Stellar Economic Outlook

Its getting hard to find a forecaster who isn’t bullish on the U.S. economy for the year 2000.   Propelled by extraordinary consumer spending in the fourth quarter, 1999, the economy is on the verge (at the end of January) of setting a new record for longest expansion.  The previous record of 106 months occurred during the 1960s.  Nearly all of The Wall Street Journal’s semiannual survey of 53 professional economic forecasters expect growth to continue until at least 2001.   On average they see 2.6% growth in real GDP in the first quarter followed by 3.1% growth in the second, third and fourth quarters.   By comparison, growth during 1999 was about 4.0%. 

Forecasters expect the inflation picture will not change much in 2000 from the 2.6% rate experienced in 1999.   The consensus is that the consumer price index will rise at an annual pace of about 2.5% through the first half of 2000, slowing to 2.3% rate during the second half of the year.   While it is true that oil prices have risen sharply in recent months (doubling since fourth quarter, 1998), most economists believe that, with the exception of U.S. labor supply, most other productive resources, including production capacity, are in ample supply and will offset any upward pressure on prices.  The rise of e-commerce, especially business-to-business e-commerce, will heighten competitive pressures on suppliers and further limit upward price pressures.  

Most of the risk in the consensus forecast resides in the inflation scenario.   The Federal Reserve has performed admirably in accommodating the expansion while calming inflationary fears.   However, it is possible that the U.S. economy may grow even faster than the consensus, creating much stronger inflationary pressures at this critical point in the Fed’s balancing act.   Keep in mind that the Wall Street Journal’s consensus forecasts at the start of each year have underestimated the actual growth rate of the U.S. economy by about 1.5 percentage points annually since 1996.   If the economy does not slow from last year’s pace, the tight U.S. labor market (4.0% unemployment) will almost certainly begin to trigger upward wage pressures.   Companies may be more successful at passing along increases in labor costs as well as higher energy costs if consumer demand is strong.   Unfortunately, this could happen at precisely the time when foreign economies are accelerating, as seems to be the case.   Excess capacity overseas last year helped to keep a lid on U.S. manufacturers attempts to raise prices.   If consumer demand is growing worldwide, U.S. firms may be able to raise prices with less risk of losing sales to foreign competitors. 

Consequently, economists definitely look for tighter monetary policy from the Fed this year.   The big question is, how tight?   If the inflation scenario does not deteriorate expect a 50 basis point rise in 30-year Treasury bond yield by the end of the year.