Snowy first quarter
March 11, 2014
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Inclement weather introduced distortions in economic reports in the past three months. Clean readings of economic fundamentals will be available only after a few more weeks. It is a challenge to disentangle the weathers effect in incoming economic reports. Nonetheless, there is enough information to support the view that the economic growth trajectory is largely in place.
Before digging into the specific numbers, it is useful to note that the second estimate of fourth quarter real gross domestic product (GDP) growth reflected downward revisions of consumer spending, exports and inventories. Taken together, these adjustments resulted in slower growth of the economy (+2.4% versus +3.2% in the advance estimate). So we are forecasting from a more modest base than previously thought.
The harsh winters impact on commerce led us to revise our earlier estimate of economic growth in the first quarter. The outlook for the rest of the year remains largely intact.
Key Economic Indicators
Key elements of forecast
- We remain optimistic about consumer spending in the balance of the year, thanks to better employment conditions and strengthening household balance sheets. But the first quarter economic data were clearly distorted by several nonrecurring themes. The weather held down auto sales (which averaged 15.3 million units in January and February, down from 15.7 million in the fourth quarter), but boosted heating bills (which count as sales). In addition, the provisions of the Affordable Care Act gave an extra lift to consumer spending in January. Pulling these divergent trends together, a small moderation in consumer spending during the first quarter is most likely, after a 2.6% increase in the fourth quarter.
- Business spending shot up 10.6% in the fourth quarter after revisions, but a small deceleration is likely in the first quarter. Reduced fiscal uncertainty is a large positive factor that supports expectations of a decent contribution from business spending in 2014. Consistent with the accelerator model of investment spending, economic growth will support business outlays in the quarters ahead.
- Recent developments in the housing sector are mixed. Home construction activity, the key driver of residential investment expenditures, was disappointing. Housing starts fell 16% in January, partly due to weather, while residential construction outlays rose only 0.9%. Of late, credit availability has tightened a bit, while firms hired at a slower pace during the three months ended February versus the prior three-month period. We are tracking home sales and construction data closely; a modest trimming of the current outlook is likely if we fail to see a turnaround in home construction.
- The deceleration in hiring during December and January planted seeds of doubt about labor market fundamentals. But the pickup in hiring in February was a relief to markets and the Fed. The February employment data gave the Fed room to continue the current plan of tapering asset purchases. A measured decline of the unemployment rate is predicted for the rest of the year as we take into account the return of discouraged people to the labor force.
- Sequestration and the federal government shutdown in the fourth quarter led to the deep decline in outlays. While there will be some continued austerity, it will not likely be as severe as it has been in recent years. We continue to look for government spending to be among the biggest positive swings this year. Policy uncertainty has been temporarily reduced with the passage of a budget and a suspension of the debt ceiling, but the approach of mid-term elections will absorb a lot of attention.
- The Ukraine-Russia story shook U.S. markets initially. Market focus switched to economic developments as the situation simmered down somewhat. This remains a potential wild card in the outlook.
- The upcoming Fed meeting on March 18-19 should result in a tinkering of the 6.5% unemployment rate threshold because the current 6.7% unemployment rate is within reach of this benchmark. Recent Fed missives suggest the Fed is most likely to introduce qualitative forward guidance in place of the numerical economic thresholds in place now.