CBRE EA'S Q4 2015 ECONOMIC SCENARIOS

by James Lane | Apr 18, 2016
 

 Originally Published on February 9th 2016 


THIS IS PART TWO OF A TWO-PART ARTICLE ON OUR Q4 2015 FORECAST. FOR PART ONE, CLICK 
HERE.


BASELINE

U.S. economic growth is firmly positive, despite some isolated soft spots. Manufacturing and trade have become distinct weights on growth, but the core household sector of the economy has held up remarkably well. Confidence has barely wavered from near-2006 highs and households are spending energetically. Recent global macroeconomic volatility—ranging from the slowdown in China to financial market volatility here at home—has raised the risk profile, however.

Specifically, the U.S. economy still faces risk from exogenous factors, including the possibility of policy missteps, which could prove damaging at this stage of the recovery. The Federal Reserve has handled the reins well thus far, but has only managed to raise the federal funds rate by an inconsequential 25 basis points. December's rate hike stirred financial markets in the U.S. and abroad, which appears to have upset the Fed's plan to raise rates at every other meeting in 2016. With the path to normalization looking less aggressive, interest rates are poised to remain lower for longer.

This year will likely bring more of the same for the U.S. economy. Consumers will remain the driving force, assuming that a major stock market correction does not derail confidence. Housing and non-energy business investment will also continue to climb as balance sheets improve. Wage growth will contribute more. Meanwhile, the dollar will continue to appreciate versus other currencies, acting as a drag on energy-based manufacturing and goods exporters. Low oil prices have had mixed effects on the economy, but prices are expected to gradually rise in the next couple years.

The positives outweigh the negatives, but growth is set to moderate regardless. Our baseline outlook for the U.S. calls for GDP growth of 2.1% in 2016 and 1.5% in 2017. The rate of job creation will continue to be steady in the short term—adding 2.4 million jobs in 2016 and 1.9 million in 2017—but will start to slow further out as the number of available workers falls. The tight labor market will cause wages, and therefore inflation, to run above 2% by 2018. In order to curtail inflation, the Federal Reserve will continue raising interest rates, thereby putting the brakes on the economy. This could lead to one or two quarters of negative growth in late 2018. The recovery will have been 10 years old by that point, and history tells us that a recession comes around once a decade on average.


UPSIDE SCENARIO: STRONG GROWTH, WITH MONETARY TIGHTENING WELL EXECUTED

In our scenario of strong growth, the Fed navigates the rocky shoals of rate increases without causing a recession. The scenario includes job growth of 2.2% this year and 1.7% in 2017, supported by domestic consumption and momentum. Wages—and then prices—continue to rise, leading to an increase in inflation. Oil prices rise faster than in the baseline as global growth takes a turn for the better. Forced to respond to inflation, the Fed raises rates more aggressively than it does under our baseline scenario. The 10-year Treasury reacts by reaching 3.8% in 2016 and 4% in 2017. The overall economy remains on track, however, without experiencing a major slowdown. In other words, this scenario represents a situation where, over the medium term, nothing goes really wrong and the U.S. continues to grow without any setbacks.


Figure 1: Wide Employment Bands For Scenarios

 

Source: CBRE Econometric Advisors, Q4 2015.


DOWNSIDE SCENARIO: MILD RECESSION; GLOBAL FACTORS TOO MUCH TO OVERCOME

Our downside scenario depicts a slowing economy arriving at a mild recession in 2017-2018. Employment continues to grow in 2016—albeit at a tepid pace—ahead of a cumulative 1.1% peak-to-trough decline during the recession. Similarly, GDP declines by a total of 0.5%.

This recession is caused by several exogenous factors. First, the scenario assumes that China and the global economy slow more sharply than expected. The blowback from a strong dollar leads to sharp contractions in exports and manufacturing. The dour global outlook also keeps oil prices stagnant at their lows around $30 per barrel—contrary to the baseline, where prices rise gradually for the next several years. Financial markets become even more edgy, with credit spreads, stock prices and general volatility taking turns for the worse. Low oil prices' supposed tailwind for consumers is more than offset by negative wealth effects from the stock market selloff. Finally, the Fed raises rates too aggressively just as the economy begins to falter, worsening the drag on economic activity. The Fed eventually realizes its mistake and resumes zero-interest-rate-policy and possibly several rounds of quantitative easing.


SEVERE DOWNSIDE SCENARIO: WORSE THAN THE GREAT RECESSION

We are also providing a severe downside scenario, under which a doomsday recession begins almost immediately in response to numerous severe shocks. This scenario is meant to provide an outlook similar to the Federal Reserve's "Severely Adverse" CCAR stress test scenario. Our peak-to-trough decline in GDP is not quite as severe, but it is spread out over more time, so the economic impacts of the recessions are roughly similar. Additionally, our severe scenario does not feature as strong a recovery; output takes nearly a decade to reach its previous levels. The economy loses 6% of its jobs within 2 years, and most of those jobs never return. The hypothetical outlook for this scenario is worse than the Great Recession.

This is meant to represent a worst-case situation, caused by the adverse chain of events in the downside scenario plus a number of "Black Swan" events. We do not make any assumptions about what these might be, but something would have to go very wrong in the geopolitical realm for the economy to be affected so badly. Its likelihood is extremely low, but the scenario can be useful for low probability risk-management practices.


Figure 2: Self-Sustaining Expansion is Nearly at Hand

 

Source: CBRE Econometric Advisors, Q4 2015.


Figure 3: Regional Growth Continues to Strengthen

 

Source: CBRE Econometric Advisors, Q4 2015.