ODU Researchers Deliver National, Regional Forecasts for an Uncertain Economy in 2017
January 25, 2017
Vinod Agarwal discusses the regional economy with Rep. Bobby Scott (D - Newport News)
Larry "Chip" Filer chats with John Sokolowski, executive director of ODU's Virginia Modeling, Analysis and Simulation Center
Old Dominion University economist Vinod Agarwal didn't start off with the economy in the presentation of his annual economic forecast for Hampton Roads.
"Before I begin, I have to ask, 'Has Donald Trump tweeted anything?' That will change the forecast," said Agarwal, director of the Economic Forecasting Project of ODU's Strome College of Business.
Agarwal's remark was lighthearted, but it reflected the challenging environment for economic forecasting in 2017, with Donald Trump just inaugurated as the 45th president of the United States and uncertainty about a range of key economic decisions that his new administration will make.
Agarwal delivered the regional forecast, and Larry "Chip" Filer, associate professor and chair of the Department of Economics, offered the national forecast. Their predictions are eagerly anticipated by the local business community as harbingers of the year ahead.
The news from the ODU researchers was decidedly mixed, with some indicators showing the local economy falling behind the national economy, but others pointing to a healthier 2017.
"Nationally, this is the year we are going to test if Wall Street and Main Street are linked," Filer said. It isn't clear, he said, if the robust growth in markets in the past six months, particularly since Election Day, will translate to benefits for everyone.
"Do market runs play out in GDP growth, employment growth, wage growth and other things that will be felt on Main Street? We're going to find out," he said.
The ODU economists predicted the national economy will grow at a rate of 2.2 percent and the regional economy by 1.41 percent in 2017. But Agarwal said many variables could affect the local economy, from infrastructure investments to changes to the tax code to decisions about defense spending - which is vital to the Hampton Roads economy. However, he said decisions by the Trump administration are not likely to significantly affect the regional economy in 2017. "These are effects that will be felt in 2018 and beyond," he said.
The economists voiced optimism about many key indicators of growth in Hampton Roads this year. They predicted the local unemployment rate will drop to 4.4 percent, hotel revenues will increase by 4.4 percent and housing permit revenue will rise by 2.6 percent.
Agarwal said the sudden, sharp increase in 30-year mortgage rates after the election could foretell an increase in key interest rates, after almost a decade of low rates. "If you are looking to sign a mortgage, now may be the time," Agarwal said.
Details about the Old Dominion University Economic Forecasting Project's regional and national forecasts for 2017 are below:
ANNUAL 2017 ECONOMIC FORECAST AND ANALYSIS FOR THE HAMPTON ROADS MSA
The Hampton Roads MSA (formally the Virginia Beach-Norfolk-Newport News MSA) includes Currituck County NC, Gates County NC, Gloucester County, Isle of Wight County, James City County, Mathews County, York County, Chesapeake, Hampton, Newport News, Norfolk, Poquoson, Portsmouth, Suffolk, Virginia Beach and Williamsburg.
Real Gross Regional Product (up 1.41% in 2017)
We expect the Hampton Roads economy to grow at a slightly higher rate (1.41%) in 2017 than in 2016 (1.36%). However, regional growth in 2017 will once again be slower than our historical annual average of 2.6% over the past 30 years and slower than that of the nation. The Bureau of Economic Analysis (BEA) reports that the region's economy, as measured by Real Gross Regional Product (GRP), expanded at an estimated rate of 3.71% in 2015 after experiencing negative growth of 0.73% in 2014. Unfortunately, we expect the BEA to revise reported GRP growth for 2015 to about 2% later this year. The BEA estimates that Virginia's economy grew by 1.44% and the Washington metro area's economy grew by only 1.27% during 2015.
Whereas the inflation-adjusted U.S. GDP grew by 10.84% from 2009 to 2014, Hampton Roads' real GRP grew by only 0.87%. The major reasons are the Great Recession and the deceleration of Department of Defense (DOD) spending. Between 2000 and 2012, direct DOD spending in the region increased annually at a rate of 5.8%, compounded. However, DOD expenditures since that time have been stagnant or have declined. We anticipate that DOD spending in 2017 will be about 1% lower than its peak in 2012.
The two-year budget agreement passed by Congress provided $50 billion in sequestration spending relief in FY 2016 and an additional $30 billion in FY 2017 -- split evenly among the defense and non-defense discretionary accounts. The discretionary defense spending cap increased 5.18% from $521 billion in FY 2015 to $548 billion in FY 2016, but will increase by a scant $3 billion during FY 2017. Unless Congress takes further action, the discretionary cap on defense spending will decrease by $2 billion in FY 2018. We note that, under current law, the spending caps will continue through FY 2025 even though there continue to be calls to repeal these caps.
What can we expect from the Trump administration for the remainder of FY 2017 and future years? Among many possibilities, these are three likely scenarios:
First, Congress and President Trump agree on rapid and sustained increases in defense spending that could raise national defense expenditures by 5% annually. This might include a massive shipbuilding program to reach a fleet of 350 ships; increased production of the F-35A and the movement of the F-35B and F35-C into Full Rate production; the Army and Marine Corps would grow back to 2007 personnel levels; and new procurement would replace aging armor, helicopters and other weapons systems.
Second, Congress and the President agree on significant cuts to corporate and personal taxes coupled with large expenditures on infrastructure investment and defense expenditures occurring in the first year of the new administration. In this situation, significant increases in the federal deficit could become a concern by the end of FY 2018. Spiraling inflation from expansionary fiscal policy could result in Federal Reserve approval to rapidly increase interest rates. Bond yields spike and interest payments could quickly start to crowd out discretionary expenditures, including defense. Defense expenditures flatten, shelving almost all force modernization plans and hopes to increase the end strength for the Army and Marine Corps. A new BRAC round targets large savings; including bases in the Hampton Roads area. Langley Air Force Base and Oceana Naval Air Station become targets.
Third, Tax reform, infrastructure spending and defense spending compete for attention and resources in this future. Faced with this pressure, Congress modifies the Budget Control Act spending caps on a two-year cycle. The Navy remains at 300 ships and shelves expensive ship building plans. The Air Force continues to buy the F-35A, while the F-35B and F-35C remain in Low Rate Initial Production. While the downsizing of the Army and Marine Corps halts at current levels, no significant increases in end strength occur over the next five years. Here again, increasing fiscal pressure and demands for economies of scale could result in a new BRAC round significantly cutting the footprint of the Department of Defense.
Regardless of what choices the President and Congress make, we do not expect changes in defense and other spending to have a significant impact on the national or the regional economy in 2017. In all likelihood, significant impacts will not occur until 2018.
At the regional level, we expect DOD spending to increase slightly during 2017. Military personnel and federal civilian government employees received a 2.1 percent pay increase at the beginning of 2017. However, the pattern of sequester relief provided by Congress every two years in the recent past has created uncertainty and instability for firms and companies that have DOD contracts.
The Hampton Roads economy continues to be heavily dependent on DOD spending. From a peak of 45.1% in the recent past (2012), DOD spending now contributes approximately 36.7% of Hampton Roads GRP. However, the private sector in our regional economy has not taken up the slack as it did during the 1990s defense spending drawdown. The Quarterly Census of Employment and Wage (QCEW) reports that during the first q
Employment: Non-Agricultural Civilian Employment (+0.50% in 2017) and the Unemployment Rate for the Civilian Labor Force (4.40% in 2017)
We forecast that annual civilian employment in our region will increase by about 3,800 jobs during 2017. Employment growth is likely to be concentrated in firms providing professional and business services, leisure and hospitality, and health care services.
From 2007 to 2010, the recession and its aftermath were responsible for the loss of an estimated 38,400 civilian jobs in Hampton Roads. The regional economy has been able to recover only 31,900 of those jobs. Even with the forecasted gain of jobs in 2017, annual civilian employment in Hampton Roads will remain below the peak level of employment observed in 2007.
Further, it appears that many of the jobs lost due to the recession were in occupations that paid relatively higher wages. Jobs created or gained since then, on the other hand, frequently have been relatively lower-paying jobs. Thus, the changing mixture of jobs in our region has not been favorable and is a phenomenon that decision-makers should not ignore.
An examination of the annual data on jobs through 2016 show that while we continue to struggle in creating jobs, large metro areas just south of us in North Carolina have continued to add significant numbers of jobs. Northern Virginia and Richmond are the only major metro areas in Virginia that have created large numbers of jobs.
We expect the region's unemployment rate to fall from 4.59% in 2016 to 4.40% in 2017. Our region's unemployment rate has declined since 2010. While declining unemployment rate is good news, we also have seen declines in labor force participation. This means that many individuals have dropped out of the labor force and therefore are not counted as being unemployed. The reasons for this are not yet clear, but perhaps can be attributed to discouraged workers, changing demographics, a more generous social safety net and rising worker disability claims.
Retail Sales (Taxable Sales, +2.60% in 2017)
Taxable sales include all retail sales except new automobile sales and gasoline sales. Compared with their pre-recession peak in 2007, retail sales in Hampton Roads fell by 8.6% in 2009 and continued to decline slightly, -0.2%, during 2010.
However, retail sales began to recover slowly in 2011 and in 2014 were 2.0% higher than the 2007 peak level. It took eight years to recover the loss in retail sales. Retail sales now are increasing at a decent pace; 3.8% in 2015 and by another estimated increase of 2.0% in 2016.
We expect retail sales in the region to grow by 2.6% in 2017. Continued relatively low gasoline prices, growth in regional economic activity, rising incomes, consumer confidence, and the increase in wealth of households are all expected to result in growth in taxable sales.
Tourism (Hotel Room Revenue, +4.20% in 2017)
Hotel industry revenue increased by 6.7% in 2017. Factors contributing to higher hotel revenue during 2016 were: moderate increases in federal travel; higher per diem rates; lower gasoline prices; lower heating oil prices in the Northeast; growth in the national economy, particularly in the Hampton Roads' main tourist market areas, and a continued slowdown in additional supply of hotel rooms. However, in real, price-adjusted terms, despite substantial increases in 2015 and 2016, hotel revenue at the end of 2016 still was about 4% below the 2007 level.
Virginia Beach has been the sub-market that has exhibited the largest growth in Revenue Per Available Room (REVPAR). The Williamsburg market, after outperforming other sub-markets in Hampton Roads in 2015, performed rather poorly in 2016. REVPAR in Virginia Beach during 2016 increased by 11.6%, whereas it increased by only 3.5% in Williamsburg.
Factors contributing to higher tourism revenue during 2017 will continue to be the same as those observed during 2016. We expect to see moderate increases in federal travel; slightly higher per diem rates; historically low gasoline prices; lower heating oil prices in the Northeast; growth in the national economy, particularly in the Hampton Roads' main tourist market areas, and a continued slowdown in the number of additional hotel rooms in Hampton Roads.
Port (General Cargo Tonnage, (+2.70% in 2017); TEUs, (+3.20% in 2017)
Economic activity connected to the Port of Virginia long has been an important contributor to the region's economic well-being. The Great Recession adversely impacted the Port and the cargo flowing through the Port---whether measured by general tonnage or by twenty-foot equivalent container units (TEUs). In 2009, general cargo tonnage and TEUs were 16.4% and 18.0%, respectively, below their peak levels. The volume of general cargo and TEUs flowing through the Port has increased every year, 2009 through 2015, with particularly large increases occurring in 2012 and 2013. Nevertheless, it took the Port almost five years to recover the losses incurred during the recession. General cargo tonnage and TEUs continued to increase in 2016---by 4.5% and 4.2%, respectively. However, excluding the movement of empty containers, loaded TEUs increased by 4.8%.
The Port continues to set record volumes in TEUs as well as tonnage. Tonnage and TEUs handled at the Port in 2016 are 17.0% and 24.8% higher than their pre-recession peak levels. During 2016, the rail segment of the Port's business increased by 15.4 %. This speaks volumes for the Port as this type of cargo could easily move to other ports. Furthermore, average TEUs per container vessel call continue to grow and have increased by 30.7% from 2011 to 2016.
The Port has gone through a transition as it has attempted to improve its relative competitiveness, especially with respect to other East Coast ports. The Port has also focused on improving its operating efficiency. Consequently, it has reduced its operating losses significantly and recorded an operating income of $13.6 million during its fiscal year 2015, ending June 30, compared with an operating loss of $16.9 million in fiscal year 2014. Its operating income for fiscal year 2016 was lower but positive as the Port was operating near capacity and trying to manage growth at the same time. However, during the first 10 months of 2016, the Port has generated an operating income of $14.6 million compared with $9.6 million during the same period in 2015.
Factors that have contributed to the Port's growth include larger ships calling, its access to round-the-clock deep water and additional business generated by the Commonwealth's economic development efforts. Another factor that could help cargo growth at the Port in future years will be the expanded and refurbished Panama Canal, capable of handling much larger ships. Analysis of data on container vessels calling at the Port reveals that the average TEU capacity of these ships has been increasing. For example, the average TEU capacity of the largest 10 percent of these ships increased from 5,691 TEUs in 2009 to 9,067 TEUs by 2014. We do not have the data for 2015 and 2016, but we have some evidence that larger ships are either already coming here or will be doing so soon. In July, 2016, the Port handled the MOL Benefactor, which was the first and largest container ship at 10,000-TEU capacity to come to our port via the widened Panama Canal. Since then, more than a dozen ships larger than the MOL Benefactor have come to Virginia, and even larger ones are on the horizon. The larger-ship trend will only accelerate with the Panama Canal expansion now complete and again after the Bayonne Bridge project in New York is finished.
In 2016, the Port, supported by the Governor and General Assembly, announced two large expansion projects that will provide momentum for continued growth and progress -- Norfolk International Terminal (NIT) South Optimization and Virginia International Gateway (VIG) II. By 2020, the Port will have the capacity to process 1 million additional container units, a 40% increase overall. The two projects represent combined investment of $670 million: $350 million from the Commonwealth for the NIT South modernization and $320 million of private investment for VIG II. In February 2016, the Port executed a 40-year lease with the City of Richmond for the operating rights at Richmond Marine Terminal allowing the port to improve service and further diversifying the port's service offerings.
Going forward, the Port continues its work on the construction of the North Gate at NIT with expected completion in summer 2017. When complete, the project will provide a 26-lane gate complex doubling the terminal's gate capacity and link it with the I-564 Connecto -- a project that will provide motor carriers faster access to the market and reduce idle time in traffic. In 2017, construction will begin on both the VIG phase II and NIT expansion projects. CSX is expanding its double-stack capability going north and opening new markets for the Port in the Northeast. CSX completed the first phase to be double-stack cleared on one line in December 2016 and it hopes to open the second line by mid- 2018.
Housing (Value of Single Family Housing Permits (+2.60% in 2017)
The residential construction industry in Hampton Roads is expected to grow moderately in 2017. The sale of newly constructed homes -- except for 2014 -- has been rising each year since 2010. The relatively small inventory of existing homes in the market, low mortgage rates and continued moderate prices should help stimulate the growth in new construction homes.
The market for existing residential homes in Hampton Roads has also been steadily improving since 2011. Measures of supply and demand indicate that it would take approximately 4.3 months to clear the existing inventory based on the current absorption rate. This is much lower than Hampton Roads' historic average of 5.6 months. Even so, we continue to be concerned about the volume of distressed (short sales and bank-owned) homes in the local residential market. Distressed homes, whether measured in distressed sales as a proportion of all existing homes sold or in listings as a proportion of existing homes currently on the market, continue to represent a significant proportion (nearly one-sixth) of residential market activity. The problem is that bank-owned homes, for example, often sell at prices barely more than one-half those of non-distressed properties.
Although mortgage interest rates are at relatively low historic levels and household income in our region is recovering, the persistent large proportion of the distressed market activity likely will mean only a modest recovery in sales prices of homes in Hampton Roads in 2017.
2017 ANNUAL NATIONAL ECONOMIC FORECAST
Real GDP (2.2%)
The U.S. economy grew at a much slower rate in 2016 compared with 2014 and 2015, driven in part by weak growth at the start of the year. Real GDP growth was only 0.8% in Q1 of 2016 followed by 1.4% growth in Q2. In contrast, initial estimates of Q3 growth were 3.5%, which represents the largest rate of quarterly real GDP growth since the Great Recession. Our projection of Q4 growth is 1.6% (the BEA will release data for 2016 Q4 on Jan. 27, 2017). Given this projection for Q4, we are estimating 1.6% annual growth in 2016.
The forecast for real GDP growth in 2017 is 2.2%. Our forecast is clouded in tremendous uncertainty, however. Now that the new administration is in office, we will learn more about potential economic policy proposals and their impact on growth as the year evolves. In addition, there is some uncertainty surrounding the path of the economy as it inches closer to full employment and Federal Reserve stimulus is removed in moderation. Growth in the early part of 2017 is likely to be subdued as a result of this uncertainty. However, the latter part of 2017 is likely to be strong.
World economic growth will continue to be a drag on the United States in 2017. The Euro Area, China and Japan are all expected to grow faster than they did in 2016, but still well below pre-Great Recession levels. This, combined with a strengthening dollar, will hamper U.S. exports. As a result, we expect net exports to continue being a drag on GDP in 2017.
Private fixed investment peaked in 2015 Q3. While it still provides a positive contribution to growth, we do not anticipate the positive impacts on real GDP from private fixed investment to accelerate in 2017.
Finally, growth in personal consumption expenditures will continue to be the main source of growth in real GDP. Consumption is forecast to contribute between 2% and 2.5% to real GDP during 2017.
Payroll Employment (1.5%)
Nonfarm payroll employment began to slow during 2016, ending the year with 1.7% growth. We are forecasting 1.5% growth in nonfarm payroll employment during 2017. This is identical to our employment growth forecast for 2016 and represents the reality that the labor market is steadily approaching full employment.
Wage growth was strong during 2016. Average hourly earnings in the private sector grew 2.5%, representing the fastest pace of growth for the post-recession time period. We are anticipating strong growth again of 2% for 2017.
Unemployment Rate (4.7%)
The unemployment rate continued to improve in 2016, ending the year at 4.7%. This improvement is less than the improvement we saw in 2014, and it is expected that further improvements in the unemployment rate will become increasingly difficult as we approach full employment.
Therefore, we anticipate very little change to the unemployment rate in 2017 as the economy finds it increasingly difficult to squeeze out the remaining slack in the labor market. Depending on the dynamics of labor force participation in 2017, the United States could even see increases in the unemployment rate at times during the year. This could occur as those that have dropped out of the labor force re-enter with the hope of finding employment in the improving economy but remain unemployed for a period of time while job hunting.
We are confident that the unemployment rate will not end 2017 higher than in2016, but we also believe that it is unlikely we will see a significant decrease in the unemployment rate. As a result, we are forecasting the unemployment rate at the end of 2017 to remain near 4.7%.
Consumer Price Index-Headline (2.8%)
Consumer Price Index Core (2.4%)
We are forecasting a significant change in the relationship of headline and core inflation in 2017. For the first time since mid-2014, we are anticipating that headline inflation will slightly outpace core inflation for the year. This is highly dependent on the price of oil, which is excluded in measures of core inflation and has been historically inexpensive over the last two years.
Negative demand shocks are no longer the driving force behind cheap oil. Positive supply shocks are mostly responsible for current price levels. We anticipate, given OPEC statements and rhetoric, contractions in oil supplies during 2017. This, combined with stable world demand for oil, will drive oil prices toward $62 per barrel by the end of 2017, setting the stage for headline inflation to inch higher than core inflation.
Overall, our current forecasts for real GDP growth, the removal of monetary policy accommodation and moderate wage increases suggest that inflation should be well contained in 2017.
Three-Month Treasury Bill Rate (Year Avg. 1.31%)
Ten-Year Treasury Note Rate (Year Avg. 3.15%)
30-Year Conventional Mortgage Rate (Year Avg. 4.25%)
Our forecasts for interest rates in 2017 are nearly identical to our forecasts from 2016. Rates in 2016 finished well below our forecast, reflecting a Federal Reserve that was far more dovish than we anticipated. The Federal Reserve has begun the process of normalizing interest rates. Statements from the Fed are hinting at a 75 basis point increase in the Federal Funds target rate during 2017.This change in policy, coupled with stronger economic conditions, should lead to higher interest rates at all maturities across the yield curve. The largest rate increases are likely to occur in the 3-month Treasury Bill rate, as it is very closely tied to the Federal Funds Rate. Therefore, we are forecasting 3-month Treasury bill rates to end the year at 1.3%.
The forecast for the 10-year Treasury is slightly more uncertain. Recent rate increases have been consistent along the full spectrum of maturities, leaving spreads largely unchanged, but that trend may not continue in 2017. Market perceptions regarding deficit spending are likely to cause 10-year rates to increase at a faster pace than short-term rates, widening the spreads between the 10-year and shorter maturity bonds. This phenomenon was already occurring in late 2016. The spread between the 10-year and 3-month stood at 130 basis points in September, but increased to 209 basis points by December. We expect this spread to remain at or above 200 basis points through 2017.
Housing market dynamics will be as important to the path of the 30-year conventional mortgage rate as Federal Reserve policy decisions during 2017. We are forecasting the mortgage rate to average 4.25% during 2017, up from an average of 3.65% during 2016. Recent increases in the 30-year mortgage rate have moderated, but we anticipate that rates will move higher again in the near term as a result of Federal Reserve tightening.