The Economic Outlook: A Mid-Year Update

Jul 29, 2016 - 12:00pm

Senior Economist

The Commerce Department reported on Friday that real gross domestic product (GDP) increased at an annual rate of 1.2% in the second quarter, slightly above the first quarter’s dismal pace of 0.8%. The outlook for the second half is not much better. GDP is unlikely to surpass 1.5% in 2016, which would be considerably slower than the still-moderate 2.4% growth experienced in 2014 and 2015.

The latest report highlights an important discrepancy between consumption and business investment. Personal consumption expenditures rose 4.2% in Q2 following an increase of 1.6% in Q1. Modest increases in wages and household wealth, coupled with reasonably strong job growth, form the foundation for continued growth in the second half of 2016.

Business investment, by contrast, has declined for the past three quarters, due in part to headwinds from declining energy sector investment and political and economic uncertainty. Business confidence remained weak in June but was above the crucial threshold of 50, which signifies an expanding economy. In a healthier economic climate stronger domestic consumption growth would suggest possible acceleration in business investment. However, excess capacity, an outpouring of government regulations, and overseas concerns present formidable challenges.

Following three consecutive quarterly declines exports actually rose 1.4% in Q2 while imports declined 0.9%. However, a stronger dollar and considerable weakness among our major trading partners indicate U.S. net export growth will face strong headwinds for the next few quarters. Europe and the U.K. are still considering the full implications of “Brexit” while simultaneously grappling with recent terrorist attacks and continuing economic uncertainty.

This second quarter GDP report has important implications for monetary policy because the Fed will not have an estimate of third quarter growth before their next meeting in September. The Fed’s current assessment of the economy, based upon its statement from its most recent meeting (July 26-27) could best be described as tentative. In particular, the Fed noted, “Near-term risks to the economic outlook have diminished,” which is Fed speak for “no need to fear ‘Brexit’ right away.” 

The Fed hinted it could raise interest rates later this year, but that seems unlikely at this point. The recent GDP report and the modest performance of the labor market suggest caution, and the Fed’s decision may also be influenced by the U.S. presidential election. The next Federal Open Market Committee (FOMC) meeting is in September, although the market does not anticipate an increase at that time. The following meeting occurs a week before the election, which likely precludes any movement. That leaves us with the December FOMC meeting and the soonest the Fed is likely to move, but even then it is less than a 50% probability. With economic weakness persisting along with below-target inflation, the Fed is balancing the desire to normalize policy with a distinct lack of urgency arising out of the economic data; thus far the weak data is winning that contest.

One final source of uncertainty stems from the upcoming election. Every election creates unwelcome uncertainty, but none in memory creates as much unhealthy uncertainty as 2016. First and foremost, the two nominees evidence little to no interest in effective pro-growth policies and provide no real hints of what they would really attempt once elected beyond imprecise proposals for “infrastructure spending.” Neither candidate is very appealing at this point from a business point of view. 

This unhealthy election uncertainty is sure to weigh heavily on business investment decisions, further dampening the business investment climate and further depressing the rate of overall economic growth in the second half of 2016. Hopefully some of these uncertainties along with the onslaught of regulations will abate enough in 2017 to allow for a more optimistic economic outlook.

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About the Author

About the Author

Brian Higginbotham
Senior Economist

Brian Higginbotham is a senior economist at the U.S. Chamber of Commerce.