Separating Signal from Noise

U.S. Overview
Separating Signal from Noise

For decision makers, separating the signal from the noise is a constant challenge. Over the past three quarters, we have heard a lot of noise in the quarterly GDP estimates from the Bureau of Economic Analysis (BEA), which are compounded by significant subsequent revisions each month. Yet, once we pursue the signal underneath the noise, we find the U.S. economy continues to evidence stronger and broader growth— with a clear uptrend for inflation as well. 

For the past two years, real final sales have averaged 2.2 percent, and we expect a repeat of a similar number in 2014. Consumer spending accelerated in 2013 over 2012, and we expect similar growth this year. Employment gains are expected to average above 220,000 this year and have risen each year since 2011. Housing starts have risen each year since 2011. The focus on quarter-to-quarter volatility in GDP noise obscures the gains in the economic signal. 

Meanwhile, inflation, measured both by the PCE deflator and the CPI index, has increased since the fourth quarter of 2013, and both are expected to hit 2 percent year-over-year gains by the end of this year. Consistent with the rise in inflation has been a rise in the yield on two-year Treasury notes as markets are discounting the approach of the Fed decision to raise the funds rate. Our view remains that the Fed will announce a change at the June 2015 meeting—in contrast to the volatility of views by others. Finally, we expect pre-tax profit growth to continue its typical pattern of slower growth as we move further into the expansion.

International Overview 
Global Economy Continues to Grow at Modest Pace

GDP data for Q2 2014 are starting to roll in, and it appears that the global economy continued to expand at a modest pace in the second quarter. Moreover, we look for the global expansion to remain intact through, at least, the end of next year. On a global basis, we forecast that economic growth will strengthen from 3.2 percent in 2014 to 3.8 percent next year, a bit above the long-term average of 3.6 percent. 

There are some downside risks to keep in mind. First, a cycle of sanctions and counter-sanctions between the West and Russia could eventually lead the latter to temporarily curtail its energy exports, which would have adverse effects on economic growth, especially in western Europe. Renewed financial market tension due to a re-emergence of the European sovereign debt crisis, would also slow global economic growth. Although we do not look for a debt crisis to play out in China in the near term, Chinese economic growth could slow sharply if debt problems in that country are greater than what we believe they are. 

The time is drawing closer when monetary policy will cease to be as accommodative as it is currently, at least in some countries. We look for the Federal Reserve to begin hiking rates in mid-2015, and the Bank of England probably will commence a rate-hiking cycle next year as well. That said, both the European Central Bank and the Bank of Japan probably will maintain a highly accommodative policy stance through at least the end of 2015.