The US Economy Has Reached A Turning Point
Two key trends will solidify the recovery in 2015: higher wages as unemployment falls below 6%, and an expansion in consumer credit as households reach the end of the debt deleveraging cycle.
Despite some downside risks posed by higher interest rates and weak demand from Europe, we expect a steady economic expansion over the next year.
The economy powered ahead in the second quarter by 4.6% at an annual rate, matching the fastest quarterly growth rate since 2006. Bouncing back from the weather-induced downturn in the first quarter, growth was boosted by improvements across all sectors, including consumer spending, residential and non-residential fixed investment, net exports and government spending.
Growth appeared to have been reasonable in the third quarter (official results won't be known for a few weeks) and economic data suggests it was above 3% at an annual rate. Consumer spending rose 0.5% month on month in August, pushed up by auto sales, which reached an eight-year high.
However, according to a recent poll from the Public Religion Institute, more than 70% of the population think the economy is still in a recession. This is unsurprising. The unemployment rate is still elevated, millions of Americans are out of work, and the recovery still has some distance left to run. Recessions caused by systemic financial crises do greater damage to the underlying economy than a business-cycle recession, and the economy takes longer to fully recover.
Two influential academics, Carmen Reinhart and Ken Rogoff, found that post-war economies have required, on average, four and a half years to reach the same GDP per head they had before a financial crisis, that unemployment rates take a similar time frame to hit bottom, and that housing prices take even longer. That said, by those standards, the US has, in fact, bounced back quite strongly from the 2008 crash.
Higher wages and lower debt will power economic growth
The Economist Intelligence Unit expects two key trends to support strong economic growth in the coming months, ensuring that the recovery starts to feel real for more Americans. The economy is driven, for the most part, by consumers-private consumption accounts for almost 70% of GDP. These consumers can choose to take one of three actions with their income; spend it, save it or use it to pay down debt.
Household debt exploded when the housing market crashed and Americans have been spent much of the past six years reducing debt to a more manageable level. However, the ratio of household debt to disposable income dropped below 100% in the second quarter of 2014, the lowest level since 2002, and the debt-deleveraging cycle is coming to a close.
Consumers will gradually take on more credit, devoting less of their income to paying down debt, and ploughing more of it back into the economy. This is in stark contrast to the US's northern neighbour, Canada, which was relatively sheltered from the global financial crisis but where household debt levels have reached unprecedented levels.
The second key trend is in the labour market: the unemployment rate fell to 6.1% in August and the US is on track for its best year of job creation since 1999. The Federal Reserve (Fed, the central bank) has said 6.1% unemployment is a tipping point for wage acceleration; a tighter labour market puts upward pressure on real wages, as nominal wage growth outpaces inflation.
This will put more money in the pockets of employees, increasing household wealth and supporting consumer spending. One caveat to this unemployment forecast is the slump in the labour force participation rate, which has averaged 62.9% so far this year, well below the average of 66% in 2008.
Some analysts have suggested that strong job creation will attract more workers back to the labour force, adding to labour market slack, and that the unemployment rate will stall above 6%. However, we think that some of the decline in labour force participation is structural, owing to the ageing of the labour force and the growing number of Americans claiming disability, and we expect the unemployment rate to decline below 6% in the months ahead.
Things are looking up
While higher wages and lower debt will be the two major trends shaping the economy, there are also several other forces lining up to support US growth. On the political front, the EIU has, for a long time, expected little policy action from the government, as the sharp ideological split between Democrats and Republicans makes political compromise and passage of legislation difficult.
Nevertheless, with the mid-term elections approaching in November, the post-election "lame duck" session presents the best chance of bipartisan action for some time. In addition, more than three years of austerity have mended the public accounts, and government spending is gradually starting to support economic growth again; public spending increased by 1.7% at an annual rate in the second quarter.
Lower energy prices will also provide a lift, reducing business costs and lowering petrol prices for the car-dependant American consumer. Despite a summer of heightened sectarian violence in the Middle East and a political stand-off between Russia and the West over Ukraine, global oil prices actually declined to a two-year low this week.
A glut of oil in the Atlantic basin, a partial recovery in Libya's output, a stronger US dollar and weak global demand have contributed to the low prices. In addition, in the longer term, the "shale gas revolution" in the US will add to downward pressure on domestic energy costs. Production has ramped up so fast that the US will be the world's largest oil producer next year (counting crude oil and natural gas liquids).
Still some downside risk
There are, however, risks to this rosy scenario, and the contraction in the first quarter of this year was a timely warning to expect the unexpected. Looking ahead, three headwinds are clearly visible. First, we expect the Fed to start tightening monetary policy in the summer of 2015, which will make it more expensive for consumers to borrow, dampening spending.
Second, the outlook for the housing market is soft, owing to low inventories, a decline in distressed sales, and difficulties facing first-time buyers trying to get on the ladder. The third downside risk comes from the euro zone, which ground to a halt in the second quarter of 2014 as sanctions imposed by Russia took a toll on Germany, the growth engine of the bloc for the past few years.
Nevertheless, we expect the US to take these obstacles in its stride and, with several quarters of steady growth ahead, it will finally shed some of the deep scars left by the financial crisis. On balance, the economy is in better health than it has been for some time. More Americans are working than ever before, consumers are carrying a lighter debt burden, and salaries are finally set to start rising for beleaguered US employees.
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