Closing the curtain on the first quarter
May 7, 2014
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The U.S. economy stalled in the first quarter (+0.1%) after a 2.6% increase in the fourth quarter of 2013. Inclement weather, a noticeable decline in inventory accumulation and a drop in exports held back growth. It is nearly certain that assumptions about exports and inventories for March embedded in the advance report will be revised when the estimate of real gross domestic product (GDP) is updated at the end of this month. Analysts expect that the first quarter could show a decline, the first in three years.
However, the underlying momentum within the economy is certainly stronger than this reading will suggest. Incoming economic data attest to this, and we expect the economy to advance at a pace of better than 3% during the rest of the year.
Key elements of our forecast, along with some reflections from todays Congressional testimony by the Federal Reserve Chair Janet Yellen, follow.
- Consumer spending rose 3.0% in the first quarter, following on the heels of a 3.3% increase in the prior quarter. This is the largest back-to-back gain seen in the current expansion. A 10% jump in health care outlays related to the Affordable Care Act is not likely to be repeated in subsequent quarters, and the sharp increase in expenditures for utility bills should normalize as the weather returns to typical ranges. But auto sales are improving, and consumer spending should maintain the current trajectory in the quarters ahead.
- Residential investment expenditures in the GDP report have stumbled for two straight quarters. Combined sales of new and existing homes fell at a nearly 24% annualized rate in the first quarter after a 21% drop in the final three months of 2013. Very poor weather, tight lending conditions, higher mortgage rates and rising home prices held back home sales.
The housing picture should improve as firms expand payrolls and household formation increases. The small amount of deceleration of home prices seen in the two months ended February suggest that affordability of homes will be less of a constraint. However, as Fed Chair Yellen noted in her remarks, the recent deceleration in housing activity could prove to be more protracted than currently expected.
- Recent developments in the labor market are noteworthy. The unemployment rate dropped to 6.3% in April, down from 6.7% in December 2013. The six-month moving average of the participation rate held at 63% for the first four months of the year, and broader measures of unemployment also trended down. The 288,000 gain in payroll employment during April and revisions put the average monthly pace of job growth at nearly 200,000 in the past year.
Labor market conditions are still not perfect. Elevated long-term unemployment, nearly 7.5 million part-time workers seeking full-time employment, and subdued wage trends are factors pointing to "substantial slack in the labor market." Essentially, hiring has improved but as Yellen stressed, while conditions in the labor market have improved appreciably, they are still far from satisfactory.
- Inflation data continue to point to contained readings, and they remain far below the Feds preferred target of 2.0%. The personal consumption expenditure price index and the core price measure, which excludes food and energy, moved up 1.2% during the 12 months ended March. Fed Chair Yellen indicated that persistent inflation readings below 2.0% "could pose risks to economic performance."
- Treasury market yields in the long end of the curve have moved in a very narrow range in the past month despite bullish economic news in the United States. The Ukraine crisis and soft economic data from China are factors holding down bond yields.
- The Fed is widely expected to end the asset purchase program in October. Adverse geopolitical developments present the largest external risk to the U.S. economy, while the housing area is a key domestic sector we are watching closely. The caveats about employment and inflation in Janet Yellens testimony strongly suggest the Fed will err on the side of caution in formulating monetary policy after the asset purchase program winds down completely.