I usually begin thinking about my economic forecast for the next year around the third quarter. At that point, the current year is largely on the books, and we know enough to start looking ahead a bit.
Not this year. Although the election seemed like a lock, the uncertainty about whether the result would be disputed and what Congress would look like—not to mention substantial questions around policy and the Federal Reserve—meant the glass was still too dark to see clearly.
Now, much of that uncertainty has resolved. We know the winner, we know the makeup of Congress, and we even have a fairly solid grip on the new administration’s policy course and the Fed’s decision process. Finally, we can start to think about 2017.
Faster growth seems likely
Though solid, economic growth has been slow, and many feared it would slow further after the election. Since then, however, data has shown that consumer confidence and spending continue to improve—a significant plus. One of the weak sectors of the economy, business, may also be poised for a turnaround, with the stock market’s post-election bump clearly signaling that investors are feeling positive about the new administration.
There are real reasons for that:
- Infrastructure investment, one of Donald Trump's expected core policies, could help spur faster government spending growth, and this alone could boost overall economic growth.
- Tax cuts stand to further benefit both consumer and business confidence and spending.
- The deregulatory trend expected from the Republican Congress—plus the already improving fundamentals, with company revenues and earnings increasing for the first time in several quarters—makes faster economic growth and a stronger stock market look very reasonable.
Based on these factors, I expect that we could see real growth of around 1.5 percent in 2016, which could increase to 2 percent or more in 2017. The risks here are probably to the upside. Similarly, we should see faster revenue and earnings growth in the stock market, which could push returns above the mid-single digits that have been expected.
No guarantees, of course
Potential roadblocks include the federal deficit, which would rise with lower taxes and higher spending, and it remains to be seen whether congressional Republicans will sign off on those moves. Another headwind could be higher interest rates. With signs of growing inflation and rising inflation expectations, the Fed may feel compelled to act faster than it is now signaling, and the bond vigilantes may decide to ride again.
In addition to political risks, there are also external factors to consider. China, in particular, remains a concern, and there is a real chance that Europe may deteriorate further politically. Based on how Trump chooses to express his trade policies, exporters such as China, Japan, and Germany may face significant exposure; closer to home, Mexico may also feel the effects. International markets will likely see greater challenges this year than they did last year, which itself wasn’t easy.
A surprise turn toward the bright side
Despite some very real constraints, faster U.S. growth and continued economic improvement look likely in the coming year. Much of this outlook is based on expectations, which are hard to quantify. Nonetheless, both the stock and bond markets are sending signals that better times are ahead. Fundamentally, for the reasons outlined above, this makes sense. As a result, my full annual forecast will likely end up much more optimistic than I thought only a couple of weeks ago.