Slowing activity in China and other emerging market economies will be a headwind to growth over the next year, but the U.S. economy is in good shape to weather the storm, according to a report released today by TD Economics (www.td.com/economics), an affiliate of TD Bank, America's Most Convenient Bank®.
"We can't ignore the renewed bout of financial volatility and deterioration in global growth, but also recognize that the American economy has a lot of strengths," says TD Bank's Chief Economist, Beata Caranci. "Domestic sectors of the economy, such as housing and consumer spending have been gaining strength over the last several months. With lower gasoline prices leaving even more in consumers' pockets, this is likely to continue."
Led by consumer spending, economic growth is expected to average 2.5% on an annual average basis in 2015, before rising to 2.6% in 2016. With the unemployment rate falling to 4.8% and the Fed in the midst of a gradual tightening cycle, growth is expected to slow modestly to 2.4% in 2017.
China's growing pains spread to the rest of the world...
The chief cause for concern for the economic outlook is the slowdown in China and its ramifications for the rest of the world. Unease reached a fever pitch in August, following steep declines in the Chinese equity market and a decision by the central bank to devalue the Chinese yuan. Contagion spread to equity markets around the world and led the U.S. dollar to rise against a range of global currencies.
"China is the world's second largest economy and the largest source of demand for many of the world's commodities," says Caranci. "Its slowdown will weigh heavily on commodity-producing countries and those in its immediate vicinity."
For the United States however, the impact is more indirect. China accounts for just 10% of U.S. exports, but 23% of U.S. imports. A bigger issue is the fear created in financial markets and the cascading effect of China's currency depreciation on the currencies of other countries. As financial volatility spread in August, the U.S. dollar jumped close to 5% on a trade-weighted basis, with most of this coming against emerging market economies.
"With a higher dollar and slower global demand, America will export less and import more from the rest of the world. This will weigh on production growth in America, even as it helps to pull the rest of the world up," says Caranci.
Lots of reasons for optimism on the home front...
The good news is that the U.S. economy appears to be taking the global shock in stride. Households have shown few signs of hunkering down, while businesses are looking for new workers at the highest rate on record.
"Light vehicle sales hit an annualized 17.8 million in August, the highest level in over a decade," says Caranci. "The tumbling stock markets appear to have had less of an effect on consumer behavior than the continued decline in gasoline prices. Employers, too, appear to be little phased by the global weakness. In July, the job openings rate hit its highest level on record."
The other good news on the home front is that Americans are forming new households and buying new homes at an increasing rate. "There is growing evidence that after years of living with roommates and mom and dad, young people are increasingly getting out on their own," says Caranci. "This will support housing demand for years to come and bodes well for future construction growth."
Fed held the line on interest rates in September, but won't hold out for long...
The continued improvement in the economy is likely to lead to a gradual tightening in monetary policy from the Federal Reserve.
"Heightened global uncertainty led the Fed to err on the side of caution at their September meeting, but continued improvement in the job market is likely to tip the scales in the months ahead," says Caranci. "We expect that by early next year, there will be enough progress on employment and inflation to warrant the Fed to begin a gradual tightening cycle."
From a starting point of 0.25%, TD Economics expects a slow grind higher in rates with the fed funds rate reaching 1.0% by the end of 2016 and 1.75% by the end of 2017.
TD Economics provides analysis of global economic performance and forecasting, and is an affiliate of TD Bank, America's Most Convenient Bank®.
The complete findings of the TD Economics report are available online at http://www.td.com/document/PDF/economics/qef/qefsep2015_us.pdf