Published in Economic Development

Optimism percolates as national economic policy comes into focus

BY Sunday, December 25, 2016 07:37pm

President-elect Donald Trump will enter office in January with an economy that experts say is stable and growing, but one that could probably do better.

How much better may well depend on what kind of stimulus package and tax reforms the new president proposes and Congress enacts to drive economic growth higher in 2017 and beyond. 

President-elect Trump has said he wants a massive $1 trillion, 10-year infrastructure plan. That kind of federal spending, combined with a cut in the corporate tax rate the president-elect also plans to seek, would drive economic growth and potentially bring millions of people back into the workforce “if growth were stronger than it is in this current state of things,” said PNC Bank economist Kurt Rankin.

“There’s still going to be debate and negotiation on how big or small those packages are, but we do expect them to be implemented and enhance our stronger growth forecast for the second half of 2017 and going into ’18,” Rankin said.

Real GDP growth for the U.S. was 3.2 percent for the third quarter. PNC projects fourth quarter Real GDP growth of 2.2 percent and 1.5 percent for all of 2016, followed by 2 percent in the first quarter of 2017 and 2.3 percent in the second quarter. PNC expects growth to inch higher in the latter half of the year.

Economists elsewhere are projecting similar national economic growth.

The University of Michigan’s latest outlook issued last month predicts 2.3 percent growth in Real GDP in 2017 and 2.1 percent growth in 2018, with lower unemployment nationally and increases in home construction and housing sales. The Federal Reserve forecasts Real GDP growth of 2.1 percent for next year.

Economist Mitch Stapley, chief fixed income officer at ClearArc Capital in Grand Rapids, expects Real GDP growth of “2 percent-plus” in 2017, and maybe as high as 2.5 percent. Corporate tax reform and an infrastructure spending package are likely in 2017, although Stapley cautions against “getting too exuberant” and expecting quick action by Congress.

Fiscal hawks “are not just going to rubber stamp” higher federal spending and restructuring of the tax code, Stapley said. 

“It’ll come. It just won’t come as fast as people would think or hope it’s going to be coming,” Stapley said. “It’s something that’s going to require a fair amount of time.”

Comerica Inc. projects annualized Real GDP growth of 3 percent for the first quarter of 2017 and 2.9 percent for the full year.

Real GDP growth for the third quarter of 2016 was upgraded recently to 3.2 percent and Robert Dye, Comerica’s chief economist, expects a similar result for the fourth quarter after a “fairly weak” start to the year.

“It looks like as we end 2016, the U.S. economic momentum is increasing,” Dye said. “The U.S. as a whole is in pretty good shape.”

OPTIMISM BUILDS

Members surveyed by Business Leaders for Michigan agreed with the notion that the U.S. economy continues to strengthen. In a quarterly economic survey conducted after the Nov. 8 presidential election, the Detroit-based business roundtable found far greater optimism among executives in Michigan than it did a few months earlier.

Among the CEOs and university presidents in the state who answered the survey, 74 percent expect the U.S. economy to improve in the next six months, compared to 8 percent in the prior survey last summer. 

The new findings were the most optimistic response ever in the Business Leaders for Michigan’s survey.

Eighty-four percent of survey respondents believe the U.S. economy will continue to improve over the next 18 months, versus just 13 percent three months earlier.

“Michigan’s business leaders have substantially improved economic outlooks this quarter,” said Doug Rothwell, president and CEO of Business Leaders for Michigan. “Optimism was deteriorating over the last year headed into the November elections, but dramatically improved after the election this quarter. Getting the election behind us removed uncertainty for the market and resulted in renewed hope that long-standing policy and regulatory issues might get addressed, particularly at the federal level.”

MORE CAPITAL TO INVEST? 

While the U.S. economy “should and could use stronger growth” based on the labor force participation, it remains “stable, solid and strong” and growing at a moderate rate that Rankin says is not necessarily a bad thing.

“There are benefits to a long, stable pace of growth, as opposed to a boom or a bust. One of the benefits is we don’t really have any bubbles we’re looking at or any imbalances in the U.S. economy as we head into 2017,” he said. “Offsetting that is we’re just now starting to see wage growth accelerate, which is something that’s been missing through much of the economy but looks to be returning in 2017.”

PNC Bank built its U.S. economic forecast based on expectations that 2017 will see some kind of infrastructure spending and corporate tax reform with the new presidential administration.

A reduction in the corporate tax rate would make the U.S. more competitive globally and “put more money into businesses’ coffers (and) available for investment” at a time when corporate earnings remain in good shape, Rankin said.

“This isn’t for lack of money. Business profits have been solid. They’ve been a little weaker than they were in the earlier parts of the recovery, but businesses are making money and interest rates are low as an incentive to invest. So if corporate tax rates are lowered, all of a sudden there is a new injection of money available for businesses,” he said. “At some point, the scale has to tip and businesses need to look at their balance sheets and say, ‘This money has to be put to use.’”

Amid the expectations for an infrastructure stimulus package and corporate and income tax reform are worries about what they will do to the federal debt, particularly as monetary policy tightens and interest rates rise.

While a stimulus package and tax reform could spur higher economic growth, both need to take into account the potential unintended consequences, Dye said.

“This is going to be a really interesting balancing act for the Trump administration to put some sort of meaningful boost to the economy without pushing the debt too high and pushing interest rates too high as a consequence,” he said.

A MATTER OF INTEREST (RATES)

Dye and others expect to see two increases in 2017 — at midyear and at the end of the year — of a quarter-point each in the federal funds rate, which would come on top of the quarter-point hike the Federal Open Market Committee made earlier this month with indications for more increases in 2017. An uptick in inflation and a stronger economy could result in more than two interest rate increases in 2017, Dye said.

Interest rates have been at historic lows since the financial crisis in the fall of 2008 and the subsequent Great Recession. Many economists view higher rates as being long overdue.

“We are looking at gradually higher interest rates over time, but not radically higher. I’m not expecting this to be a huge cost burden on businesses or consumers, just a gradual set of increases over the next couple of years,” Dye said. “This has been an absolutely unprecedented period and we’ve been in it for a long time, so it starts to feel normal. It’s important for people to realize that this is not normal and the Federal Reserve is trying to normalize it. They want to have interest rates up a little bit so they have some space to do some things in the next downturn.

“There will be another recession out there, and the Federal Reserve will have to respond at some point, and so they need to position themselves while the economy is still strong and (can) tolerate higher rates.”

Stapley at ClearArc Capital anticipates two quarter-point increases in the federal funds rate in 2017. Some interest rates have been going up already this year, he said.

HEADWINDS EMERGE

While the U.S. economy will remain in good shape, higher interest rates could cause a slowing in home and auto sales as the cost of credit rises.

“Manufacturing and housing are not going to have the wind behind them from interest rates at multi-year lows like they have for the previous six or seven years,” Stapley said. “Will it derail the economy? No. But it’s going to be a headwind.”

Another potential headwind in 2017 is that higher interest rates and a stronger U.S. economy will make the dollar stronger, possibly hurting exports, particularly for businesses in border states such as Michigan, according to Dye and Rankin.

Exports account for about 13 percent of the U.S. economy, Rankin said, noting the incoming president needs to take care not to make the U.S. dollar too strong.

“There are going to be international concerns,” Rankin said.

President-elect Trump also wants to re-negotiate trade agreement such as NAFTA, the North American Free Trade Agreement enacted in 1994 under President Bill Clinton. As with the strength of the dollar, the new president needs to tread carefully to negotiate a better agreement for the U.S. and do so without triggering a trade war, Dye said.

Dye’s encouraged that since the election, the president-elect has been “pivoting away from some of the very aggressive campaign rhetoric” on foreign trade.

“No one wins in a trade war, but I think the Trump administration is going to be a little smarter than that,” Dye said. “An out-and-out trade war would be a lose-lose for everybody, and I don’t expect to see that.”

University of Michigan economists hold the same view. They wrote in an outlook issued in mid-November that they are “cautiously optimistic that incoming policymakers will avoid any major disruptions to international trade.”

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