Quarterly GDP figures are extremely volatile, I will therefore not restrict myself to a point forecast. Instead, I will assign subjective probabilities to different outcomes. After reading Nate Silver's ecxellent book "The signal and the noise", I am more convinced than ever that macroeconomists should engage in these kind of forecasts instead of getting pinned down on a single number.
My predictions for Q1 2017:
Less than 0.5% 10%
0.5% to 1% 30%
1% to 1.5% 30%
1.5% to 2% 20%
above 2% 10%
My point forecast would thus be about 1.25% growth for Q1 2017. As a result of the new incoming data, I'm more pessimistic than the Blue Chip consensus. However, my 90% confidence interval is ranging from 0.25% to 2.5%.
Yearly GDP is much less volatile than the quarterly figures. While Trump has promised to deliver 4% growth in the coming years, it is extremely unlikely that the actual growth will come in much higher than 2%. This is roughly the trend growth rate estimated by the Fed. Given that Q1 2017 is likely to underperform, annual growth might be actually somewhat but not significantly lower.
My predictions for Q1 2017:
Less than 0.5% 5%
0.5% to 1% 10%
1% to 1.5% 15%
1.5% to 2% 40%
2% to 2.5% 20%
above 2.5% 5%
My point estimate for annual GDP for the year 2017 is thus about 1.8% with a 80% confidence interval roughly ranging from about 1% to 2.5%.
When it comes to inflation, the long-term track record of the Fed is relatively good even though they have somewhat undershot their target in recent years. The 5-year TIPS spread suggests an average inflation rate (based on the CPI) of about 1.9% in the coming 5 years. Based on past performance and market indicators, I am extremely confident that the yearly inflation rate in 2017 based on the CPI will come in close to 2%. My 90% confidence interval ranges from about 1.5% to 2.5% with the point estimate being just in the middle.
Note though that the FED is actually targeting the PCE, which has historically been 0.3% lower than CPI, meaning that they will continue to undershoot their 2% inflation target by a little bit in the years to come.
When it comes to interest rate hikes, Fed officials have made it abundantly clear that at least another two rate hikes if not more are baked in for 2017. As Q1 is more likely to underperform now and inflation continues to be low, I think that 2 rate hikes are reasonable. Financial markets based on Fed funds futures expect 2 hikes for this year, but not more. This is also my baseline expectation.
Most of my predictions are based on the assumption that the U.S. economy will continue to grow, though at a more moderate pace than before the financial crisis. 2% growth is the new normal. The probabiltiy of a recession is relatievly low, maybe 5 to 10%. As Rudi Dornbsuch once said, economic expansions don't die of old age, every single one of them was murdered by the Fed. The Yellen Fed has shown no sign that they are willing to murder the current recovery. "Steady as she goes" has been the normal for a few years. The Fed also has the necessary toolkit to fight an economic downturn.
Stock market volatiliy as measured by the VIX has been extremely low in recent months despite all the fuss that the new administration has created. However, Trump has now made clear that China is not a currency manipulator, so some extremely undesirable events like an international trade war are now much less likely.
On the other hand, the new administration is extremely unpredictable. The probability of an outlier event (Black Swan) happening has markedly increased since Obama has left office. This is supported by the fact that the SKEW index, a measure of tail risk in the stock market, has recently trended upwards. So while volatility is low, the likelihood of extreme events might actually have increased. This, however, does not change the baseline assumption that a recession is relatively unlikely.
Finally, one of the things that worry me the most at the moment is the French election. The Hypermind prediction market now only gives Macron a 56% chance of becoming president, down from 65% a few weeks ago. A standoff between Mélenchon and Le Pen has now become much more likely than just a couple of weeks ago and would be really bad new (Fillon vs. Le Pen is somewhat more likely but also somwhat less concerning as Fillon is more likely to win the 2nd round against Le Pen than Mélenchon is).
A Le Pen victory could reignite the Eurocrisis. A French exit from the euro could definitely spark a European banking crisis and would plunge the currency area back into recession. It could also affect financial markets on a global scale. Even a Mélenchon victory is quite undesirable and probably bad news for the economy. He is far too left and his platform seems to be dominated by policies that are simply infeasible.
Macron is the most liberal of all the candidate. His victory would be great news for France and for Europe as a whole. The world desperately needs some liberal pushback after the wave of populism that we have experienced in recent years, from right-wing parties gaining a lot of ground in many European countries to the Brexit vote in the UK and the election of Trump last fall.
PS: I wrote this a few days ago. New incoming data suggests that Q1 2017 might actually be even more disappointing that I expected. Industrial production tumbled in March, thus increasing the likelihood that growth will come in at below 1%, which would be in line with the Atlanta Fed's Nowcast estimate.
PPS: One problem with the kind of exercise I engaged in above is that probabilistic statements are not falisfiable. As an example, some models gave Clinton a 99% chance of becoming president on the eve of election night. We can be relatively confident that their models were flawed somehow. Nate Silver at Fivethirtyeight, on the other hand, gave Trump a more than 33% chance of becoimg president, with 1/3 significantly better odds than anybody else gave Trump at the time. Even ex-post, however, we cannot evaluate whether his model was "good" and whether this election was literally the proverbial third time, or whether his model was flawed as well and underestimated Trump's odds of becoming president.
PPPS: In terms of past predictions, I was a little too pessimistic on inflation and interest rates. Over the course of the last year, the Fed was able to increase interest rates at a somewhat faster pace than I predicted. Nevertheless, financial markets still believe that the long-run interest rate is not much higher than 3%, which is exactly what I wrote more than a year ago. At the time the Fed was still believing that the long-run would allow for a 4% interest rates. However, they had to revise this estimate significantly downward over the course of last year. 4% nominal GDP growth, roughly equally split into 2% inflation and 2% real growth, is the new normal. Long-run interest rates will remain at a relatively low level. The "Trump reflation" has already run its course it looks like.