Spring brings green shoots
April 8, 2014
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After a long, cold, lonely winter, there are finally green shoots coming through the flower beds. Fortunately, the same can be said for the U.S. economy.
Growth of real gross domestic product (GDP) is projected to have slowed in the first quarter to below 2.0%, following an average gain of 3.1% in the prior three quarters. The loss of business momentum in the early months of the year is attributed to poor weather conditions.
A rebound in auto sales, an improved factory sector survey, and a pickup in hiring during March confirm that weather played a role in holding back growth and a turnaround in economic activity is highly likely. Overall economic fundamentals remain supportive of 3.0% economic growth during the rest of the year.
Key elements of the forecast:
- The projected deceleration in consumer spending during the first quarter stands out because it is likely to come in at about half the robust 3.3% jump in consumer outlays recorded in the fourth quarter of 2013. Auto sales slipped in January and were nearly steady in February, while non-auto retail sales also shared a similar trend. The strong rebound in auto sales in March (16.4 million units versus 15.3 million in February) is noteworthy and we predict auto sales will maintain an upward trend in the rest of the year. Consumer credit continues to advance and households debt service obligations are at historical lows. Along with improving employment conditions, all of this supports expectations of continued growth in consumer spending.
- Although shipments of non-defense capital goods excluding aircraft (a proxy for capital spending in the GDP report) have been disappointing in the first two months of the year, the latest surveys about capital expenditures present a constructive outlook. These positive readings suggest that a pickup in capital spending in the months ahead should not be surprising.
- Sales and construction of homes are sending mixed signals. The January-February average of new home sales was flat compared with the fourth quarter performance. Sales of existing homes have been trending down since August 2013. Construction of new homes slipped in the early part of the year, partly due to bad weather. The Mortgage Purchase Index of the Mortgage Bankers Association recovered in March after a drop in February, implying that an increase in homes sales is around the corner. We are watching the housing market closely to ascertain if there is more than weather at play.
- Business inventories remain a wild card after a consistent accumulation for the first three quarters of the 2013. The January-February inventories data do not point to a large decline in the first quarter; the timing of a correction after a big buildup of inventories is always a challenge to predict.
- Inflation in the U.S. economy and among major economies of the world is subdued because demand conditions are not uniformly robust. Also, the deceleration of activity in China has held down commodity prices. The strength of the dollar, contained import prices and moderating health care costs are some of the factors accounting for the tame inflation situation. In fact, inflation is far below the Feds 2% target.
- In March, the unemployment rate held steady despite an increase in hiring because the participation rate moved up, an undoubtedly positive development. Private sector payroll employment exceeds the peak seen in 2007. The latest labor market turnover report shows that the number of job openings in February was the highest level since January 2008. The strengthening of labor market conditions allows the Fed to complete the reduction in asset purchases by October 2014.
- The Fed remains short on its inflation and employment mandate, which led to the new forward guidance language introduced following the March Federal Open Market Committee meeting. Essentially, the Fed indicated that even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time warrant keeping the target federal funds rate below levels the Committee views as normal in the long-run. In other words, the Fed will be cautious about tightening monetary policy, with labor market conditions dictating its strategy.