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Wednesday, December 27, 2017

Q4 Review: Ten Economic Questions for 2017

by Calculated Risk on 12/27/2017 11:59:00 AM

At the end of last year, I posted Ten Economic Questions for 2017. I followed up with a brief post on each question. The goal was to provide an overview of what I expected in 2017 (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).

Here is a Q4 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 2017: Will housing inventory increase or decrease in 2017?

right now my guess is active inventory will increase in 2017 (inventory will decline seasonally in December and January, but I expect to see inventory up again year-over-year in December 2017).   My reasons for expecting more inventory are 1) inventory is historically low (lowest for November since 2000), 2) and the recent increase in interest rates.
According to the November NAR report on existing home sales, inventory was down 9.7% year-over-year in November, and the months-of-supply was at 3.4 months. I was definitely wrong.  Inventory will be a key metric to watch in 2018.

9) Question #9 for 2017: What will happen with house prices in 2017?
Inventories will probably remain low in 2017, although I expect inventories to increase on a year-over-year basis by December of 2017.  Low inventories, and a decent economy suggests further price increases in 2017.

Perhaps higher mortgage rates will slow price appreciation.  If we look back at the "taper tantrum" in 2013, price appreciation slowed somewhat over the next year - but that was from a high level.  In June 2013, the Case-Shiller National index was up 9.3% year-over-year.  By June 2014, the index was up 6.3% year-over-year.

If inventory increases year-over-year as I expect by December 2017, it seems likely that price appreciation will slow to the low-to-mid single digits.
The Case-Shiller data released yesterday showed prices up 6.2% year-over-year in November.  With falling inventory, house prices increased faster in 2017 than in 2016.

8) Question #8 for 2017: How much will Residential Investment increase?
Most analysts are looking for starts to increase to around 1.25 million in 2017, and for new home sales of around 600 to 650 thousand. This would be an increase of around 7% for starts and maybe 10% for new home sales.

I think there will be further growth in 2017, but I think a combination of higher mortgage rates, less multi-family starts, and not enough lots for low-to-mid range new homes will mean sluggish growth in 2017.

My guess is starts will increase to just over 1.2 million in 2017 and new home sales will be in the low 600 thousand range.
Through November, starts were up 3.1% year-over-year compared to the same period in 2016.  And new home sales were up 9.1% year-over-year.   About as expected.

7) Question #7 for 2017: How much will wages increase in 2017?
As the labor market continues to tighten, we should see more wage pressure as companies have to compete for employees. I expect to see some further increases in both the Average hourly earning from the CES, and in the Atlanta Fed Wage Tracker.  Perhaps nominal wages will increase more than 3% in 2017 according to the CES.
Through November 2017, nominal hourly wages were up 2.5% year-over-year. This is a decrease from last year, and it appears wages will increase at a slower rate in 2017.  Wages were disappointing in 2017.

6) Question #6 for 2017: Will the Fed raise rates in 2017, and if so, by how much?
Analysts are being cautious on forecasting rate hikes, probably because they forecasted too many hikes over the last few years. However, as the economy approaches full employment, and with the possibility of fiscal stimulus in 2017, it is possible that inflation will pick up a little - and, if so, the Fed could hike more than expected.

My current guess is the Fed will hike twice in 2017.
The Fed hiked three times in 2017, and started to reduce their balance sheet.

5) Question #5 for 2017: Will the core inflation rate rise in 2017? Will too much inflation be a concern in 2017?
The Fed is projecting core PCE inflation will increase to 1.8% to 1.9% by Q4 2017.  However there are risks for higher inflation.  The labor market is approaching full employment, and the new administration is proposing some fiscal stimulus (tax cuts, possible infrastructure spending), so it is possible - as a result - that inflation will increase more than expected in 2017 and 2018.

Currently I think PCE core inflation (year-over-year) will increase further and be close to 2% in 2017, but too much inflation will still not be a serious concern in 2017.
Inflation has eased, and is below the Fed's target by most measures.

4) Question #4 for 2017: What will the unemployment rate be in December 2017?
Depending on the estimate for the participation rate and job growth (next question), it appears the unemployment rate will declining slightly by December 2017 from the current 4.7%.
The unemployment rate was at 4.1% in November, below the level I expected for the end of 2017.

3) Question #3 for 2017: Will job creation slow further in 2017?
So my forecast is for gains of 125,000 to 150,000 payroll jobs per month in 2017.  Lower than in 2016, but another solid year for employment gains given current demographics.
Through November 2017, the economy has added 1,916,000 jobs, or 174,000 per month, down from 187,000 per month in 2016. This was slightly above my expectations.

2) Question #2 for 2017: How much will the economy grow in 2017?
There will probably be some economic boost from oil sector investment in 2017 since oil prices have increased (this was a drag last year).

The housing recovery is ongoing, however auto sales might have peaked.

And demographics are improving (the prime working age population is growing about 0.5% per year, compared to declining a few years ago).

All these factors combined will probably push GDP growth into the mid-to-high 2% range in 2017, but this will depend somewhat on which policies are enacted.
GDP was a 1.2% in Q1, 3.2% in Q2, and 3.1% in Q3.  It appears GDP will be around 3% (annualized) in Q4, putting GDP growth around 2.6% for the year.  About as expected.

1) Question #1 for 2017: What about fiscal and regulatory policy in 2017?
We are still waiting for the details. As far as the impact on 2017, my expectation is there will be both individual and corporate tax cuts - and some sort of infrastructure program. I expect that something will happen with the ACA (those that have insurance for 2017 will keep their insurance, but they might not have insurance in 2018 - and that impact would be in 2018). I think the negative proposals (immigration, trade) will impact the economy in 2018 or later - overall there will be a small boost to GDP in 2017.

A final comment:  The words of a President matter. Mr Trump has been impulsive, reckless and irresponsible with his comments, and that has continued since the election. One absurd comment could send the markets into a tailspin and negatively impact the economy (and that could happen at any time).
The key policy change was the recently passed tax cuts.   Policy had little impact on 2017, but will have an impact going forward.

Currently it looks like 2017 unfolded mostly as expected. GDP was at expectations, employment gains were slightly better, but down from 2016 (as expected), housing starts and new home sales were also at expectations.    The key surprises were wage growth disappointed and housing inventory declined further.