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Monday, October 10, 2016

Q3 Review: Ten Economic Questions for 2016

by Calculated Risk on 10/10/2016 09:59:00 AM

At the end of last year, I posted Ten Economic Questions for 2016. I followed up with a brief post on each question. The goal was to provide an overview of what I expected in 2016 (I don't have a crystal ball, but I think it helps to outline what I think will happen - and understand - and change my mind, when the outlook is wrong).

By request, here is a quick Q3 review. I've linked to my posts from the beginning of the year, with a brief excerpt and a few comments:

10) Question #10 for 2016: How much will housing inventory increase in 2016?

Right now my guess is active inventory will increase in 2016 (inventory will decline seasonally in December and January, but I expect to see inventory up again year-over-year in 2016). I don't expect a double digit surge in inventory, but maybe a mid-single digit increase year-over-year.  If correct, this will keep house price increases down in  2015 (probably lower than the 5% or so gains in 2014 and 2015).
According to the August NAR report on existing home sales, inventory was down 10.1% year-over-year in August, and the months-of-supply was at 4.7 months.  It now appears inventory will decrease in 2016.  I changed my view on this earlier this year.

Two of the key reasons inventory is low: 1) A large number of single family home and condos were converted to rental units. Last year, housing economist Tom Lawler estimated there were 17.5 million renter occupied single family homes in the U.S., up from 10.7 million in 2000. Many of these houses were purchased by investors, and rents have increased substantially, and the investors are not selling (even though prices have increased too). Most of these rental conversions were at the lower end, and that is limiting the supply for first time buyers. 2) Baby boomers are aging in place (people tend to downsize when they are 75 or 80, in another 10 to 20 years for the boomers). Instead we are seeing a surge in home improvement spending, and this is also limiting supply.

9) Question #9 for 2016: What will happen with house prices in 2016?
Low inventories, and a decent economy suggests further price increases in 2016. However I expect we will see prices up less in 2016, than in 2015, as measured by these house price indexes - mostly because I expect more inventory.
If is early, but the recently released Case-Shiller data showed prices up 5.1% year-over-year in July. The price increase is a little lower than in 2015 (prices were up 5.25% nationally in 2015), even with less inventory.

8) Question #8 for 2016: How much will Residential Investment increase?
My guess is growth of around 4% to 8% in 2016 for new home sales, and about the same percentage growth for housing starts. Also I think the mix between multi-family and single family starts will shift a little more towards single family in 2016.
Through August, starts were up 6.1% year-over-year compared to the same period in 2015.  New home sales were up 13.3% year-over-year.  My guess is starts will increase about 4% to 8% this year (as expected), new home sales will be little higher.

7) Question #7 for 2016: What about oil prices in 2016?
It is impossible to predict an international supply disruption, however if a significant disruption happens, then prices will move higher. Continued weakness in Europe and China seems likely, however sluggish demand will be somewhat offset by less tight oil production. It seems like the key oil producers (Saudi, etc) will continue production at current levels. This suggests in the short run (2016) that prices will stay low, but probably move up a little in 2016. I'll guess WTI will be up from the current price [WTI at $38 per barrel] by December 2016 (but still under $50 per barrel).
As of this morning, WTI futures are at $51 per barrel.

6) Question #6 for 2016: Will real wages increase in 2016?
For this post the key point is that nominal wages have been only increasing about 2% per year with some pickup in 2015. As the labor market continues to tighten, we should start see more wage pressure as companies have to compete more for employees. I expect to see some further increase in nominal wage increases in 2016 (perhaps over 3% later in the year). The year-over-year change in real wages will depend on inflation, and I expect headline CPI to pickup some this year as the impact on headline inflation of declining oil prices fades.
Through September, nominal hourly wages were up 2.6% year-over-year. This is a pickup from last year - and wage growth appears to be trending up. It looks like Wages will increase at a faster rate in 2016.

5) Question #5 for 2016: Will the Fed raise rates in 2016, and if so, by how much?
I've seen several people arguing the Fed will be cutting rates by the end of 2016 - I think that is unlikely. Instead I think the Fed will be cautious - and they will not want to reverse course. Right now I think something around three rate hikes in 2016 is likely.
Events have pushed the Fed to delay rate increases, and it now looks like zero or one are the most likely number of rate hikes in 2016.  My guess right now is the Fed will hike rates in December.

4) Question #4 for 2016: Will the core inflation rate rise in 2016? Will too much inflation be a concern in 2016?
Due to some remaining slack in the labor market (example: elevated level of part time workers for economic reasons), I expect these measures of inflation will be close to the Fed's target in 2016.

So currently I think core inflation (year-over-year) will increase further in 2016, but too much inflation will not be a serious concern in 2016.
It is early, but inflation has moved up close to the Fed target through August.

3) Question #3 for 2016: What will the unemployment rate be in December 2016?
Depending on the estimate for the participation rate and job growth (next question), it appears the unemployment rate will decline to around 4.5% by December 2016. My guess is based on the participation rate declining slightly in 2016 and for decent job growth in 2016 (however less in 2016 than in 2015).
The unemployment rate was 5.0% in September, unchanged from 5.0% in December.  I still expect the unemployment rate to decline later this year.

2) Question #2 for 2016: How many payroll jobs will be added in 2016?
Energy related construction hiring will decline in 2016, but I expect other areas of construction to be solid. For manufacturing, growth in the auto sector will probably slow this year, but the drag on manufacturing employment from the strong dollar should be less in 2016.

As I mentioned above, in addition to layoffs in the energy sector, exporters will have a difficult year - but probably not the severe contraction as in 2015, and more companies will have difficulty finding qualified candidates. Even with some boost from lower oil prices - and some additional public hiring, I expect total jobs added to be lower in 2016 than in 2015.

So my forecast is for gains of around 200,000 payroll jobs per month in 2015. Lower than in 2015, but another solid year for employment gains given current demographics.
Through September 2016, the economy has added 1.6 million jobs; or 178,000 per month.  It now appears employment gains will be lower than in 2015 (as expected), and somewhat below 200,000 per month in 2016.

1) Question #1 for 2016: How much will the economy grow in 2016?
In addition, the sharp decline in oil prices should be a net positive for the US economy in 2016. And, hopefully, the negative impact from the strong dollar will fade in 2016. The most likely growth rate is in the mid-2% range again ...
GDP growth was sluggish again in the first half (just up 1.1% annualized), and GDP is now tracking 2.1% in Q3.

Currently it looks like 2016 is unfolding mostly as expected with some key exceptions (one of the reasons I write down what I think will happen).  I changed my view on Fed rate hikes earlier this year, and now I expect only 1 hike in 2016.  I've also revised down my outlook for GDP and existing home inventory is declining again this year.

Residential investment, house prices, oil prices, inflation, wage growth and employment are unfolding about as I expected.