Soft patch or weather anomaly?
February 11, 2014
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Real gross domestic product (GDP) of the economy grew at an annual rate of 3.2% in final three months of 2013, following a 4.1% increase in the third quarter. Overall, the pace of business activity in the second half of the year was twice that of the first half.
December and January were marked by colder-than-typical weather across much of the country, which resulted in data distortions. Mixed incoming economic data partly reflect the weather effect, but there is concern that a decline in economic momentum is also at play.
It will be a while before a completely clean read on the economy is available. At the present time, it appears that inclement weather has trimmed real GDP in the first three months of the year. But the economy is on track to advance at a little over 3.0% pace during the rest of the year and potentially exceed it by a good margin.
The latest report from Washington suggests that a clean debt ceiling bill is likely to be passed shortly. The main implication of this positive development is that yet another fiscal drama will not cause avoidable uncertainty and market volatility in the very near term.
Looking past bad weather conditions, the fundamentals of the U.S. economy are on a firm foundation, and economic growth in 2014 should surpass the performance seen in 2013, barring unexpected developments.
Key Economic Indicators
Key elements of our forecast
- Consumer spending grew at an annual rate of 3.3% in the fourth quarter, the strongest quarterly performance since 2010. The steady improvement in employment conditions and higher asset prices are factors that helped to lift consumer purchases. Auto sales are predicted to rebound after a small dip in January. Inclement weather is predicted to trim consumer spending in the first quarter, but it is predicted to gain stronger momentum in the rest of the year.
- Business equipment spending closed on a strong note in the fourth quarter (+6.9%), the best reading for the entire year. Surveys indicate that business capital expenditures are most likely to gather additional momentum in 2014. Absent restraints on credit availability, there is growing optimism that capital expenditures will make a noteworthy contribution to growth.
- The sharp 12.6% decline in federal government spending in the fourth quarter places the annual contraction in federal government outlays (-5.1%) as the largest decline since 1970. The good news is that the fiscal drag will nearly vanish in 2014 and provide support to overall growth in the economy. In addition, state and local government spending has picked up and should continue to advance in 2014.
- The projected growth in 2014 should translate into a lower unemployment rate by year end. However, improving economic conditions should result in discouraged workers returning to the workforce and raising the participation rate. This is a constructive development, but it will trim the downward trajectory of the unemployment rate.
- Inflation and inflation expectations are both subdued. The Federal Reserves preferred measure of inflation stood at 1.1% in 2013, which is below the Feds 2% inflation target. As economic growth strengthens during the year and one-off cuts in Medicare payments that helped to contain inflation are no longer prevalent, inflation should gradually move up toward the Feds target.
- Janet Yellen, the new chair of the Federal Reserve, indicated in todays testimony that crossing the 6.5% unemployment rate threshold or the inflation threshold is not an automatic trigger for an increase in the federal funds rate but would prompt a discussion about whether the broader economic outlook would justify an increase. This is only a partial answer to the current market concern, as the jobless rate could possibly touch the critical 6.5% mark in February. The Fed will need to offer more clarity on forward guidance quite soon.
- The Federal Reserve is watching recent emerging market volatility closely and does not believe it is a source of significant risk to the U.S. economy. This, plus the mixed nature of incoming data, are unlikely to result in a pause of the Feds measured tapering of asset purchases. Yellen echoed this message in her testimony, despite her observation that the recovery in the labor market is far from complete.
- Markets have digested the fact that tapering of asset purchases is on course to be completed by year end. Markets will now be sensitive to the nature of future economic reports to confirm forecasts of continued forward momentum.