With the gradual healing of private sector balance sheets, US growth is at last returning to normality after nearly seven years of balance sheet-constrained weakness. The weather-induced weak real GDP of 0.6% (annualised) in Q1 2015 was followed by a bounce back of 3.9% in Q2, and a more normal 2.1% in Q3. For the year as a whole average GDP is likely to be 2.4%, above the OECD estimate of current US potential growth (1.6%).
Since the third phase of QE ended in October 2014 the recovery in the US economy has been hugely assisted by the return of commercial banks to the business of credit creation. For example, since the start of 2015 total loans and leases of US commercial banks have been growing at a steady 8.0%, ample to fuel the liquidity needs of the economy.
With the Fed having now started the process of rate normalisation, the key issue will be whether US banks continue to create credit at a similar rate, or whether they curb the rate of credit creation. Credit growth of 8% per annum would be enough, if sustained, to support nominal GDP annual growth of 5-6%.
In addition, labour market data have continued to be buoyant but not showing any signs of overheating. For example, non-farm payrolls increased by an average of 210,000 per month for the year to November, and the unemployment rate fell from 5.8% in January to 5.0% in November.
Average private non-farm weekly hours worked have held steady at 33.7 hours, returning to their pre-crisis trend. Moreover, growth in average hourly earnings of production and non-supervisory workers has averaged fractionally less than 2.0% during 2015 and does not appear to be showing any clear uptrend.
Furthermore, the labour force participation ratio has continued to decline from 62.9% in January to 62.5% in November.
However, the economy is showing signs of a two-speed split, with manufacturing weakening and services strengthening. For example, industrial production slowed from a year-on-year growth of 4.6% in December 2014 to only 0.3% in the year to October 2015, reflecting the decline in shale oil investment in the US, the strong US dollar, and the excess capacity in basic industries abroad, especially in China.
Similarly, the ISM index of manufacturing declined to 48.6 in November (indicating a majority of industries were contracting) from 55.1 in December 2014. By contrast, the ISM non-manufacturing index has remained above 55 since April 2014.
In summary, given the dominance of the service sector, this adds up to a recovery that is now self-sustaining even without Fed asset purchases, although it is unlikely to become exuberant any time soon in my view.
US consumer spending expanded from 60% of GDP in the 1970s to 68% of GDP by the time of the financial crisis in 2008-09, helped by a major increase in consumer indebtedness over the subsequent three decades. Since the crisis spending has remained at roughly 68% of GDP, but households have deleveraged relative to income, putting an effective ceiling on consumer spending.
Unless consumers are prepared to start adding to their indebtedness once again, consumer spending will now be limited to the rate of growth of personal incomes. Consistent with this analysis, personal consumption spending grew 3.4% year-on-year in Q3 2015, slightly less than personal incomes in the year to October 2015 which grew at 4.6% in nominal terms.
Investment spending also remains subdued, gradually climbing from its post-crisis lows of 13.5% of GDP in 2010 to 16.3% of GDP in Q3 2015. Non-residential private fixed investment surpassed its pre-crisis peak in late 2013 and has continued to move gradually upwards, but the corporate sector is still showing a clear preference for financial investment in the form of share buy-backs or mergers and acquisitions rather than investment in physical plant and equipment.
Housing investment experienced a particularly weak first quarter, but since then it has continued its gradual recovery, showing a modest improvement over 2014 as measured by a composite of housing starts, permits and completions. These data suggest an economy that is gradually returning to normal rather than surging ahead on the basis of low interest rates. For 2016 I expect 2.6% real GDP growth.
On the inflation front consumer prices have continued to surprise most forecasters on the downside, recording a 0.2% year-on-year increase in October 2015, and 1.9% when volatile food and energy prices are excluded.
This is usually explained by the fall in commodity prices over the year, especially oil prices, but the truth is that weak commodity prices are a symptom of a weak global economy, which in turn is a result of slow growth of money and credit. With no acceleration in money and credit growth it is unlikely that inflation can rise significantly. For 2016 I forecast a 1.4% increase in headline CPI inflation.