Quarterly Market Update
U.S. Economic Growth Achieves Traction
The U.S. economy steadily gained steam throughout the year after a January polar vortex knocked manufacturers and businesses offline and kept consumers indoors. Better-than-expected GDP numbers propelled the S&P 500 and the Dow Jones Industrial Average to record highs in the fourth quarter. Third-quarter GDP (the most recent available) was revised to a seasonally adjusted annual rate of 5.0%, up from 4.6% in second quarter, the strongest pace since the 6.9% return of third quarter, 2003. The revision was attributed to stronger than estimated spending by U.S. consumers, particularly on services like health care, as well as more spending by businesses on new buildings and research and development.
Job creation grew at its strongest pace in 15 years as nonfarm payrolls averaged just shy of 250,000 on a monthly basis in 2014. In November, U.S. payrolls grew by 321,000, the best month since January 2012, following gains of 243,000 in October. The unemployment rate was 5.8%, unchanged from the prior month, and the lowest since mid-2008. The November report also indicated a 0.4% gain in private average hourly earnings, exceedingly encouraging given the continued low inflation. However, despite the advances, we continue to see signs of structural unemployment in terms of a falling participation rate, elevated long-term unemployment, and part-time versus full-time hiring.
Consumer confidence rose to 92.6 in December from 91.0 in November, driven partially by lower prices at the gas pump, but overall by significant improvements in the domestic economy. The increase, while promising, is a rather far cry from the pre-recession peak of 138. The sharp drop in oil prices caught a number of people by surprise, and it is too soon to tell whether energy prices will remain low, and thus a positive driver of confidence for the remainder of 2015. (See the Q&A at the end of the BBVA Compass 1Q15 Market Outlook for a full review of the current oil price decline.)
Figure 1. The December employment report revealed an unemployment rate remaining steady at 5.8%, down from 7% this time last year. The U.S. economy has been gaining an average of 224,000 jobs a month over the past year. Any month with job gains over 200,000 is considered strong.
U.S. manufacturers benefited from falling oil prices, stronger jobs growth, and improving corporate profits. According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector expanded in December for the 19th straight month. While the ISM Manufacturing Index closed the year in positive territory and above January’s level, the index reached a high point in August and October, but declined in November and December. The downward pressure was due to minor declines in production and inventories, as well as a significant fall in new orders in December.
Housing Market Recovery is Sporadic
The housing market continued to post sporadic results despite 30-year mortgage rates falling to 3.87% in December from 4.53% at the beginning of the year. New homes sales, which make up a tenth of the overall housing market, fell for the second straight month in November, pointing to an underlying weakness despite low interest rates and steady economic growth. Existing home sales, the bulk of the housing market, also fell in November to a 6-month low.
Two to three years ago, the case could be made that the market had not returned to pre-recession levels, but now prices and sales in a number of regions have returned to those levels. Much of the weakness in existing home sales has simply been a lack of affordable inventory after prices in some regions skyrocketed. The rush to buy a new home or refinance an existing one has passed, and buyers are waiting on the sidelines because prices have risen beyond their budgets.
The Fed Ends Bond Purchases
The Fed ended its third round of bond- buying in October, and financial markets are now focused on the timeframe for short-term rate hikes. The Fed has held its benchmark interest rate near zero since December 2008 when the Fed was struggling to keep the banking system from collapse during the U.S. financial crisis and subsequent recession. Many now believe that the Fed will not raise rates until June, and possibly later, if inflation persists below the 2% target. But both GDP and the jobs market are trending up, and oil prices on balance are more of a positive than a negative for main street America, so rate increases are to be expected at some point in 2015.
The Fed made subtle but strategic changes to the forward guidance language during the quarter, effectively decoupling the pace of the stimulus withdrawal to an unemployment rate below 6.5%. While unemployment has declined more quickly than anticipated, the Fed has nonetheless left stimulus plans unchanged, and has articulated patience about raising rates given the mix of conflicting signals about the U.S. economy.
Further gains in the housing market are dependent upon low rates and affordability.
The BBVA Economics Research Department sees the pattern of stronger economic data continuing in 2015, and are currently projecting 2.4% GDP growth in 2014 and 2.5% in 2015, with the potential for an upside surprise in both periods. December economic reports reflect a better job market, increased consumer confidence, and good retail season. As the U.S. economy is driven 70% by consumer consumption, and despite the weather-related downturn of 2.9% in first quarter GDP, strong numbers in fourth quarter could push 2014 GDP over the 2.4% estimate.
The nice tailwind provided by lower oil prices could increase consumer’s discretionary spending. The U.S. dollar will likely continue to strengthen on the heels of higher domestic interest rates which is a positive for the economy, although it could weaken the export sector of the economy.
Low interest rates and affordability will be the reasons for future gains in the housing market. The housing market has always been regionally fractured, prone to boom and bust cycles, particularly in California, Florida, and Nevada, although Texas has been something of the anomaly, behaving more like a blue chip stock. The drop in oil prices could help support the housing market, especially in context of interest rates staying low, although large gains sparked by low interest rates are a thing of the past. Should we see a retrenchment in prices in certain areas where the housing market has run up in lock step with higher energy prices, Houston being a good example, then we could see some normalization of housing prices in marginal areas like New York, New Jersey, California, Nevada and Florida.
2015 should mark the beginning of the great unwind of the Fed’s six-year stimulus programs. The Fed now holds close to $4.5 trillion in U.S. Treasuries and mortgage-backed securities, up from less than a trillion when the financial crisis began in late 2008. The impact of moving these assets off the Fed balance sheet is certainly an unknown, although the impact will be offset to some extent by the accommodative monetary policies of Japan and the Eurozone.
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