The U.S. and Midwest Economy in 2016: Implications for Supply Chain Firms Rick Mattoon Senior Economist and Economic Advisor Federal Reserve Bank of Chicago Right Place Supply Chain Management Conference March 17, 2016
Themes Still struggling to get faster growth. While the U.S. economy is arguably the strongest in the world, it sure doesn t feel that way. Latest estimates suggest U.S. GDP growth in 2016 will be around 2.0 to 2.5%. Pockets of strength and pockets of weakness Good news for 2-handed economists. Big question is where will aggregate demand come from? Consumer, business, international, government? Need to answer this question to determine where faster growth might occur. Clashing world monetary policy U.S. tightens (?) while much of the rest of the world is moving into QE First the good news
The argument for why the economy will grow faster in 2016 Employment. Job gains have been strong (200K+)and the job mix is improving. Tighter employment is finally lifting wages. Higher wages coupled with a sustained decline in energy prices will lift household income and consumer spending. A Mastercard report found that holiday retail sales grew 7.9% vs 5.5% last year. However, other surveys suggest consumers are still spending selectively. Even after an essentially flat year for stocks, US household wealth is near record levels ($83 trillion). Household debt levels are down, balance sheets are better. Evidence.
Employment up, unemployment down to 4.9% 2015 saw average monthly gains of 142,000
Wages and salary cost increases, finally showing some life, but is the labor market all the way back?
Labor market participation some of the reason for 4.9% unemployment rate. Also underemployment is still high the U-6 is 9.7%
Is the consumer back? Low energy prices give a $500 to $700 boost plus wage gains, car sales are up sharply and Christmas retail sales were up almost 6%
The argument for why the economy will disappoint in 2016 Very weak foreign markets both developed and emerging economies. Europe is either pushing QE or negative interest rates to spur consumption and there is still little lift. China is slowing to under 7% growth (probably even less than what is said publically) as it shifts away from a high investment/construction model to a more consumer economy. Emerging markets often dependent on commodity prices are getting hammered. Who is going to buy our stuff? Continued strong dollar makes exporting harder Rising interest rates will cut into consumer purchases for items like cars or anything that was benefiting from cheap financing. The previously strong parts of the U.S. economy, manufacturing and agriculture are under serious pressure. Unlikely to get much lift here. Continued fiscal stress and policy uncertainty
Manufacturing index has gone negative
In addition to headwinds for manufacturing, all is not well on the farm
What might tip the balance? Housing. Case-Schiller index showed some life as prices have begun to improve. Last Case-Schiller index saw prices up 5.4% (20 city composite) over previous year. However, gains are uneven Denver, Portland and SF up 10%, Chicago at 2.4% was the worst of the 20 city index. In aggregate, prices are still 11 to 13% below peak. Infrastructure investment. State and local governments started increasing construction toward the end of last year after sitting on the sidelines Business spending. Do they do more than just stock buybacks, dividend increases and mergers? Does the service sector, particularly business and professional services, take up the slack from manufacturing?
Better Public Construction Numbers? (% change year over year)
The Current Forecast Last FOMC (December, 2015) central tendency projection for GDP growth in 2015 is 2.1%, the 2016 projection is 2.3 to 2.5%. Long-run 1.8% to 2.2%. More plodding growth in 2017 at 2.0 to 2.3% inflation is running well below target. CPI and core have seen either declines or minimal growth, although gas/food prices might cause a blip. FOMC forecast has PCE at to 0.4% (2015) and 1.2% to 1.7% in 2016. Long-run estimate is at 2%, with 2017 projected at 1.8 to 2.0%. FOMC forecast has unemployment at 5.0% (2015) and 4.6% to 4.8% (2016). Long-run 4.8% to 5.0% Fed policy. December was the first quarter point increase since 2008. Big issue will be the pace of potential future increases to get to normalization (3 to 3.5%). Inflation rising to 2% was a significant justification in the statement. Big question is just how sensitive is the U.S. economy to super-low borrowing costs? 13
Turning to the Midwest Big picture suggests the region will be challenged in 2016 why? o Unfavorable industry mix manufacturing and agriculture o Long-term less favorable demographics o Fiscal stress in select states, particularly Illinois, and some Michigan municipalities Challenges to 2 key industries
The challenge for manufacturing Who are you going to sell to? Outside of the US, world demand is weak particularly for large capital equipment. Even if you have a market, the strong dollar will make you less competitive. Oil and gas extraction was responsible for a significant part of the growth in manufacturing demand in certain industries. A prolonged period of low energy prices will keep this sector under pressure. Autos continue to show strength but for how long? On the plus side, the fleet is still pretty old but how sensitive is the decision to buy a car to super-low interest rates?
The challenge for agriculture Less attractive export opportunities Victim of productivity, continues pressure on prices Limited benefits from lower energy prices. Diesel fuel, fertilizer prices haven t dropped as fast. One other industry to consider construction and residential and commercial real estate. Both have seen limited upturns with growth in specific sectors. For housing, multi-family (rental) has been strong and in commercial, office and hotel. Suppliers to these sectors should do okay.
Understanding Midwest Performance Using the Midwest Economy Index (MEI) What is the MEI? Produced by the Chicago Fed, it is the weighted average of 129 state and regional indicators for 5 states Illinois, Indiana, Iowa, Michigan, Wisconsin. Examines contributions across four broad sectors Manufacturing, Construction, Services and Consumer spending 2 indexes o MEI national and regional factors driving Midwest growth o Relative MEI Midwest Growth conditions relative to the nation How to interpret the index o A zero value means the Midwest economy is expanding at the historical rate of growth, a number above suggests faster growth, below slower growth. For the Relative MEI, the number reflects growth relative to the nation
Chicago Fed Midwest Economic Index (December) Illinois Indiana Iowa Michigan Wisconsin Total Manufacturing -0.07 +0.01-0.13 +0.03-0.04-0.21 Construction -0.01 +0.01 +0.02 0.00 +0.01 +0.02 Services -0.03-0.03 +0.02 +0.02-0.01-0.04 Consumer +0.01 +0.01 +0.01 +0.01 +0.02 +0.08-0.11 +0.01-0.07 +0.06-0.01-0.15
Measuring Midwest growth relative to the nation Relative MEI has the region outperforming the US in construction (+0.14, driven by strong performance in Indiana and Iowa), services (+0.06, strongest in Michigan and Iowa) and consumer, +0.13. Weakness is manufacturing (-0.05) with only positive numbers in Indiana and Michigan
How have Midwest states performed over the Business Cycle? Federal Reserve Bank of Philadelphia Coincident indicators index July, 1992=100 Shows how hard a recession hit a state and how well it has recovered.
The pattern of recovery in the region (Philly Fed Coincident Index)
Midwest vs an energy boom state
One final observation-- competitiveness Figure 1. State Financial Position Index and Competitive Posture (Price Waterhouse Coopers, 2015) 2014 Relative Taxpayer Burden/Income Ratio* 2014 Relative Retirement Obligations Burden/Surplus Ratio 2015 Competitive Posture Quartile (1=best) 2014 Net Domestic Migration US Median -0.108-0.137-0.12% US Mean -0.148-0.204-0.01% Illinois -0.819-0.701 4-0.74% Indiana -0.015-0.134 1-0.12% Iowa 0.016-0.032 1-0.03% Michigan -0.348-0.324 4-0.29% Wisconsin -0.071-0.009 2-0.17% *The ratio is calculated as total net financial assets and liabilities and unfunded retirement balances divided by the numberoffederal taxpayers in that state. This is then compared to the real median household income for the state. The tax payer surplus/burden is divided by the real median household income to get the Relative Taxpayer Burden/Surplus ratio.
Summary 2016 will see growth but it will only be moderate Big question is where will demand come from? Second big question is how interest rate sensitive is the economy? For the Midwest, industry mix will provide challenges Suppliers to manufacturing and agriculture will be pressured Suppliers to real estate may do okay but recovery in the sector is uneven. Commercial real estate still favors big cities for growth as firms chase millennials.