McGladrey LLP Chief Economist Joe Brusuelas shares his views on the economy in 2015 and beyond with Middle Market Growth Editor Deborah Cohen. Backed by a recent McGladrey middle-market survey, Brusuelas forecasts increased productivity for U.S. midsize companies, bolstered by a strengthening U.S. dollar and improvement in domestic labor trends. He cautions, however, that global currency volatility could be a risk for firms with overseas exposure.
Q: You said in your recent Real Economy report that the strength of the U.S. dollar is not a short-term phenomenon. What are the most compelling reasons?
Joe Brusuelas: There is a shift in the tectonic policy plate globally, among central banks. That is the first and foremost reason we’re seeing a sharp acceleration in the value of the dollar. The European Central Bank and the Bank of Japan have entered open-ended asset purchase programs and have implemented zero-interest-rate policies. It’s natural that capital will flow into the United States into dollar-denominated positions. The U.S. is set for a period of long-term growth, while Europe and Japan are going to struggle to remain out of recession over the next year. Once European and Japanese growth resumes, it will likely be very low, below those countries’ respective long-term trends.
Q: How much more lift does the U.S. dollar have as this scenario plays out?
JB: In foreign currency markets, you’re going to see considerable volatility on a day-to-day basis; one needs to look where you expect the dollar to move over the medium to long term. Right now the dollar is trading at $1.08 against the euro; I wouldn’t be surprised if the dollar moves toward parity early next year. Then the dollar’s strength will continue into 2016 and 2017; that means U.S. purchasing power of European goods will rise significantly. The Europeans are dancing at the edge of deflation; it is very difficult, once you enter a deflationary period, to get out. So once you take a look at growth rates, inflation, and central bank policy, that does strongly suggest we should see the dollar continue to climb against the euro, and against the Japanese yen, over the next several years.
Q: Staying with your long-term forecast into 2016, will U.S. middle-market companies tend to benefit more or less than their large-cap rivals or smaller companies from the strengthening U.S. dollar?
JB: In McGladrey’s recent middle-market survey, our core middle-market clients, the beating heart of the U.S. real economy, estimate they expect to see revenue increase by 9 percent this year. They’re going to expand their labor force by 3.2 percent, which is well above the 2.5 percent trend for the United States overall, which is seeing a period of fairly strong employment growth. A full 77 percent of respondents indicated their businesses are primarily North America-oriented. When you take a look at their growth expectations, along with the rising value of the dollar, this suggests middle-market firms are going to benefit—especially those that purchase goods made abroad, or raw materials used at earlier stages of production. As the value of the dollar continues to rise, it tends to cause goods or raw materials purchased from abroad to be cheaper—everything from rare earth minerals to finished goods such as steel, aluminum and machine tools. If you’re importing any goods you use to make your final product, this tends to result in a cost savings for you. The challenge is when you’re selling your finished goods abroad; then you’ve lost some competitiveness if the dollar appreciates.
Q: So what should the smaller universe of middle-market companies with international exposure do to protect themselves?
JB: If you’re the 12 percent of our client base that has exposure to the external sector, you want to make sure you have an effective hedge against the rising value of the dollar to offset the loss of competitiveness due to cheaper substitutes for your goods abroad. Hedging needs to be managed on a case-by-case basis. Each company will have a horizon they manage, whether it’s the near term of one to three years, the medium term of three to five, or the longer term of five to ten. Those companies need to begin thinking about some of the structural changes going on in the global economy, the likes of which haven’t been seen in quite a long time.
Q: Do midsize companies have the expertise to undertake hedging programs themselves?
JB: Small and medium enterprises typically don’t have the intellectual capital in house to effectively hedge volatility in commodity and currency markets the way a Southwest or McDonald’s does. They need to form relationships with bankers who offer those products. If you’re a middle-market firm, you’re buying a form of insurance that you hope you never have to use. What was interesting for McGladrey was that we started to put out a series of (hedging) products last year and we got a very strong response from our client base, with respect to concerns over competitiveness issues and the likely appreciation of the dollar.
In some ways, small and medium enterprises are not that much different from large companies. If you take a look at earnings in the United States in the first quarter of this year, the reason they are likely not to be so hot is likely due to big companies being caught off guard by the shift in (monetary) policy and the appreciation of the dollar. But big firms are different than medium enterprises—within six months, they can usually make the adjustment and hedge against the volatility of their supply chain and foreign exchange markets.
Q: Stocks have been depressed in the first few trading sessions of the second quarter due to growth worries and concern about lackluster first-quarter earnings. How does that factor into your forecast?
JB: The U.S. definitely decelerated in the first quarter of the year, primarily due to transitory reasons. We had fairly significant disruption due to another difficult winter in the Northeast and Midwest, and then a West Coast port strike that really disrupted the domestic supply chain. When you layer on top of that the fact that firms were watching commodity prices plummet for the last two months of the previous year and the first three months of this year, a lot of orders were withheld until prices found their floor. Then there’s the part that’s not transitory, which is the slowdown in demand from the external sector.
On balance, we’re going to have a pretty strong rebound in the second quarter as the weather effects dissipate, the West Coast ports clear their backlogs, and pent up demand for new orders is released now that commodity prices appear to have found a floor. We’re adding 288,000 jobs per month in the private sector and we’re seeing wages begin to rise. With the fall in gasoline prices, which is putting more disposable income in people’s pockets, you’re going to see a household bounce in the second quarter. We’re going to get a pretty good set of data between April and October.
Q: Are you fairly positive about next Friday’s employment report?
JB: Yes, I’m expecting 265,000 jobs to be created, with some downside risk due to weather effects in the Northeast. Even if the numbers come in a bit soft, I’m expecting over 300,00 jobs in April or May. We’re really seeing firms have to scramble to hire right now.
If ever there were an area to call me bullish, this would be the area. This is where we’re going to see middle-market expansion in 2015—in revenue and hiring. Our clients are expecting 9 percent revenue growth this year, but they only expect to increase their labor force by 3.2 percent. If they do see a revenue lift of 9 percent, they’re going to have to really ramp up. Firms are very optimistic on revenue but they haven’t yet really become comfortable enough to hire in numbers to support that growth. They’re going to have to step up demand for labor … to keep productivity levels where they are or improve them.
Q: Do you think the recently announced McDonald’s wage hike of a $1.00 per hour for workers at its company-operated stores will have a ripple effect for other U.S. employers?
JB: I do. When you take a look at what Target, Wal-Mart and McDonald’s are doing, they’re attempting to get out ahead of a tightening labor market. In 2009, we had seven unemployed people for every job opening. The labor market has tightened enough where we only have 1.7 individuals for every job opening. Traditionally in U.S. expansion cycles, once that number drops below two, typically six months later you tend to see wages rise. You know what? That’s exactly what we’re beginning to see. We dropped below two last August; forecast forward six months, we saw a nice little pop in wages, in average hourly earnings. I would expect to continue to see some improvement in the data as the next few months roll along, with some fairly noticeable improvements in the second half.
Q: Are U.S. wage trends tracking with your expectations?
JB: I expect, in inflation-adjusted terms, by the end of 2015, wages will have risen by 3 percent in contrast with the 1.7 percent cyclical average. While that’s an improvement, we can do better. At this point in the cycle we should be near 4.5 percent. There’s a lot more room for improvement. I’m sensing, when I talk to my clients, a real urgency to begin hiring skilled workers who really are at the point where they can begin to name their own wage. As the labor market begins to narrow, bargaining power is going to shift from firms to workers, not just in skilled areas, but also in semi-skilled jobs. A full 67 percent of our respondents were significantly or somewhat concerned about the cost of labor. Seventy-five percent were concerned about access to skilled labor. That’s another sign of improvement in the U.S. economy.
Joe Brusuelas has more than two decades of experience analyzing U.S. monetary policy and the broader economy. As co-founder of the award-winning Bloomberg Economic Brief, he was named one of 26 economists to follow by The Huffington Post.