GSU Economic Forecaster Advises Patience for Remainder of 2018

ATLANTA–Following a quarter-point rate hike in March, expect the Federal Reserve to raise rates twice more this year, according to Rajeev Dhawan of the Economic Forecasting Center at Georgia State University’s J. Mack Robinson College of Business.

“We will get a rate hike in June,” Dhawan wrote in his “Forecast of the Nation,” released Wednesday, May 23, 2018. “Then the Fed will wait until December to see the impact of its previous hikes.

“Two factors may come in to play as the Fed waits to take further action,” Dhawan said. “First, evidence has to emerge that tax cut-induced consumer spending is finally taking hold as weak retail sales numbers in the first quarter were a snapback from a hurricane rebuilding spending surge in the last quarter of 2017. But the real reason to wait between hikes is to allow the factors that determine a rise in long-bond yields to play out.”

Despite other forecasters and members of the media signaling that an inverted yield curve could be on the horizon, potentially indicating a recession, Dhawan believes the Fed can hold off these concerns.

“Recession talk is premature,” Dhawan wrote. “What happens to the long-bond yield as the Fed hikes rates is key. Long-bond yields are determined both by global capital flows (especially foreign demand for Treasurys) and the domestic debt issuance in response to the federal fiscal deficit. Global capital flows may fluctuate with the volume of trade but it’s clear given the recent budget passage of spending increases and last December’s tax cuts that issuance of Treasury bills is expected to rise sharply in the coming quarters.”

Dhawan expects a steady rise in the long-bond yields.

“After the two remaining hikes in 2018, expect two more in 2019 and one in 2020. This is a perfect soft-landing forecast with no recession,” said Dhawan.

Dhawan advises patience when reviewing poor consumption and retail sales figures from the first quarter.

“Consumers have just begun to experience the tax cuts in their paychecks, but they still haven’t registered fully,” Dhawan said. “Some purchasing power has been eaten away by elevated gas prices, which will delay the impact of the tax cut led spending boom small businesses are eagerly awaiting.”

Gas prices have soared, mostly because of a catastrophic drop-off in imports from Venezuela as OPEC producers have kept supply constant. Dhawan expects oil to level off in the $70 per barrel range for the remainder of 2018, but cautions any NAFTA trade fallout involving Canada, which provides 50 percent of oil imports, could be devastating.

The forecaster expects job growth to remain around the same level due to a slight pickup in business investment.

“We heard a lot of companies making plans to bring back their cash from abroad, but it seems to have gone into share buybacks,” Dhawan wrote. “Tax changes take time to filter through, and businesses require much calmer financial markets than we are currently experiencing.”

As a result of this corporate investment, Dhawan expects GDP to grow by a strong 2.9 percent in 2018. Growth in 2019 will be 2.4 percent, then further moderate to 1.8 percent in 2020.

The forecast has a caveat: No major trade war or skirmish in the coming quarters. Skirmishes at the physical level, including tariffs on goods by each side, are easy to analyze and may not be even that costly.

“But, the biggest unknown of trade actions is their impact on global capital flows,” Dhawan said. “If tariffs on our major trading partners, especially China, drive them out of the U.S. Treasury market, it will make 10-year bond yields rise in three months. In a normal forecast, that would happen in three years.”

If such a scenario occurs, Dhawan said all bets on a soft landing are off.

“But, forecasting the probability of a trade war is more dependent upon political calculations than economic logic,” said Dhawan. “Thus, we aren’t forecasting it, but cannot deny this as a potential outcome.”

Highlights from the Economic Forecasting Center’s National Report

  • Following GDP growth of 2.3 percent in the first quarter of 2018, the economy will expand at 2.9 percent in 2018, 2.4 percent in 2019 and 1.8 percent in 2020.
  • Business investment grew 6.1 percent in the first quarter of 2018. Growth will settle at 5.9 percent in 2018, 4.8 percent in 2019 and 3.8 percent in 2020. Jobs will grow by a monthly rate of 180,200 in 2018, 158,700 in 2019 and 111,800 in 2020.
  • Housing starts will average 1.297 million units in 2018, fall slightly to 1.267 in 2019 and rise again to 1.303 in 2020. Expect auto sales of 17.0 million units in 2018, 16.2 in 2019 and 16.0 in 2020.
  • The 10-year bond rate will average 3.2 percent in 2018, 3.9 percent in 2019 and 4.0 percent in 2020.