Absent significant productivity gains, the best growth rates for the US economy are probably behind us for this business cycle. Yes, GDP growth is likely to bounce from last quarter’s 1.4% (or the 4-quarter average of 1.3%), reflecting payback from persistent inventory drag, but durable growth in the US any faster than our recent rate is probably unsustainable. Our slow working-age population growth and unimpressive productivity growth are severely limiting the US potential growth rate. In prior posts, I’ve discussed why I believe the best we can do over the next decade is about 1.4%.  Low potential growth rates aren’t always a problem or a hindrance however; when unemployment is high, reflecting significant untapped labor resources, the economy can grow consistently above potential as new jobs are created and previously sidelined workers reenter the economy as producers. This has occurred since 2009, so even though our post-crisis average growth rate of around 2% has felt uninspiring, it’s still been considerably above potential. We know this by definition, because the unemployment rate has fallen from 10% to 5%. Operating above potential is the way an economy brings underutilized labor back into productive jobs.
Now though, as the unemployment rate has fallen toward levels which reflect tightening labor supply (fewer available and suitable workers), one of three things must happen: 1) actual growth slows, 2) potential growth speeds up through higher productivity*, or 3) inflation pressure builds.
The reality is that actual growth has been slowing. Over the past year, our growth rate has averaged 1.3%, which is at-or-below our potential growth rate. And, sneakily, the unemployment rate has stopped going down. In fact the most recent September employment report showed our unemployment rate at 5.0%, which is actually now above the 12-month average of 4.9%. As with nearly everything in economics, there are easy ways to dispute these points. First, our growth rate over the past five quarters has been negatively impacted by inventory drag. That is, companies are replenishing inventories slower than the inventories are being depleted by consumption, which reduces the measured Gross Domestic Product. Secondly, our unemployment rate has risen recently because the Labor Force Participation Rate has risen – new entrants to the labor market are now looking for jobs. These are positive mitigants for otherwise concerning statistics. However, if potential growth in the US is around 1.4% and realized growth has been around 1.2%-1.4%, then we would expect the unemployment rate to stop declining. And it has, plain and simple.
It is possible that these two economic data points are coincidentally affected in the right way by separate factors (inventories and labor force participation) as to look consistent with growth converging to potential, when in reality they are a red herring. The timing would also have to be coincidental though, because the general pattern of slowing growth in the US began in Q4 2014, almost exactly the time when the Fed’s balance sheet stopped increasing, and measures of monetary conditions such as the Wu-Xia shadow Fed Funds rate began rising. To me, the simplest explanation is that realized growth has been slowed by tighter financial conditions, and because potential is so low, the extent of the tightening necessary to bring growth down was pretty small. Because the inventory effect has distorted the recent growth stats lower, I do believe that some modest amount of further tightening will be necessary to bring US growth down to potential, but absent productivity gains, the Fed needs slower growth to fulfill their dual mandate (though they would not say it like this).
This is one core reason why fiscal stimulus that fails to facilitate rapid productivity gains is undesirable and far from a silver bullet to return the economy to the “old normal” growth rates. Productivity gain needs to be the critical focus, of both stimulus and “structural reforms.”
Ordinarily, calls for fiscal stimulus would occur during the recovery phase, when monetary policy is loose and lots of labor market slack remains. Now, we have fiscal spending in the policy discussion as labor markets are tight, and the Fed is trying to tighten monetary policy. The fact that fiscal stimulus is still an active part of the discourse with the unemployment rate so low here in the US really illustrates how reluctant all of us are to accept that structurally slow growth may be inevitable. 
*Sticklers will note that I have omitted immigration or lengthening the work week as other release valves for expanding potential growth. You’re right. But I consider productivity gain to be the lowest hanging fruit.
 For a reminder of why slow growth makes life difficult for politicians, Main Street, and Wall Street, see: Structurally Slowing Growth: Some Implications
In my February 2016 article Saudi Arabia having a change of heart?, I concluded that “the possibility of a supply cut during OPEC’s June meeting (was) on the table.” Though the timing was three months shy, the market finally saw confirmation on September 28, 2016. OPEC affirmed my base case of a deal being struck at the 170th (Extraordinary) meeting in Algiers; in the official press release, OPEC stated the OPEC-14 will “target (a) range between 32.5 and 33.0 mb/d, in order to accelerate the ongoing drawdown of the stock overhang and bring the rebalancing forward.” It is my expectation that with the support of numerous non-OPEC nations, OPEC will finalize the details of implementing these production cuts with accommodation for Iran, Libya and Nigeria.
This is a significant change in OPEC/Saudi policy, which might as well be appropriately named “mission accomplished”. The Saudi policy of the last two years has effectively eradicated shale exuberance and reigned in competition from conventional and alternative sources. It would take at least six months of sustained prices above $55 a barrel to encourage redeployment of capital and even longer to source a sufficient amount of skilled labor to bring a significant amount of shale barrels back online. Conservatively modeling global inventories with a 33mb/d OPEC production shows a swing of 700kb/d, flipping the market into a substantial deficit starting in February 2017 (see Demand and Supply Outlook chart below). If OPEC follows through, the market will eliminate the entire inventory build of 2016 by the fourth quarter of next year.
With all focus on the OPEC deal/no deal, market participants seem distracted from changes in demand that seem to be materializing. Total oil and product stocks in the four major storage centers (USA, Europe, Japan and Singapore) have been rapidly drawing since OPEC, in mid-August, announced their intention to hold their extraordinary meeting in Algiers. In the last six weeks these centers have seen an astonishing 60 million barrels of crude and petroleum products, counter seasonally, drawn from inventory. This is the first period of sustained draws in almost two years, shrinking the year on year surplus from 12% in mid-August to only 5.42% today. A large amount of this demand is coming from China’s renewed increase in crude oil purchases after a two-month pause. By my calculations, China has stored 230 million barrels of crude this year, about 100 million barrels more than they stored all of last year. Last month a geospatial analytics company released satellite images showing that China has about 900 million barrels of petroleum tankage available, three to four times more than market analyst expectations. Furthermore, shipping activity in the dirty tanker market is at a 10 year high; traders have been scrambling to book cargoes heading east. Nigeria to China and Saudi Arabia to Singapore shipping routes are now trading $2.48 and $0.99 per barrel respectively (up 42% and 50% from July). Expectations of higher crude oil prices in 2017 due to OPEC intervention could have spurred China’s aggressive purchase of barrels, which is likely to continue for the rest of the year.
Four months ago the world was awash with gasoline. In the New York harbor, ships were being turned away whilst others converted to floating storage. There were reports of full product storage in Germany and lines of product tankers in Antwerp and Rotterdam; at the same time China exported excess gasoline into the U.S. Gulf Coast with the hopes of alleviating their swelling inventory. As such, it is astonishing to see the pace of inventory draws even more severe in the gasoline market. The year on year surplus has all but disappeared, falling from 10.15% in mid-July to just 0.65%. It is evident that demand has picked up, and is arguably higher than most market participants realized. Most of this additional demand seems to be coming from emerging markets as realized gasoline demand in developed markets have held steady. These developments lead me to believe that the 2016 global oil demand is likely to be north of 1.4mb/d year on year which is 200kb/d higher than market consensus.
In conclusion, there are two sides to a balance sheet. The combination of product demand and the implementation of OPEC production cuts could flip the curve from contango to backwardation and send oil prices towards $70 a barrel by the end of next year.
NOT FOR RETAIL DISTRIBUTION: This communication has been prepared exclusively for institutional/wholesale/professional clients and qualified investors only as defined by local laws and regulations.
The views contained herein are not to be taken as an advice or a recommendation to buy or sell any investment in any jurisdiction, nor is it a commitment from J.P. Morgan Asset Management or any of its subsidiaries to participate in any of the transactions mentioned herein. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own professional advisers, if any investment mentioned herein is believed to be suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yield may not be a reliable guide to future performance.
J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. This communication is issued by the following entities: in the United Kingdom by JPMorgan Asset Management (UK) Limited, which is authorized and regulated by the Financial Conduct Authority; in other EU jurisdictions by JPMorgan Asset Management (Europe) S.à r.l.; in Hong Kong by JF Asset Management Limited, or JPMorgan Funds (Asia) Limited, or JPMorgan Asset Management Real Assets (Asia) Limited; in India by JPMorgan Asset Management India Private Limited; in Singapore by JPMorgan Asset Management (Singapore) Limited, or JPMorgan Asset Management Real Assets (Singapore) Pte Ltd; in Taiwan by JPMorgan Asset Management (Taiwan) Limited; in Japan by JPMorgan Asset Management (Japan) Limited which is a member of the Investment Trusts Association, Japan, the Japan Investment Advisers Association, Type II Financial Instruments Firms Association and the Japan Securities Dealers Association and is regulated by the Financial Services Agency (registration number “Kanto Local Finance Bureau (Financial Instruments Firm) No. 330”); in Australia to wholesale clients only as defined in section 761A and 761G of the Corporations Act 2001 (Cth) by JPMorgan Asset Management (Australia) Limited (ABN 55143832080) (AFSL 376919); in Brazil by Banco J.P. Morgan S.A.; in Canada by JPMorgan Asset Management (Canada) Inc., and in the United States by JPMorgan Distribution Services Inc. and J.P. Morgan Institutional Investments, Inc., both members of FINRA/SIPC.; and J.P. Morgan Investment Management Inc.
Copyright 2016 JPMorgan Chase & Co. All rights reserved.