animal spirits

Suddenly, the economic outlook is brighter — and pinned on the hopes that the U.S. manufacturing sector will fare well under a President Trump.

On Tuesday, U.S. carmaker Ford told Wall Street that it was canning plans to build a plant in Mexico. Instead, it would create about 700 jobs in Michigan via a $700 million plant expansion to build self-driving and electric cars. Mark Fields, chief executive officer at Ford, said in news reports that the change was due to a decline in the overall demand for small cars. Fields acknowledged, though, that a “more positive” U.S. manufacturing environment expected under the change in the presidential administration also factored into the decision.

The more optimistic mood from the business community follows a strong uptick in consumer confidence last month. As a result, IHS chief economist Nariman Behravesh, senior research director Sara Johnson and director Patrick Newport expect the pace of the U.S. economy to increase this year.

The analysts noted that in the “wake of the recent U.S. presidential election, there has been a noticeable unleashing of animal spirits. Both consumer and business optimism have surged — and stock market indexes have hit record highs.”

And in a separate report from Telsey Advisory Group, the analysts at the firm also noted the sweeping, positive outlook. “Optimism is high as we head into the new year, with expectations for change under the new Trump administration leading to accelerated growth,” the analysts said in their report this morning. “Despite the increased optimism, lots of unknowns lie ahead.”

“Animal spirits” is a term coined by John Maynard Keynes to described the impulses of investors. The economic perspective is now being used to explain the optimism of businesses as well as consumer behavior. The basic premise is that a positive outlook can translate into higher consumer spending as well as greater business investments. Moreover, Rhys Bidder, an economist at the Economic Research Department of the Federal Reserve Bank of San Francisco, explained in a research note last year that volatility also plays a role in animal spirits behavior: a less volatile market results in improved sentiment – with businesses and consumers alike.

But the IHS analysts note that a rise in “animal spirits” may only play a minor role in actual economic growth.

And with consumer confidence, the presidential election itself may have changed sentiment. “Some of this may be a ‘relief rally’ after a particularly contentious election cycle,” the authors of the report noted. “However, in the case of business optimism and the stock market rally, the revival of animal spirits has a lot to do with the expectation that the incoming Trump administration and a Republican-led Congress will cut taxes, roll back regulations and make it easier to repatriate profits.”

Behravesh said the optimistic view is “that both the expectation and reality of a more business-friendly environment could translate into stronger growth in capital spending, which, in turn, could help boost productivity growth. Likewise, rising stock prices could increase household wealth and consumer spending even more.”

On the flip side, Behravesh said that a less optimistic perspective focuses on three elements. “First, and perhaps most important, the actual policies enacted by the incoming president and Congress may be less generous than current expectations — the legislating process inevitably involves many compromises,” Behravesh said. “Second, the link between sentiment/confidence and spending is tenuous. Finally, in the case of consumers, the impact of wealth on spending is small (around 3 cents on the dollar).”

Behravesh went on to note that if animal spirits somehow triggers higher consumer spending, there are other economic forces at play that must be considered, and will likely undermine the optimism. “Long-term interest rates have risen by 70 basis points since the election and are projected by IHS Global Insight to advance another 30 basis points in the coming year,” the authors of the report said. “This will be a drag on consumer spending, housing activity, and business capital spending.”

The other “hard fact” is the rise of the U.S. dollar, which will hinder net exports.

“That said, IHS Global Insight forecasts that there will be a pickup in the pace of the U.S. recovery, from 1.6 percent in 2016 to 2.3 percent in 2017 – not so much because of ‘animal spirits,’ but because of an easing in both the recent inventory correction and the rout in energy-sector investment,” Behravesh said adding that any policy-related increase in real GDP growth “is most likely to show up in late 2017 and 2018, when the expected personal and corporate tax cuts take effect, and when the scope of actual deregulation becomes apparent.”