According to the Bureau of Economic Analysis (BEA), total production in the U.S. economy grew at a 2.1% clip in the third quarter of 2015. In the second quarter, real gross domestic product (GDP) was revised up to 3.9% growth. There are some problems with relying on GDP to gauge economic health, but these are still encouraging signs for a country fighting through the slowest post-recession recovery in its history.
Positive economic numbers only add to expectations about a potential interest rate hike by the Federal Reserve heading into 2016. The Fed has not raised interest rates since before the Great Recession, and nobody is certain how markets will react when an increase finally arrives.
A momentous 0.25 Fed funds rate hike is only one challenge the U.S. economy faces as the new year approaches. Labor force participation is still historically low. Politicians continue to rack up enormous deficits and finance them with cheap credit. And the entire global financial system is teetering because China's economy finally slowed after years of ravenous growth. The following are three challenges that American businesses and policymakers will likely confront in the coming year.
The Fed's Difficult Balancing Act
The Federal Open Market Committee (FOMC) has openly toyed with the idea of raising interest rates since at least Q4 2013, Why hasn't it pulled the trigger? It is likely because the Fed is caught between a rock and several hard places.
There is ample historical evidence to suggest low interest rates fuel bond, equity, and housing prices. The opposite tends to occur when rates increase. The current recovery, though fledgling, is likely built on higher asset prices and lower energy costs. Raising interest rates will not cause oil prices to jump, but they could drive down assets. If that happens, a small recovery could turn into a contraction.
Then again, interest rates cannot stay at zero forever. The economy already suffered the terrible results of unchecked housing and stock market growth in 2007-2008, and the Fed does not want to double down on that mistake. Additionally, savers and retirees have been crippled by record low payments on traditional income devices such as CDs and bonds.
Just as critically, the federal government does not want rates to rise. First, the illusory growth from low interest rate policies is politically popular. Second, the United States has an enormous interest payment on the debt. These interest payments suddenly get much larger when the government has to issue new bonds with higher coupons.
Weakness in Europe and China
The U.S. is not immune to the ebbs and flows of a complex global economy, and the two largest foreign markets, Europe and China, seem poised to struggle in 2016. When the Shanghai Stock Exchange Composite more than doubled between October 2014 and August 2015, many pronounced China as the economic superpower of the future. That optimism all but disappeared in a flash after Chinese equities fell by nearly 40% over the next two months, despite massive purchases of failing companies by the Chinese Security Finance Corporation.
It turns out China had a real estate and stock market bubble that felt disturbingly similar to the American experience in 2007-2008. The "red economy," seemingly impervious to a slowdown just a year ago, is now on the brink of a multiyear struggle.
News out of Europe is not much better. Recorded growth in the eurozone was just 0.5% in Q1 2015, and numbers were even worse for Q2 and Q3. Germany and the United Kingdom have been reluctantly dragging the rest of the continent out of the red for years, but economic and political concerns are numerous in the new year.
Sluggish Jobs Market
The U.S. economy has added jobs each month in 2015. This is the good news. The bad news is very few of those jobs are full-time, productive jobs in the private economy. The middle class is still struggling, and the economy does not seem well equipped to provide new, lasting and high-paying opportunities.
Total government employment increased by more than 1.1 million between November 2014 and November 2015. Over the same time frame, nearly 500,000 jobs were added to an increasingly bureaucratic health care sector. And, as the November jobs report from the Bureau of Labor Statistics points out, "the number of persons employed part-time for economic reasons, sometimes referred to as involuntary part-time workers, increased by 319,000 to 6.1 million."
The labor force participation rate has been near decade-long lows all year, standing at under 63%. And, even though 211,000 jobs were added in November 2015, there were 2.3 million workers only "marginally attached to the labor force" or who were discouraged and not believing there are jobs out there for them. This means that, by a factor of eight-to-one, more people gave up looking for jobs than found them.