U.S. financial assets delivered another year of strong investment returns as the economy finally exhibited signs of accelerating growth. Including the weak first quarter of 2014, which was marked by severe winter weather in the east, the U.S. economy has posted real GDP gains of at least 3.5% in four of the last five quarters. Although the fourth quarter of 2014 is unlikely to match this pace, the momentum of U.S. economic activity is clearly building.
Even including last year’s first quarter, when unseasonably severe winter weather played a big role, economic growth has been notably stronger since mid-2013. After averaging just a 2.0% pace over the first four years of the expansion, average growth has picked up to a 3.1% rate over the past five quarters. Notably, this has all occurred before the recent decline in oil prices, and suggests we were correct to believe the strength in underlying fundamentals of the economy were being held back primarily by the lingering effects of the financial crisis and the unprecedented degree of fiscal tightening.
As those headwinds fade and allow the traditional cyclical drivers of expansion to take hold, economic growth should naturally accelerate. Indeed, now that government spending has finally turned the corner and private sector deleveraging has largely wound down, businesses and households are beginning to enjoy the fruits of an economic recovery that appears to be stronger and more widespread. For households, in response to the strength of job growth over the past year, measures of employment compensation have begun to accelerate, and other survey-based evidence suggests that further increases in wage gains are just around the corner.
At the same time, rising equity portfolios and sustained home price appreciation continue to boost household wealth to all-time record levels, providing consumers the freedom to spend more freely and obtain additional credit. This powerful combination of improving fundamentals has, unsurprisingly, sent consumer confidence soaring, and looks set to finally usher in a sustained period of faster spending growth. Similarly, capital investment has also recently begun to show long-awaited signs of improvement as business owners, emboldened by improving sales, are becoming more focused on how to meet rising demand, rather than on how to hold down costs.
Topping it all off , this is occurring under the best of circumstances, as sluggishness in most other global economies is helping keep inflation, oil prices, and interest rates low. Lower commodity prices, especially for energy, provide particularly strong support for the consumption-centric U.S. economy, generating new purchasing power for consumers and businesses. In fact, the 46.0% plunge in gas prices is expected to add between 0.4% and 0.8% to annual GDP growth in 2015.
If we are correct, the combination of improving domestic demand, rising wages, and a stable core inflation rate should persuade the Fed to begin lifting policy rates by mid-year. While some Federal Open Market Committee members recently hinted at a potentially earlier start, international conditions and the potential for further declines in headline inflation suggest that “patience” is a virtue, and that the pace of Fed tightening will be slow, measured, and as undisruptive to economic activity as possible.
Of course, despite all of these positive developments, clear skies and smooth sailing are not ensured. Though the U.S. is much less exposed to the effects of slowing global growth than other foreign economies, weakening demand around the world and the stronger dollar can be expected to negatively impact U.S. multinational company earnings, the manufacturing sector, and exports. Likewise, geopolitical risks posed by events in Russia, the possibility of another Eurozone crisis, violence in the Middle East, and other unforeseen circumstances have the potential to disrupt financial markets and shake confidence. Nevertheless, with the powerful tailwinds of stronger consumer spending, business investment, and an ending of fiscal drag filling the economy’s sails, we remain upbeat about the voyage ahead.
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