Mike Schenk

Forecast reveals bright future

The economy should grow 2.5% in 2017, according to CUNA’s economists.

February 24, 2017

CUNA economists recently gazed into our crystal ball—and the future looks bright.

Our newly minted outlook is a bit more upbeat than our previous forecast, reflected in a modest increase in economic growth prospects for the year and, by extension, faster credit union loan growth and higher credit union earnings than previously advertised.

We now expect the U.S. economy to grow 2.5% in 2017, a modest nudge up from the 2.4% advance previously forecasted.

A booming stock market, buoyed by expectations of substantial fiscal stimulus later this year, has the Conference Board’s consumer  confidence index bumping along near a 15-year high.

Our baseline forecast projects robust domestic demand in both the household and business sectors, boosting growth during the year.

If the Trump administration’s promises of massive tax cuts and big increases in government spending on infrastructure materialize, those steps will almost certainly boost economic growth. But the effects will be seen later in the new president’s term.

The big downside risk to this outlook is the potential for a trade war should the new administration take an aggressive anti-free-trade stance. But we think it likely that election-year rhetoric will be softened by more careful consideration of this big downside risk.

Modestly higher growth should lead to more pronounced price increases. We now expect inflation (both headline and core) to average 2.5% in 2017, up marginally from our previous 2.25% forecast.

Higher energy prices, against the backdrop of an economy now at full employment, will drive the uptick in headline inflation.

Inflationary pressures from higher consumer spending and higher labor costs will be more obvious in the coming months. The unemployment rate now projects to finish 2017 at 4.6%, which means we don’t see much of a change at all during the year.

Currently, the unemployment rate is 4.7%. Monthly job gains will continue to come in at healthy levels.

The quality of jobs created continues to shift from lower-paying, entry-level jobs to higher-paying, professional and construction positions.

But the re-entry of discouraged workers into the job market will mean we won’t continue to see the big year-over-year unemployment rate declines experienced over the past five years.

Against the backdrop of higher output, tight labor markets, and higher inflation, we now expect the federal funds interest rate will increase 75 basis points (bp) in 2017.

The Federal Reserve raised the federal funds interest rate in December 2016, to a range of 0.50% to 0.75%—only the second increase in the past decade. We predicted two increases would occur last year.

At the other end of the spectrum, we also see the 10-year Treasury interest rate increasing a bit faster than previously thought. We now expect the 10-year benchmark to finish 2017 at 3%, reflecting marginally higher inflation pressures as well as expectations for additional price pressures in 2018.

Still, geopolitical uncertainty will continue to offset some of the pressures arising from higher domestic demand.

The combination of those last two observations means we’re now expecting a parallel shift in the Treasury yield curve, whereas our previous forecast reflected a flattening of the yield curve in 2017.

If we’re right on that, it should be good news for the bottom line because net interest margins should be modestly higher under this scenario.

From an operating perspective, we agree the improving economy will have a generally positive influence on credit union operations.

Most important, our expectation for solid economic growth this year compelled us to increase our estimate for credit union loan growth. We now believe overall loan balances will increase 10% in 2017, up from our previous expectation of a 9% gain.

As the economy continues to expand, we expect households to continue to release pent-up demand for autos, furniture, and appliances.

Mortgage refinancing activity will ease but purchase money mortgage growth should gain momentum during the year.

Call Report data shows that credit union memberships increased at an astounding 4.1% rate in the year ending September 2016. That’s five times the rate of U.S. population growth and the fastest gain in over a decade.

We expect when full-year data is available, memberships will reflect a 3.8% increase.

In addition, our outlook now has memberships growing at a 3.5% pace in 2017, a modest bump up from our previous forecast but still a slight declining trend as the auto lending boom begins to slow and indirect borrower memberships decline.

We see credit union savings balances growing 5.5% in 2017, a bit slower than the 6% increase we previously forecasted. This simply reflects slower than expected growth reported by credit unions in our monthly survey of credit union operating results.

A backdrop of strong labor markets, bigger income gains, and strong loan growth is the recipe for healthy credit union asset quality. Our outlook on this front is unchanged: The delinquency ratio should finish the year at 0.75% and the net charge-off ratio should average 0.50% in 2017.

Return on assets (ROA) should come in at 77 bp in 2016 (essentially matching the 2015 result) and should remain at that lofty level in 2017. Our previous forecast had ROA declining to 0.65% in 2017.

We continue to expect bottom-line pressure related to lower mortgage refinancing activity (lower origination fees and gains on sales) and modestly higher operating expenses due to a tighter labor market and wage pressures. But stronger than expected loan growth should help to offset these effects.

Finally, slower asset growth and healthy earnings should push credit union net worth ratios closer to record levels in 2017. A bright future indeed.

MIKE SCHENK is CUNA’s vice president of economics and statistics. Contact him at 608-231-4228.