By Lynn Michaelis
No, this is not going to be a biblical sermon. As laid out in my presentation at NWPCA’s ALC last March 2014, and emphasized in the two earlier PalletCentral articles, economic growth was forecast to build momentum as we entered 2015. The promised momentum has arrived. Almost all of the economic reports in the last month have been extremely positive. There have been a couple of interesting and unexpected twists as well. The collapse in oil prices is number one. The surge in the value of the U.S. dollar and the turbulence in global financial markets is the other.
Economic Growth Remained Strong
Overall economic growth as measured by the Gross Domestic Product (GDP) continued to grow at the 4% annualized rate in the third quarter. Growth in the second quarter of 2014 was primarily a rebound from the dismal first quarter. The growth last quarter was due to strong consumer spending and higher growth in business investment. There was one special factor: a big one-time jump in Federal Government spending on defense.
Consumer spending growth is going to be even higher over the next few quarters. The last retail sales report suggests that consumers spending growth will be near 3.5% this quarter. The last employment report of 321,000 additional jobs in November was the strongest increase in employment since 1999! Total non-farm employment last month moved above 140 million—2% above year ago levels. (We passed the previous employment peak of 2007 a few months ago.) Unemployment is now below 6%--boosting consumer confidence back to levels last seen in 2005. Wage pressures are finally building as well. (Sorry, this is a positive message for consumer spending, might not be so good for the employers however.)
Unexpected Twist #1
...the collapse in oil prices was not forecast by any of the energy experts. The decline has lowered inflation rates and will boost consumer spending. Oil prices rebounded after the global recession in 2009 and then hovered near the $100-120/ barrel range during 2011-14. The large gap that developed in 2011 was due to the growth in U.S. oil production because of the new fracking technology. Oil production in the U.S. grew by 3 million barrels/day between 2009 and 2013. This puts U.S. oil production at the same level as Saudi Arabia. U.S. oil imports fell. This combined with the weaker demand growth for oil in Europe and China led to glut during 2014. OPEC (Saudi Arabia) would not curtail production. Result: a 35% drop in oil prices and drop in gasoline prices of $1.30/gallon-so far. Since the average American consumes over 1,000 gallons of gasoline per year, this is about like getting a 2% pay hike (after tax) for the average household if gas stays at the current level through 2015—and that looks likely.
As a result, consumer spending growth, which accounts for 70% of GDP, should exceed 3% next year. Government spending which held growth back for the last several years will contribute to growth in 2015. As seen this month, the congress had no appetite for shutting down the Federal government again and actually compromised on a variety of issues. Housing starts have remained stuck near 1 million units, but employment growth and recent financing developments will push starts higher in 2015. Taken together, overall economic growth will be much stronger in 2015 than in 2014.
Prospects for Industrial Production Bright, but…
Industrial production (this is THE key driver of pallet demand) remains much stronger than the overall economy. While the overall economy grew 2.4% over the last year, industrial production growth was up near 5% in November compared to year ago levels. Durable goods (autos and furniture) production was up 7%, with production of non-durables (food, clothing, etc.) up 3%.
Unexpected Twist #2
...the surge in the value of the U.S. dollar exchange rate value could put a damper on the growth in industrial output. Exports are an important component of industrial output. Although a stronger dollar is great if you plan to travel to Europe, Japan or Russia (scratch that one), it makes imported goods cheaper and increases the price of U.S. goods sold offshore. The U.S. exchange rate fell sharply during the financial crisis in 2008-2009 as investment funds were taken out of U.S. investments. Then it stabilized near 100 for several years. Recently there has been a flood of foreign money into U.S. Treasury securities because of concerns about developing countries and oil dependent economies (Russia for example). With strong growth, U.S. interest rates are expected to rise as discussed next.
End of the Low Interest Rate Period: Clearly in Sight
As I stressed in the last outlook (September-October PalletCentral), the Federal Reserve (Fed) would not move interest rates this year. Inflation is not an issue, so the Fed could be patient. The good news on economic and employment growth make it certain that interest rates will move higher in 2015—best guess is middle of the year. On the one hand, the Fed could move sooner if GDP growth continues above 3% and employment increases remain near 300,000 per month. On the other hand, it could move later if inflation drops below 1% for 6 months or if foreign capital markets remain distressed.
Bottom Line: U.S. Growth Outlook Remains Very Positive
We have entered the promised land of stronger growth moving into 2015. If anything, things look too good. The strength of the U.S. economy and likely Fed action will keep driving the dollar value up and attracting investment flows into this country. Domestic spending will keep the manufacturing base busy and result in another year of healthy pallet demand growth.
The global international problems that are driving oil prices down remain my primary concern. This write-up has touched on a few of the uncertain issues very briefly. At this year’s ALC Conference, we look more closely at the international events (plus other unexpected twists) and how they will affect industrial output growth prospects beyond 2015. We will also look more closely at the expected actions by the Fed, an interest rate forecast and implications for 2016-17—especially for inflation and wages. Finally, I will delve into the housing start outlook for 2015-17 and implications for wood products demand and supply.
The forecast of a few of the key indicators that are important to the pallet industry are summarized in the table above. Industrial production should continue to grow faster than the overall economy (GDP).
Lynn Michaelis is president of Strategic Economic Analysis, a company which assists business managers in thinking about the future. Although the primary focus of his firm is housing and wood products, the company stays current on overall economic activities in the U.S. and globally.