As we enter the new year, we find diverse forces that challenge economic forecasters. The major concern is centered on the outlook of the so-called "balanced budget." We label it "so-called" because even under the most conservative plan, it is back loaded! Projections are for actual deficit increases during 1996 and 1997, with all of the balancing to occur during the final five years of the seven-year plan.
Obviously, this is the attempt of the current politicians to spend into this election year. One would wonder about future elections when these same election pressures could again undo the scheduled balanced budget. Graham-Rudman-Hollings legislation comes to mind as an example of a previous congressional attempt that ended in failure. The past year has seen the marketplace over-stimulated by expectations for the final agreement between the administration and Congress.
Expectations are for low inflation rates for the coming year to continue. Current interest rates and stock price levels reflect the expectations for price stability. Some concerns must be taken into consideration which could reverse these expectations: (1) increasing wage pressures arising out of the current unemployment level of 5.6%, which has been consistently below the stated approximate 6% natural rate of unemployment for the past 16 months, (2) current levels for gold prices are significantly higher than Federal Reserve Board of Governors targets to achieving long-term price stability, and (3) possible increase in food and fiber prices from the growing demand for U.S. goods as a result of escalating living standards in China. These factors could re-ignite inflation fears in 1996, bringing to an end the current Federal Reserve interest-lowering agenda.
Chief among economic data that endorse the low inflation expectations is the unprecedented high level of Consumer Installment Credit Outstanding. The current credit level has exceeded the highs that occurred prior to the recession of 1990. Coupling the high levels of consumer debt with recent reports of low retail sales, consumer spending will likely slow in the first half of 1996. Thus, expectations for inventory levels to rise beyond manufacturers' desired levels, and a decrease in capacity utilization may be realized. A combination of these scenarios would result in further declines in interest levels during 1996.
The general economic climate entering the new year is one of moderate growth. The Gross Domestic Product measured year over year is expected to grow by 2.5% to 2.75%. Capacity utilization at levels above 80 indicate continued expansion. Loan demand remains strongly above Federal Reserve upper target limits. Newly unveiled leading indicators are very positive for several months into the future. Low interest rates have brought mortgage rates close to 20-year lows. These low rates give credence to expectations for the housing industry to remain strong in the coming year. The relatively flat yield curve presumes a moderate slowing of economic activity, as does the National Association of Production Managers' monthly survey running below an index of 50 that tends to predict economic slowdown.
Concerns that could bring economic and market disruptions center around events outside our own national market. The year 1996 was a year of immense liquidity flowing to the United States, beginning with the devaluation of the Mexican Peso when dollars returned to U.S. assets. The Dollar/Yen exchange rate fell to new lows, bringing large central bank intervention. This purchase of dollars resulted in large increases in holdings of U.S. financial assets. Japanese interest rates fell to extremely low levels, thus, purchase of dollars to invest in U.S. Treasury bonds and stocks were a natural.
This flow of money into the U.S., coupled with a great deal of domestic liquidity, provided a large increase in the value of stocks and bonds. This event cannot be expected to continue into the current year. Concerns for a reversal of 1995 liquidity must be considered. Reports of one trillion in loan losses in Japanese banks raise questions concerning the realization of profits from sales of U.S. assets being used to offset loan losses as their fiscal year ends on March 31.
Economic expansion will be moderate with only small decreases in short term interest rates. Mortgage rates will remain near their 20 year lows. Real estate values will rise only modestly with some major variances by locale.