How Did Goldman Sachs Do On Its 2016 Economic Outlook?

Here’s Goldman’s self-assessment on their 2016 economic predictions.


Today’s comment looks back on the “8 Questions for 2016” that we posed at the end of 2015. The tightening in global and US financial conditions associated with the onset of Fed policy normalization took a bigger toll on H1 growth than we had expected. This undermined our call for one hike per quarter this year, despite an increase in inflation in line with our forecasts. Since midyear, growth has picked up and the Fed has resumed tightening, but this came too late to rescue our 2016 Fed call.

In our annual review of the key questions for the prior year, we revisit each question, what we predicted, and what actually happened, with a brief discussion of the reasons for any hits and misses.

1. Will growth stay above trend?

Our answer: yes.

Verdict: narrowly correct for 2016 as a whole, though incorrect for H1.

For the year as a whole, the US economy seems to have grown at a modestly above-trend pace. Real GDP grew 1.8% for the first three quarters and an estimated 1.9% for 2016 on a Q4/Q4 basis; our current activity indicator (CAI) has also averaged 1.9% through November. These numbers are slightly above our estimate of potential GDP growth of 1¾%, though clearly below our 2.3% forecast and the 2.6% Blue Chip consensus for Q4/Q4 growth as of the end of 2015.

Indicators of labor market slack tell a clearer story of above-trend growth. For example, both the U3 unemployment rate and the broader U6 underemployment rate have declined by 0.4pp and 0.6pp since December 2015, respectively. Other labor market indicators such as the employment/population ratio for prime-age workers, job openings, quit rates, and consumer labor market assessments have also clearly improved.

But it was a tale of two halves. In the first half, real GDP grew just 1.2%, our CAI averaged 1.7%, and both U3 and U6 edged down only marginally. The likely reason was the larger-than-expected financial conditions fallout from the onset of Fed normalization—both before and after the December 2015 rate hike itself—and its impact on growth. In the spring, financial conditions eased, partly because the Fed turned more dovish, and this set the stage for a meaningful growth acceleration. In the second half, real GDP is currently tracking 2.6%, our CAI has averaged 2.1%, and labor market slack is clearly shrinking, with U3 and U6 down sharply in recent months.

2. Will homebuilding remain the fastest-growing sector?

Our answer: yes.

Verdict: incorrect.

Real residential investment actually fell 1.7% (annualized) in the first three quarters and likely stagnated for the year as a whole. Some of this weakness is related to a surprising decline in the average value of new single-family homes that does not comport with other house price indicators, but even housing starts made little headway for most of this year. The weakness looks temporary as new home sales have been growing strongly and the homebuilders’ survey surged in December. We think the outlook for homebuilding in 2017 is quite decent, but 2016 was below our expectations for the year as a whole.

3. Will the consumer stay strong?

Our answer: yes, though not as strong as in 2015.

Verdict: correct.

The fastest-growing sector in the economy was the consumer. Real consumer spending grew 2.9% in the first three quarters and an estimated 2.8% for the year as a whole, below the very strong pace seen for most of 2015 but at least a percentage point above trend. The main driver was the strength of real disposable income in an environment of good job gains and accelerating wage growth, buttressed by the lagged effects of the earlier sharp decline in oil prices.

4. Will capex accelerate as the energy drag fades?

Our answer: yes.

Verdict: incorrect.

Overall, real capital spending was approximately flat in 2016, just as in 2015. There are clear signs of improvement in some parts of the energy sector, including a sharp rebound in the weekly rig count measures, and overall business confidence also seems to have improved since midyear. But this has not yet shown up in the national income accounts. In Q3, real business investment was flat overall and still down nearly 30% (annualized) in mining structures. While Q4 should look a bit better, business investment for the year as a whole was disappointing.

5. Will inflation rise?

Our answer: yes.

Verdict: correct.

Core PCE inflation has risen from 1.4% year-on-year in December 2015 to 1.7% in October 2016. Other inflation measures have also picked up, most notably the headline indices where the increase was led by higher oil price inflation. The increase was due to a combination of reduced labor market slack, stronger wage growth, reduced pass-through from the earlier dollar appreciation and commodity price plunge, and somewhat higher healthcare inflation.

6. Will the FOMC deliver more than two hikes in 2016?

Our answer: yes.

Verdict: incorrect.

We thought that the FOMC would hike four times in 2016, compared with the two hikes that were discounted in market pricing at the end of 2015. But they hiked only once.

Where did we go wrong? A combination of factors was undoubtedly at play, including greater-than-expected market turbulence following the December 2015 liftoff, somewhat weaker-than-expected data on growth and labor market slack, nervousness about “rocking the boat” in the runup to the UK referendum on EU membership and the US Presidential election, concern about the potential economic effects of the outcome of the UK referendum, and ongoing downward revisions to the Fed’s estimate of the equilibrium funds rate, r*. It is difficult to disentangle these issues entirely, but we would put most of the weight on the greater-than-expected impact of the onset of Fed policy normalization on financial conditions and the resulting drag on US economic growth in the first half of 2016. Although this was only a temporary setback, it was enough to undermine our Fed call for 2016.

7. Will the market’s estimate of the terminal funds rate rise?

Our answer: yes.

Verdict: inconclusive.

Market estimates of the terminal funds rate fell substantially for much of 2016 but have reversed this decline since September, with most of the change coming after the election. At present, we estimate that the overnight indexed swap (OIS) market is pricing a terminal funds rate of about 2.5%, virtually identical to the level at the end of last year—though up 100bp from this year’s lows. We expect further increases in coming years.

8. Will the Fed start shrinking its balance sheet?

Our answer: no.

Verdict: correct.

Given the more dovish rate decisions, it is hardly surprising that the Fed kept its balance sheet unchanged. We now expect the first move toward balance sheet normalization in mid-2018.

Source: Goldman Sachs US Daily — A Retrospective on “8 Questions for 2016” (Hatzius/Pandl)