Lately the economy reminds me of a Volkswagen Beetle I borrowed when I was a college freshman. My girlfriend was stranded overnight in a bus station an hour away (long story), and I had to borrow a car to rescue her. The owner of the car warned me that not all the cylinders fired reliably, but this car was the best I could find under the circumstances.
The warnings were on target. The Volkswagen accelerated nicely on each downhill stretch of the hilly highway I had to travel, but there was serious doubt whether the car would make it to the top of each uphill segment. Similarly the long-running U.S. economic recovery remains weak and continues to sputter. Economic releases indicating growing economic strength (home sales and house prices, for instance) alternate with mixed or disappointing signals (weak first-quarter GDP growth and stagnant wage growth).
At the start of the year, we predicted acceleration in real growth, tightening labor markets, and an uptick in inflation that would finally convince the Fed to begin increasing interest rates. Instead, another severe winter in the Northeast, along with a strike in the ports of Los Angeles and Long Beach, generated negative real growth in the first quarter. These events, combined with deterioration in global growth prospects helped push down long-term interest rates in the U.S.
The national unemployment rate ticked up in January to 5.7 percent, then resumed its steady improvement to its current mark of 5.3 percent, the lowest rate since early 2008. However growth in employment remained weak to moderate, a reflection of the continuing decline in the labor force participation rate. Nonfarm payroll employment growth averaged only 195,000 jobs per month in the first quarter of this year, dropping from an average of 324,000 in the last quarter of 2014. The pace picked up a bit in the second quarter of this year, to an average of 221,000 per month, however the data on wage growth has been mixed.
The housing market posted convincing gains despite the winter weather. Home sales are on track for the best year since 2007. Pending home sales data in May recorded the highest volume in over nine years. However, it's important to remember that, despite these gains, housing market activity has not yet fully recovered.
We expect the economy to post a stronger second half, especially in the housing sector. Real growth should average a bit over 3 percent, and the unemployment rate will decline a little bit more in the next six months. Wage gains, which have disappointed so far, should accelerate.
The recovery from a weak first quarter accounts for some of the expected strength in the second half of the year. A second factor is the Federal Reserve's decision to defer any tightening of monetary policy until compelling evidence accumulates for a stronger labor market and inflation near the Fed's 2 percent target rate. By delaying to September – or possibly later – the interest rate increase that had been expected in June, the Fed is giving the economic engine more time to quit sputtering and to start hitting on all cylinders.
The housing sector will benefit from the delay in monetary tightening. For the year as a whole, we expect housing starts to increase 14 percent and single-family mortgage originations to increase 8 percent. Strong housing demand combined with continued tight supply, should boost house prices by over 4 percent this year. The improvement in house prices should support an eventual increase in the supply of homes for sale as the number of homeowners with negative or negligible equity continues to shrink. Nonetheless supply is expected to remain on the tight side.
Overseas events – the Greek debt crisis, financial volatility in China, etc. – may put a damper on the U.S. economy in the second half. The recent depreciation of the euro and some Asian currencies pose a more-concrete risk to the U.S. economic outlook. Our forecast already incorporates an expectation that declining net U.S. exports will dampen real growth by 0.3 percent this year, but increasing headwinds overseas could reduce export demand even further.
My experience with the not-entirely-reliable borrowed Volkswagen had a happy ending. Several times I was convinced I was facing a grade that would bring the car to a complete and final stop, but each time the car painfully chugged its way over the top of the hill. I did feel guilty about the frustrated drivers stuck behind me as the car slowed to a crawl. But, after a nerve-racking journey, I successfully retrieved my stranded girlfriend – and she eventually married me.
Similarly, we expect the U.S. economy eventually to reach its destination – full employment, steady growth, a fully-recovered housing market – but not without continuing frustration with the stops and starts and unevenness of its progress. In the absence of some unexpected significant disruption, the sputtering progress of this recovery should slowly get us there.
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