In its January 27 meeting the Federal Open Market Committee (FOMC) members indicated that they expected economic data to be supportive of further tightening, but they continue to remain data dependent. U.S. employment – a primary focus of the FOMC – continued to improve. While realized inflation is low, they pointed out that inflation expectations have remained relatively stable. This emphasis on stable expectations may suggest the board will seek confirming evidence to resume tightening. The board did acknowledge that they will give due consideration to global events – oil prices, lower growth in China, the impact of the dollar appreciation on emerging markets – in making their decision to raise interest rates, but made clear their position that these events are only relevant insofar as they have an impact on U.S. employment and inflation data. By removing their prior statement that domestic and international risks to economic growth and employment are balanced, they may have indicated heightened risk regarding the impact of global events on the U.S. economy.
We believe the market continues to underestimate the likely increase in rates in 2016; the market currently expects only one rate increase at the end of 2016. While volatility has increased as a result of lower oil prices, uncertainty about China’s growth and dollar appreciation, these factors may have a limited impact on the U.S. economy. We believe U.S. GDP will enjoy 2%-2.5% growth, driven by consumption, housing and improved government spending.
- Employment continues to be strong, with the unemployment rate expected to breach 5% this year. While the jobless claims, an important leading indicator of employment, have increased modestly from mid-2015 lows, they remain under 300,000, a level consistent with an improving job market.
- In our view, the overall impact of lower oil prices in the U.S. should be neutral, at worst. The negative impact of lower capital investment and job losses in the energy sector should be offset by the benefit to the consumer. The U.S. continues to be a net importer of oil, so lower oil prices should benefit the economy.
- The impact of lower growth in China should also have a modest effect on the U.S., we believe. U.S. exports to China account for approximately 1% of U.S. GDP, according to the S. Census Bureau.
- The 8% loss in the U.S. equity markets so far this year and the resulting reduction in household wealth may have a less significant impact on consumer confidence than some fear. Financial wealth is less broadly held by the U.S. population than housing wealth. Every dollar increase in housing values can change consumption by $.06, significantly higher than the impact from an increase in financial wealth, which is estimated at $.02, according to Federal Reserve Board data. Housing prices have grown over 5% year over year, and the outlook for housing continues to be strong, with residential fixed investment growing at approximately 8%, supporting solid household formation statistics.