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TD Economics: Cloudy, With a Chance of Fireballs

December 16, 2016, 07:14 AM
Filed Under: Economy

The American economy is back on track, but, with new leadership in Washington, the band of uncertainty around the forecasts has widened, according to a new report by TD Economics, an affiliate of TD Bank, America's Most Convenient Bank®.

"A lot has changed over the past three months, even as the economy has advanced in line with our expectations," says TD Bank's Chief Economist, Beata Caranci. "We have refrained from adjusting our forecasts and jumping on the optimism bandwagon that equity markets have displayed since the election. We need to see more meat on the bones of government policy initiatives in order to assess the economic and monetary impacts," says Caranci.

TD Economics projects real GDP growth of 1.6 percent in 2016, 2.2 percent in 2017 and 2.0 percent in 2018, with the unemployment rate falling from its current level of 4.6%, to 4.4% by the end of 2018.

President-elect inherits a healthy economy...

Consumer resiliency has been a long-standing story for the economic outlook and nothing is expected to change on this front.

"At just 4.6%, the unemployment rate is at its lowest level in nearly a decade," says Caranci. "Even without a tax cut, income growth is accelerating on the back of a tighter labor market. This is a firm foundation for spending growth over the next year and has always been the key pillar to our forecast."

With a healthy demand outlook and upward pressure on labor costs, businesses should be incented to increase investment. This has been a weak spot for the economy over the past year, in large part due to declines in the energy sector. There is already evidence that the stabilization in oil prices is turning the tide, which should extend into 2017.

Upside and downside risks from fiscal policy...

The risks to the outlook come mainly from the "unknown factor" related to the potential for significant fiscal policy shifts that might evoke market volatility and impact the economic forecast.

"Financial markets reacted sharply and swiftly to the election news. There is now a high bar for this new administration to meet in providing growth-enhancing fiscal measures.  In addition, bond markets will cast a wary eye at deficit-financed fiscal stimulus that elevate future deficits and spur higher inflation," says Caranci.

TD Economics outlines how a large package of tax cuts and infrastructure spending that was promised on the campaign trail could provide an economic boost. But, it would likely be 2018 before more material impacts are felt in the economy. (For more details on the potential impacts of fiscal stimulus please see TD Chief Economist Perspective)

Changes in Washington also clouds the outlook for the Federal Reserve...

Even without new fiscal policy initiatives, the path for interest rates will continue to be upward. "The Fed recognized that the U.S. economy no longer requires emergency-level interest rates when it raised its policy rate for the second time at its December meeting." says Caranci. "However, hiking by a quarter-point twelve months after an equivalent move doesn't exactly smell of desperation. This cautious glide path will likely continue going forward."

"Until estimations of fiscal policy impacts can be done with a 360 degree view on both sides of the balance sheet, we anticipate just one hike in 2017 and one more in 2018, bringing the Fed funds target to just 1.25% by the end of that year," says Caranci,. "However, we can definitely say that the risks are skewed to more, rather than fewer rate hikes."

TD Economics provides analysis of global economic performance and forecasting, and is an affiliate of TD Bank, America's Most Convenient Bank®.

The complete findings of the TD Economics report are available online here.

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