Executive Summary
- The U.S. economy is on solid footing, with overall strong labor and housing markets, two key components of economic performance. Output growth has been steady but weaker than desired, and inflation remains low, thanks to still-low energy prices. Manufacturing conditions are generally positive but the sector still has considerable slack. Consumer confidence is high, incomes are growing, and spending has picked up.
- A key driver of performance in the next several years will be the changing of the guard that took place in Washington, D.C. in November. The new administration has proposed a number of policy initiatives that are positive for economic growth, for businesses and consumers, and for financial institutions. These include cuts in corporate and individual tax rates; regulatory relief for financials and other businesses, especially small business; replacing the Affordable Care Act with a plan that is intended to reduce premium costs for both individuals and employers; and increased infrastructure spending.
- The key risk factor will be whether the administration can achieve those objectives, whether it can achieve them in a timely manner, and whether new initiatives put in place are successfully in attaining the desired outcomes without unintended adverse consequences. The odds of success are enhanced by GOP control of both houses of Congress, but there is considerable resistance from Democrats. The administration’s window of opportunity may only last until the mid-term elections in 2018.
- The Fed has commenced tightening, and has signaled a further three rate hikes this year, which would take the funds target to 125-150 bp. This is unlikely to produce more than a modest increase in market rates, which should be positive for financial institutions. The Fed has adopted a more hawkish stance of late.
- Credit unions may also benefit from proposed regulatory relief, though it is unclear at this point just what that may look like. Some clients have noted that they have already made significant investments to comply with increased regulations imposed by the previous administration, and unwinding those compliance programs may require some effort and expense.
- We anticipate continued strong loan demand based on consumer confidence, a strong labor market, positive housing fundamentals and continued demand for autos. Share growth may pick up as rates increase, but with a declining savings rate we could well see share growth weaken. Either way, loans-to-shares should increase further.
- In terms of risk assessment, our outlook for the likelihood of interest rates increasing by 100 bp over the next 12 months is at 70% based on projected rate hikes. Our outlook for the likelihood of a recession during the same time frame is less than 10%.