America’s New Year comes with a new president, a new Republican Congress, a new Dow Jones record and a new trend in interest rates.
The question for 2017 is whether all these changes can bring new life to an old an economic recovery. It could use a boost, having plodded uncertainly since the end of the Great Recession seven and a half years ago.
President-elect Donald Trump wants to cut taxes and launch a trillion-dollar infrastructure spending spree. He pledges deregulation through rewrites or repeal of Obamacare, financial reforms and other rules. He threatens Mexico and China with trade-crushing tariffs if they don’t agree to new terms.
Interest rates have jumped and are poised to move higher under the Federal Reserve’s renewed effort to push toward a more normal policy.
China struggles with serious economic issues. Europe still faces Britain’s exit from the European Union and potentially unsettling elections in Germany and France.
So far, the financial world offers a Trumpian thumbs up to all this.
“The market is pricing in a lot of early communications, rhetoric, whatever you want to call it – tweets – from president-elect Trump,” said Dan Heckman, a national market consultant at US Bank Wealth Management in Prairie Village.
The Dow Jones industrial average failed to reach the psychologically appealing 20,000 mark but climbed 13.4 percent trying. Much of the year’s advance, a full 7.8 percent, came since the election. It was a lot better than the Dow’s 2.2 percent slide in 2015.
Surveys are finding stronger confidence among small businesses, consumers, home builders and corporate purchasing managers. Mutual fund investors are pumping money into higher-risk stock funds and out of stodgier bond funds.
“Certainly, animal spirits have been unleashed,” said economist Mark Vitner at Wells Fargo Securities.
Not that Wells Fargo has factored that into its economic forecast. It’s right there with most predictions, that the economy stays on a modest pace of 2 percent to 2.5 percent growth. Not strong, but strong enough that recession appears nowhere on the horizon.
Optimists are out there but forecast greater growth almost apologetically. Robert W. Baird & Co. called “seemingly far-fetched” its own prediction of 3 percent growth now and “over a protracted period of time.”
Here’s a certainty. There is a mismatch between stocks’ high flying records and the still modest expectations for the economy. They’ll need to get back in sync as 2017 unfolds.
Analysts widely attribute the stock market surge and rising confidence to November’s elections. It’s not just that Donald Trump won. The Republican party also controls the new Congress.
The pairing boosts the likelihood that some sort of tax cuts will happen and that, maybe, some new federal spending will follow. Both of those tend to encourage economists to boost their economic forecasts.
But forecasts aren’t budging quickly. A lot of politicking stands between Trump’s agenda and change, leaving experts uncertain about how much becomes policy.
Tax cuts seem the most likely to happen, with trims for corporate returns in line, politically-speaking, and ahead of individual tax rates.
Heckman said US Bank’s outlook factors in lower corporate taxes and less regulation but not steep cuts and sweeping reforms that investors need to justify the quick jump in stock prices since the election.
“The market has already priced in a little too much good,” Heckman said. “Some of these will be disappointing to markets because they factored in best-case scenarios in many cases.”
Trump will struggle like his predecessor, said economist Chris Kuehl, to finance a surge in federal infrastructure spending.
“This is something that everybody has been for since 2009, it’s just they can’t find the money for it,” said Kuehl with Armada Corporate Intelligence in Kansas City, Kan. “I don’t know where this magic trillion bucks is going to come from.”
Efforts to ease regulations likely will help energy and financial companies most. But sweeping changes, such as replacing the Affordable Care Act, or Obamacare, will face political push back particularly in the U.S. Senate where Democrats still have leverage.
Enacting any or all of this will take time, and the first economic benefits might start to show in the second half of 2017 and most would wait until 2018.
On another front, Trump’s first year in office poses new risks to the economy both directly and indirectly.
Analysis of his economic impact needs to include his stand on trade and his more isolationist or nationalist view of global events, according to Gregory Daco, chief U.S. economist at Oxford Economics.
“This raises the risk of a trial-and-error presidency,” Daco wrote in a Dec. 19 report.
One threat comes from Trump’s call for changes in trade relationships, especially with Mexico and China. The president-elect has threatened steep tariffs on imported goods that could disrupt the flow of companies’ supply lines from suppliers abroad.
High tariff walls at U.S. borders would give U.S.-based producers of the targeted imports a quick benefit. But economists generally expect the economy on the whole to suffer from reactions by other nations.
A BMO Capital Markets Economics report said this sort of tit-for-tat exchange would hurt Mexico’s economy most and strike Canada more than the United States. China, it said, would suffer the least.
Politics may defuse those concerns.
“He’s not going to get tariffs, that’s clear,” said Stephanie Kelton. an economics professor at the University of Missouri-Kansas City who was an adviser to Bernie Sander’s campaign. “His own party isn’t going to give him anything there.”
Trump also has chosen some unconventional key leaders and advisers. He handed the State Department and global diplomacy duties to seasoned Exxon Mobil executive Rex Tillerson who also is a political neophyte. Corporate investor Carl Icahn will be Trump’s deregulation chief.
Kuehl sees Trump setting up potentially disruptive counter forces in U.S. policy, for example talking tough about China but naming China-friendly Iowa Gov. Terry Branstad as ambassador to the mainland. He sees tension over Russia policy with Tillerson’s closeness to President Vladimir Putin and a harder line coming from James Mattis as secretary of defense.
“It’s kind of how a CEO does things,” Kuehl said. “At some point a decision has to be made and the CEO makes it and everybody falls in line until the next round.”
The Federal Reserve enters the New Year having raised interest rates slightly in mid-December and promising perhaps three more steps toward normal rates to come.
This essentially was how the central bankers ended 2015 – with a small rate increase in December and promises of four more rate increases ahead. Instead, the economy’s advance proved too weak to press harder on interest rates. And inflation remained meager, allowing the Fed to keep super low rates in place longer.
A different path may unfold in 2017 as inflation has edged higher and unemployment has fallen to 4.6 percent, which some economists say is close to full employment.
Markets already have lifted mortgage higher along with rates on 10-year U.S. Treasury securities. Higher interest rates tend to hurt the auto and housing industries, with car makers beginning 2017 in a slowdown to adjust inventories. But housing supplies remain tight and mortgage rates are still historically low at 4.3 percent compared with the average rate of 8.26 percent since 1971.
Economist David Rosenberg at Gluskin Sheff offers caution. He said inflation remains essentially flat. He said too much work is part-time and too many workers remain outside the labor market to consider this a full employment economy. Higher interest rates could pose problems at this stage of the economic cycle.
“It is true that no cycle dies of old age, but they do die nonetheless, and usually at the hands of the Fed,” Rosenberg told clients in mid-December.
One potential sting of higher rates comes from a stronger U.S. dollar. Interest rates remain extraordinarily low in Europe and Japan, tempting investors there to seek dollars to invest in higher U.S. interest rates.
They tend to bid up the value of the dollar, making U.S.-made goods more expensive for foreign shoppers who need dollars to buy U.S. exports.
Trump already has criticized Fed chair Janet Yellen, who has somewhat returned the favor over the president-elect’s spending plans.
“Janet Yellen has been indicating that she’s starting to raise concerns about how aggressive the Trump fiscal expansion could be, and she’s talking about the impact on inflation,” Kelton said.
One or two Fed rate increases seem plausible, Kelton said, but more could present problems for the economy.
The outlook for the New Year may hang on one factor that is tough to measure, what some call animal spirits. A stronger recovery depends on stirring America’s economic psyche.
Economists take note of investors’ zeal for stocks, consumers’ holiday spending and businesses rising confidence. But they mostly doubt it will boost the economy’s modest growth much higher.
The rising dollar and higher interest rates will tend to keep a lid on things, said Scott Anderson, chief economist of Bank of the West.
“So I wouldn’t get too carried away by the recent spurt of survey euphoria,” Anderson said.
Jim Paulsen, the usually optimistic investment strategist at Wells Fargo Asset Management, said he’s still waiting for evidence that animal spirits suspended by the Great Recession have returned.
Paulsen sees the most important question for 2017 as “whether this recovery will end before animal behaviors emerge or whether an era of aggressive, animal spirit optimism still lies ahead before the next recession.”
Some economists look for a cue from businesses, who’ve been largely on the sidelines.
“We’ve been overly dependent on the consumer,” Vitner told clients during a conference call about the 2017 outlook.
This is where corporate tax cuts hope to entice more investment from businesses. Trump also talks about urging companies to bring overseas profits back to the United States.
Doubters point out that money remains cheap to borrow and corporate cash accounts have been fat. Adding a tax cut to boost business likely won’t help.
Others see the U.S. economy’s growth as limited by weak economies abroad, including China, Japan and Europe. Moody’s Investors Service forecast slightly better growth for the world economy in 2017 at 3 percent, a mark that remains historically low.
Which leaves most forecasts for the U.S. economy stuck between 2 percent and 2.5 percent growth – a modest muddling ahead.
Bulls are out there, but they’re timid.
Investment strategists at Robert W. Baird & Co. said their forecast of persistent 3 percent growth is based on an inflection point in the recovery.
For too long, forecasters have had to trim their predictions to meet disappointments delivered by reality. Baird’s bunch sees a stronger-than-expected reality forcing forecasters to raise their predictions to keep up.
They acknowledge that this forecast isn’t widely shared, but they aren’t deterred.
“Economic forecasts are often wrong, especially at inflection points,” its forecast said.