The American economy is doing better than the headlines suggest and should continue to add jobs at a steady pace, according to a new report by TD Economics, an affiliate of TD Bank.
 
"Economic growth averaged just 1.0 percent over the first half of the year, but beneath the surface things look better," says TD Bank's Chief Economist, Beata Caranci. "Robust personal income growth translated into strong consumer spending alongside a rise in the savings rate. This suggests consumers have more gas in the tank and the economy rests on a stronger footing."

Supported by rising incomes and low energy prices, economic growth is expected to move higher over the next year. TD Economics projects real GDP growth of 1.5 percent in 2016 and 2.1 percent in 2017, enough to bring the unemployment rate from its current level of 4.9 percent to 4.5 percent by the end of 2017.

Reticent businesses, but resilient consumers
The soft spot in the economy in recent quarters has been business investment. In addition to falling commodity prices, the decline in investment reflects the impact of tighter financial conditions at the start of the year and the pressure on profits from sharply rising dollar. Both of these have recently improved.

"Investment has already shown signs of a recovery through the summer, which should remain supported by a sturdy domestic sales backdrop over the remainder of this year. However, investment won't be a growth-leader within a global environment marked by more cautious business spending and more subdued growth expectations relative to historical norms," says Caranci.

That leader position will be occupied by households and spending. Consumer spending ran at a rousing rate of 4.4% (annualized) in the second quarter. "This was exceptional, and expect some moderation in the quarters ahead," says Caranci. "But, a tightening labor market, solid income growth and low gasoline prices give every reason to expect consumers to lead economic growth."

Follow the leader, as housing responds to strong demand fundamentals
"Housing construction is still in the early stages of recovery with household formation having plenty of runway still in front of it," says Caranci. "And, demand continues to improve, with new home sales rising to a post-recession high in recent months."

The inventory of unsold homes is low, offering a good incentive for housing starts to move higher. From an average of 1.2 million in 2016, TD Economics expects housing starts to rise to 1.3 million in 2017 and 1.4 million in 2018.

Another December rate increase likely from the Federal Reserve
A modest rebound in investment in concert with solid household spending should lift real GDP to around the 2.0 percent mark over the next two years, enough to put further downward pressure on unemployment and upward pressure on inflation. This is all the progress the Fed needs to see to be comfortable in continuing to raise its key policy rate.

"Fed speakers in recent weeks have noted that the continued improvement in the economic outlook was likely to justify a move higher in the federal funds rate." says Caranci. "As long as the economic backdrop remains supportive of a 2 percent pace, we expect them to stick to their guns."

Investors are currently pricing in greater than 50 percent odds of a 25 basis point rate increase by year-end. Assuming relative market calm prevails, the Fed will likely nudge up interest rates at its December FOMC meeting.

"Still, as it has been thus far (just one rate hike per year), the path forward is likely to be glacial," says Caranci. "We anticipate just one hike in 2017 and one more in 2018, bringing the Fed funds target to just 1.25 percent by the end of that year."

The complete findings of the TD Economics report are available online at https://www.td.com/document/PDF/economics/qef/qefsep2016_us.pdf.