The recovery in the economy will continue to show improvement over the next year, despite the recent rise in interest rates, according to a new report by TD Economics.
“The U.S. economy has repaired much of the damage caused by the Great Recession. The housing market has worked off the excess supply that led prices to plunge, consumers and businesses have paid off debt, and government deficits are improving,” said TD chief economist Craig Alexander. “All of this sets the stage for an improvement in economic growth over the next several years.”
“But stronger economic fundamentals also means withdrawing policy support, and this transition was never guaranteed to go smoothly,” Alexander said. “The Federal Reserve’s decision not to taper asset purchases surprised financial markets, but it has not changed the fact that interest rates have risen nearly a full percentage point since May. As the Fed itself noted, higher borrowing costs will be a headwind to growth over the next year.”
A higher yield environment was always a part of TD Economics’ forecast, but the speed of adjustment over the past three months has been faster than expected. As a result, economic growth will be modestly slower than TD’s previous forecast in June, but it is still expected to accelerate. TD forecasts real GDP growth to average 1.6% in 2013, improving to 2.6% in 2014 and 3.1% in 2015.
In one of the most anticipated announcements in over a year, the Federal Reserve surprised financial markets last week by deciding not to taper the pace of its monthly asset purchase program (also known as quantitative easing or QE). Anticipation that the Fed would taper QE has been a key factor in the rise in interest rates over the last three months.
“Quantitative easing was never meant to go on forever. The Fed’s concern over near-term downside risks has pushed tapering out a few meetings, but the realization that the program will end in the relatively near future means higher interest rates are here to stay,” Alexander said.
“Failure to extend funding for the government after Sept. 30 or to raise the statutory debt ceiling could result in financial volatility and undermine consumer and business confidence at least temporarily,” Alexander said. “We continue to cross our fingers and hope for the best in Washington. It would be nice if we didn’t have to get so close to the precipice before we step back.”
To read the complete findings of the TD Economics report click here.