Spring swoon ahead?
April 16, 2013
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The U.S. economy sprinted through the just-completed first quarter of 2013 after a nearly steady performance in the fourth quarter of 2012. Based on the information available, we continue to project a slowing of economic conditions in the second quarter, largely reflecting sequestration. Overall, the economic landscape shows several areas of strength that will continue to maintain momentum despite the fiscal restraint.
Reports trickling in suggest that some categories of federal government spending cuts could be postponed to the third quarter instead of taking effect in the second quarter, as previously thought. The Federal Aviation Authority postponed the shutting down of airport control towers in the interest of safety. The Internal Revenue Service delayed furloughs until the summer. Congress put funds back into the Department of Agriculture budget to prevent furloughs of meat inspectors. By contrast, the National Parks and the National Institutes of Health has already initiated spending cuts. The bottom line is that it is a mixed picture and too early to pin down the precise impact of the cuts, which officially commenced March 1.
Europe is widely expected to post a decline in real gross domestic product (GDP) in the first half of the year, while China reported a somewhat disappointing 7.7% gain in real GDP in the first quarter. All eyes are on the U.S. economy to give a lift to global economic activity.
US Economic Outlook
Key elements of the current forecast:
- Consumer spending is most likely to have advanced 2.8% in the first quarter, the strongest performance since the first quarter of 2011. Incoming data such as auto sales (+7.0% in 2013:Q1) and retail sales excluding autos, gasoline and building materials, (+3.1% in 2013:Q1) are supportive of the forecast. The recent uptick in average weekly earnings (+3.5% in 2013:Q1) also bodes well for consumer spending. The favorable mortgage interest rate environment has increased mortgage refinancing and provided households with more dollars for other expenditures, partly offsetting the setback of the payroll tax increase.
- Residential construction outlays of the first two months of the year and permit extension increases in the first quarter both support a positive contribution from residential investment expenditures, the brightest spot among GDP components. The likely ripple effects of new construction are another aspect to keep in mind.
- Business spending shot up nearly 12% in the fourth quarter. The durable goods report and the ISM factory survey results for the first two months of the year point to a small increase in equipment and software spending for the first quarter overall. An inventory accumulation, after the correction in the fourth quarter, will give a boost to the GDP number in the first quarter.
- The upward trend of the trade-weighted dollar and the economic challenges of U.S. trading partners suggest lackluster growth in exports, at best, after a decline in the fourth quarter. It is seldom noted that a decline in imported oil contributed to the drop in imports in the second half of 2012 and, to a smaller extent, the first two months of 2013. Putting together predictions of exports and imports, the trade gap is projected to have widened slightly in the first three months of the year.
- The unemployment rate edged down to 7.6% in March, reflecting a drop in the participation rate and not a gain in hiring. Payroll employment was also not promising in March, but jobless claims fell and job openings have risen. Looking ahead, the underlying fundamentals suggest that the participation rate should reverse the recent downward trend, resulting in only a small drop in the unemployment rate by year-end.
- A confluence of recent events the Bank of Japan's announcement of an aggressive monetary policy program, soft employment and retail sales reports have been bullish for the Treasury market. However, the ingredients for a rapid increase in interest rates are not in place, as yet.
- The Fed is partly caught between a rock and a hard place with regard to the large-scale asset purchase program. There is a growing willingness to pare back asset purchases but at the same time the absence of strong and sustained hiring trends prevents it. However, if the labor market outlook improves, it should not be surprising if the Fed reduces its current plan to purchase $85 billion by year-end. It should be noted that the FOMC does not need very robust economic numbers to taper the asset purchase trajectory but only an improvement in the "outlook" for labor markets.