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U.S. economy in 2015: Not too hot, not too cold

Several long-term trends will determine America’s economic future, according to John Lonski, managing director and chief financial markets economist of Moody’s Analytics. Careful monitoring and interpretation of those trends for the period of 2010-2013 earned him the 2014 Lawrence R. Klein Award for Blue Chip Forecast Accuracy presented by the W. P. Carey School of Business.

2014-10-23

Several long-term trends will determine America’s economic future, according to John Lonski, managing director and chief financial markets economist of Moody’s Analytics. Careful monitoring and interpretation of those trends for the period of 2010-2013 earned him the 2014 Lawrence R. Klein Award for Blue Chip Forecast Accuracy presented by the W. P. Carey School of Business. “Goldilocks should be scared,” said Lonski as he presented his economic forecast for 2015 following the presentation of the award. A ‘Goldilocks economy’ is neither too hot nor too cold and Lonski said he sees indications that the perfect temperature may prove elusive. “When you have the average speculative-grade bond yield rise by more than one and a half percentage points over just a couple of months’ time,” he said, “that’s a warning that credit is becoming less available to businesses. If this goes on, you’re going to have some serious problems with business activity.” The prestigious award, named for Nobel Memorial Prize winner Lawrence J. Klein, is awarded to the individual or team with the most accurate economic forecast among some fifty Blue Chip Economic Indicators survey participants over the most recent four-year period. The Blue Chip newsletter has been published for nearly 40 years and is regarded as the “gold standard” of business forecasts. Editor Randall Moore moderated the award ceremony honoring Lonski October 16 at New York’s University Club. Also attending were W.P. Carey School of Business Dean Amy Hillman and Hannah Klein, daughter of Mr. Klein. Lonski was introduced by W. P. Carey economics Professor Dennis Hoffman, who called the recipient of the award a “remarkable prognosticator.” The fifty economists on the Blue Chip panel, Hoffman explained, were “trying to forecast an economy that was clearly weighed down by a subpar recovery from the worst overall contraction since the Great Depression.” John Lonski’s average error in his forecasts for the four key indicators over four years was just three-tenths of a percent, Hoffman pointed out. “That’s the most accurate forecast in the past five years.” Among his other honors, Lonski was named top economic forecaster in the Wall Street Journal’s survey of June, 2004. He contributes frequently to CNBC, Fox Business News, Business News Network, the Wall Street Journal Radio Network, Bloomberg News and NPR. Lonski is often cited in leading publications including the Wall Street Journal, New York Times, Barron’s, Reuters and the Financial Times. Underpinnings for 2015 forecast Despite recent blips in this indicator, Lonski’s outlook for 2015 is that real GDP will gain speed while inflation holds steady. “This recovery is going to remain the dullest and most disinflationary since the 1940s,” he predicts. “I see real GDP growth coming up from this year’s 2.2 percent to a prospective 2.8 percent in 2015. If that happens, it means the average rate of growth of the economy during the recovery is 2 percent. That’s pretty lousy compared to the three previous upswings.” Several factors are creating “secular deceleration of economic activity,” according to Lonski. “The good news is that I think we’re in the process of forming a bottom for economic growth in a range of 2 to 2.5 percent going forward.” He points out that some of those same factors are taming inflation. “The global slack, an aging workforce and a stronger dollar should go far in containing inflation risks in 2015,” he said. The annual rate of CPI inflation he expects next year is 1.8 percent. “Over the near term, you’re going to find the annual rate of PCE (personal consumption expenditure) price inflation, the Fed’s favorite measure of inflation, slowing from its latest 1.5 percent to 1.3 percent and will probably finish the year closer to 1 percent than to the Fed’s target of 2 percent.” That’s why, he said, some high Federal Reserve officials are currently talking about an extension of quantitative easing for the purpose of boosting inflation expectations. Lonski drew numerous comparisons with the last three recoveries, pointing out how much they differ from the current slow climb. “In the second quarter, we had gains of real after-tax income and real consumer spending of roughly 2.5 percent,” he said. “Historically, those are really disappointing results given that the unemployment rate dropped by more than 1 percent and growth of payrolls of nearly 2 percent.” Using comparisons from history, he said, “We should find after-tax income growth of 3.5 percent and real consumer spending up by 3.8 percent. It’s not happening.” Demographics make this recovery different A profound change in demographics for the U.S. is partly to blame, according to Lonski. “Something like this has already taken place in Japan and it’s also unfolding in Europe.” Pointing to historic data, he explained “Prior to 2007, the working age population (16-64) was growing by about three million people per year. Senior citizens ages 65 and older were growing by a half million people. We’re going through a transition now and, going forward, we’re going to see this relationship almost reverse itself. By the end of this decade, we will find senior citizens growing by nearly two million per year while the working age population grows by a half million.” The resulting effect? “This dramatic change is going to rein in economic growth, consumer spending and inflation for some time to come.” He believes this changing skew in employment growth toward older Americans has curbed gains in income and spending. “There has been quite a change in the age distribution of people who are actually working,” he observed. “As of September, 2014, we have a 4.7 percent cumulative increase in household survey employment since June, 2009. But that increase was unevenly divided. There was a meager less than one percent rise in the employment of those aged 16 to 54, while there was a 20.4 percent advance in the employment of those aged 55 and older.” Lonski says anecdotal evidence shows that many people in this category lost their jobs in the Great Recession and were rehired later as contract workers at a reduced salary. “If you’re skewing employment growth to these older workers,” he points out, “you’re going to get slower income growth and slower growth in spending.” This is a historical trend playing out, according to Lonski. “In the late 1970s, nearly 23 percent of those employed were between the ages of 16 and 24. These are horrible workers! They have low productivity, they’re unreliable and they spend like crazy!” he said. “Now, though, we have 23 percent of employment consisting of workers 55 and older.” His data shows the 16-24 year-olds now represent only about 12 percent of the workforce. “We’ve gone from an economy with a strong inflationary bias in the 70s to a disinflationary bias today.” Far from a tight labor market He identified another data point in the current recovery that differs significantly from those in the past. “The current recovery’s payrolls look weak in comparison to 2008’s previous peak and the accompanying increase in the working age population,” he explained. “As of September, we were in the 63rd month of the economic recovery. Since January, 2008, we’ve added 1.1 million jobs. However, at the same time, the number of Americans aged 16 to 64 is up by seven million people.” The change in jobs, he points out, approximated only 15 percent of the change in the number of working-age Americans. In the three previous recoveries, he says, the change in employment by the 63rd month equaled 70 percent of the change in population. “That tells me we have some ways to go before we have a tight labor market and before we have to worry about wage inflation.” Overall, Lonski predicted, “Unemployment is going to continue to decline. It’s now 5.9 percent. By the final quarter of 2015, it should average 5.4 percent.” That’s a positive sign. “We don’t tend to think of the unemployment rate as a leading indicator, but prior to each of the previous three recessions, it bottoms and turns higher,” he said. “I don’t think we have any reason to be nervous going into 2015 and 2016.” Another factor in the slow recovery, Lonski said, is the “prolonged slide by real family incomes in the United States that hints at a weakened middle class. Real median pre-tax family income peaked in 2004 and has been moving lower ever since. You’re not going to get the same lift to consumer spending you got in the past if the middle class is shrinking.” This contributes to the changing composition of the labor market. “Let’s not forget that many senior citizen baby boomers don’t have much in the way of retirement savings,” he said. “Their 401Ks aren’t what they used to be and they may be saddled with low or even negative home owner’s equity. These guys are going to stay in the labor force.” He also points out that seniors often leave the workforce only to return later at a lower salary. “The young people today not only have to worry about the emerging market countries, they also have to worry about the re-entry of senior citizens into the labor market.” Lonski says that lack of savings coupled with lower home equity means “roughly one-third of all U.S. households now live from paycheck to paycheck.” That’s why, he said, even though “we’ve had a pretty strong equity market and some recovery in home prices, consumer spending is not responding.” Looking at the recovery in another way, he says, “Not only do we have a skewed distribution of income, we have a more skewed distribution of wealth. This is not an equal opportunity recovery. Not everybody has been invited to the party.” Emerging markets drive global growth Global influences play a large role in Lonski’s forecasts. As he explained, “Projected world economic growth is better. It goes from 3.1 percent in 2014 to 3.4 percent in 2015. Advanced economies actually make it up to 2 percent growth. That’s a rarity. Emerging market countries do a little bit better. They go from 4.1 to 4.3 percent.” He added, “Material downside risk in emerging market countries matters more because they now generate 51 percent of global growth. That’s up from 40 percent ten years ago and 35 percent back in 1998.” He explains that “Global slack is depressing bond yields, especially in the United States. The current 2.16 percent U.S. Treasury ten-year yield actually looks generous compared to Japan’s less than 0.5 percent, Germany’s 0.8 percent, France’s 1.26 percent and Canada’s 1.93 percent. We’re going to have a convergence of the U.S. 2.2 percent and Canada’s 1.9 percent.” Among other contributors to the 2015 economic forecast, he believes “Public sector spending will again lag the private sector. State and local spending will grow by 1 percent in 2015, private sector spending closer to 3 percent. I assume Washington will adhere to its budgetary restraints.” He forecasts the corporate high yield default rate will rise from 2014’s 1.7 percent to “a mild and manageable 2.4 percent.” Lonski is bullish on capital spending but notes a sea of change in this recovery. “The growth in core profits favors growth in business capital spending. In real terms in 2015, business spending is probably going to grow by 4.5 percent. There’s been a switch in this relationship, however. Prior to 2008, capital spending growth topped profits by 40 percent on average. Now they move together. Companies are making more money but the growth of capital spending is not keeping pace with the growth of core profits.” His projections for year-end 2015 are for 0.5 percent to 0.75 percent rate for federal funds, and 2.75 percent to 3 percent for the ten-year Treasury yield. In summary, Lonski said he sees modest improvement for the U.S. economy next year. “Disruptive swelling of inflation risk is unlikely,” he added. “Downside risks include global wage and price deflation and failure on the part of businesses and labor to recognize the limited upsides for wages and prices.”

Economic Development & International Trade Economics