29 May 2017
Slowing labour force growth means the US economy may grow at a significantly slower pace over the longer term than currently anticipated by the Federal Reserve and investors.
Macquarie estimates the US economy will grow by 1.4 per cent a year after 2019, compared with the Federal Reserve's 1.8 per cent forecast and economists' consensus of 2.1 per cent.
Retiring baby boomers are creating supply-side labour constraints in an economy already running at the lowest unemployment level in a decade, says North America economist David Doyle.
"As fewer productive workers enter the market, and amid subdued productivity growth, output should expand at a slower pace into the next decade than it did coming out of the global financial crisis," he says.
Macquarie estimates the US economy will expand at an annual average of 1.9 per cent between 2017 and 2019, slowing down every year, and 1.4 per cent from then on.
Fed's forecasts to keep falling
From as high as 2.6 per cent in 2011, the Federal Reserve has continually reduced its forecast for longer-run real GDP growth in the US.
“As it becomes more evident that the economy is very close to full employment, if not at full employment already, and growth continues to be relatively weak, the Federal Reserve will reduce that estimate further," says Doyle.
He says this may also lead to a moderation of long-run expectations of both the Federal Reserve funds rate and Treasury yields.
“I think it will become more apparent to the Federal Reserve as they move through the current rate-hike cycle that it will be challenging to raise rates beyond the 1.5-1.75 per cent range," says Doyle. He cites a 10-year Treasury yield of 2.3 per cent as fair value.
“The Fed has based their projections on traditional rules and previous cycles' experience," says Doyle.
“My counterargument is that it is not really the financial crisis that resulted in headwinds to the economy, but rather the more structural and permanent forces of demographics."
A downgrade of long-run growth estimates also has implications for corporate earnings expectations and government budget deficit projections.
No help from stimulus
The Trump administration's plan to cut taxes and increase spending is unlikely to alter the long-run growth path significantly, says Doyle.
“There is not much the government can do about demographics – other than increase immigration," says Doyle. “And if anything, it looks like they are inclined to do the opposite."
For a copy of the report ‘Fortress America – Demographics, lower potential, and the Fed’, contact your Macquarie representative.