U.S. Economy is up 2 in the top of the 8th

• The Federal Reserve hiked rates and the 10 year bond went from 2.6% back down to 2.3%[1]
• The fall in rates suggests the market believes the Fed has properly timed its rate moves so far
• Adding 2 million more jobs in 2017 will keep slight upward pressure on overall wages
• Continued steady jobs growth will also support consumption which we expect to be 2.3% for 2017
• Globally, the manufacturing cycle is turning positive with upticks seen in Europe, Asia and the U.S.
• The effectiveness of the Republicans at governing is likely to impact animal spirits and GDP; success means positive impact, inaction means negative

The U.S. economy is plodding along. Jobs growth continues to expand. With sustained employment, many households feel more comfortable spending and consumption remains the backbone of the U.S. economy. However, we are in the 8th inning of the expansion in many respects. Auto purchases are widely expected to soften slightly this year as interest rates move higher and the auto fleet age continues to grow (11.4 years is the average age of the U.S. auto fleet[2]) due to higher quality cars being produced. Another sector impacted by higher interest rates is housing. Because in the initial quarters of a rate hiking cycle, consumers that are planning to purchase or remodel tend to bring forward that decision we expect housing to remain strong well into the 4th quarter of this year. However, a faster hiking cycle or steeper home price increases could choke off growth in this sector, somewhat reducing the pace of GDP growth.

Turning to business investment the picture is less rosy. The slow pace of business investment is a puzzle. It could be due to the slow pace of growth overall. It could also be due to the fact that investment has become more efficient and that the knowledge/service economy requires a lower pace of investment. It could also be due to business pessimism over a range of issues from the level of government debt to the steady increase in regulations to the dimming outlook for potential GDP. Oil and gas CapEx sustained investment growth from 2010-2014 when oil prices fell over 70%. In order to see a significant improvement in CapEx the economy likely needs to see oil sustain above $60/barrel. The chart above shows that unless OPEC continues to reduce output, or unless demand increases substantially, oil prices are likely to remain below $60 a barrel.

Ask the Economist

Turning to a new section of the U.S. economic update, I would like to address some of the questions I receive when giving talks around the country. One of the questions I am frequently asked is “Do you believe the unemployment statistics?” This question stems, I believe, not so much from distrust of the good folks at the Bureau of Labor Statistics, but from the changing nature of work and the fact that most people know at least one if not three or four people who have been displaced in the past decade. In fact the U-6 unemployment rate which registers 9.4% and covers those who have given up looking for work but would like to have a job, is part of the exact same survey as the U-3 unemployment rate, also known as the headline rate which registers 4.7%. 

For non-economists the difference between these rates may seem pointless. Let me explain. The three unemployment rates are useful in their own right and all are necessary to fully understand the labor market on both a cyclical and structural basis. 

The U-3 rate measures those who are actively looking for work. The reason this is important is that these are the people who determine the wage level. Like all jobs in today’s economy, up to date knowledge of the latest technology is at the very least a significant plus if not an absolute requirement. Thus those who have actively looked for work over the past 12 months are generally hired more readily than those who are so-called marginally attached to the workforce because they are perceived to have more relevant skills. When pundits in the media talk about the unemployment rate, they are speaking of the one that influences inflation, and hence Federal Reserve Policy rates.

The BLS publishes the various unemployment rates so that economists and policy makers can receive information about structural changes in the labor force. The   U-6 unemployment rate’s extreme rise after the recession and it’s still elevated level tells us that there are significant structural shifts in the labor market. Other data show that workers who perform routine tasks in both manual and cognitive jobs have lost out during this recovery. That phenomenon explains a significant part of the elevated U-6 rate. The U-6 tells us where social policy needs to lend a helping hand but it does little to help determine wages and future inflation.

[1] Bloomberg, closing price March 29, 2017

[2] US Department of Transportation, December 2014