment, plans to make capital outlays, plans to increase inventories, expectations of the economy to improve, expectations of real sales to move higher, current inventory, current job openings, expected credit conditions, whether now a good time to expand, and earnings trend.
The Citi Economic Surprise Index is a data series that measures how data releases have generally compared to economists’ prior expectations. When data is coming in weaker than expected, it declines; when data is coming in stronger than expected, it rises. This doesn’t necessarily mean that it declines when the economy is weakening, just when the data is surprising on the downside. The Index is a weighted historical standard deviation of data surprises.
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