Snowstorms and freezing temperatures slowed the economy at the start of this year, but spring will bring brighter prospects for growth, according to a new report by TD Economics, an affiliate of TD Bank.
From a pace of 1.9% in 2013, TD Economics forecasts the economy will grow by 2.7% in 2014 and 3.2% in 2015.
“Economic momentum in the first quarter was restrained by a number of temporary factors, the biggest of which was an unusually cold winter, says TD Chief Economist Craig Alexander. “As the weather warms up, the fundamentals underpinning growth will come through. With fiscal drag less than half of what it was last year and consumer finances in the best shape in several years, economic growth is set to accelerate.”
In addition to weather problems this winter, news on the economy has been sour, with a number of top line indicators like job growth and home sales losing momentum.
“The string of bad data has created doubts about the strength of the U.S. economy,” says Alexander. “These doubts are misgiven. Comparing economic data and weather across the United States, a pattern emerges — activity was hit hardest where the weather was the worst.”
Other elements, such as expiring unemployment benefits and tax credits for business investment, are also weighing on near-term economic growth, but will diminish in the months ahead.
“Moving forward, economic momentum of the private sector won’t be masked by temporary influences and the government sector,” says Alexander.
Overall the level of drag from federal fiscal policy, which is estimated to have cut 1.3 percentage points from economic growth in 2013, is likely to fall to around 0.5 percentage points in 2014. Moreover, state and local governments are likely to move from spending cuts to reinvestment.
Housing recovery to move from investors to new buyers
One of the areas of the economy where activity has slowed noticeably is the housing market. Existing home sales reached a peak in July of last year and have fallen for five of the past six months. While some of this is due to poor weather, it’s not fully to blame.
“The recent fall in home sales likely reflects the transition away from investor-supported buying,” says Alexander. “As home prices and interest rates rise, the value proposition for investors diminishes.”
The next stage of the housing recovery will shift more to traditional homebuyers. This transition was impeded by a sudden 100 basis point increase in mortgage rates in 2013 and, to a lesser extent, the introduction of mortgage regulations at the start of this year.
Borrowing costs have recently dropped, and are likely to rise slowly over the course of this year and next. Relatively low mortgage rates will keep housing affordable and, in addition to greater certainty on the regulatory front, should support a rebound in housing demand.
“The benefit of reduced fiscal drag and a more positive outlook for the economy as a whole is that it will feed back into the housing market,” Alexander said.
As economic growth pushes north of 3%, it won’t be long before the siren calls for the Fed to begin raising interest rates will begin to sound. However, scant evidence of inflation is likely to mean these calls will fall on deaf ears.
“While the economy has made substantial progress, the reality is that inflation is still running well below the Fed’s target,” says Alexander. “This should give the Fed ample leeway to leave rates accommodative even as it finishes its asset purchase program later this year.”
TD Economics expects the Federal Reserve to continue tapering its asset purchase program at its current measured pace and to end it by the fourth quarter of this year. Still, it is likely to be the fourth quarter of 2015 before the target for the fed funds rate moves off its zero lower bound.
To read the complete findings of the TD Economics report, click here.