And now, the rebound
June 10, 2014
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Real gross domestic product (GDP) of the U.S. economy declined 1.0% in the first quarter, after a 2.6% increase in the fourth quarter of 2013. Significantly, poor weather accounted for a large part of the weakness in the first three months of year. The big drop in inventories, which set back real GDP by 1.6 percentage points, partly reflects the impact of inclement weather. A resumption of very solid economic growth is predicted for the rest of the year.
Improved hiring trends and wealth effects both suggest continued support to spending. Moreover, the Federal Reserves forward guidance of a low-interest-rate environment for a long while after the asset purchase program is completed is another strong positive influence on projected economic activity.
Key elements of the forecast:
- Growth in consumer spending was steady in the first quarter (3.1% versus 3.3% in 2013:Q4), partly due to a strong contribution from service sector outlays. Some of these expenditures related to the Affordable Care Act were one-off items. Fortunately, auto sales should help sustain the momentum; the May sales pace of 16.8 million units annually (versus 16.0 million in April) is noteworthy.
Net worth of households marked a new high in the first quarter. Delinquency rates of auto loans, credit card loans and mortgage loans are approaching pre-recession levels. Both of these developments suggest a stronger household balance sheet positions that should support consumer spending.
- Historically, the housing sector is an important driver of activity in an economic recovery. However, the contribution of residential investment expenditures in the current cycle has fallen short of the historical median, and recent data from the sector shows slower progress. Sales of new and existing homes have failed to gain strength after the weakness that followed the sharp increase in mortgage rates during the summer of 2013. Tight mortgage lending standards are also at play, and we cant forget that many homes are worth less, or only fractionally more, than the mortgages against them. The trend toward rental remains firmly in place.
- The recent improvement in hiring after the lull in the early part of the year is an important development. The latest three-month moving average of non-farm payroll employment (+232,000) is one of the strongest seen since the recovery commenced in mid-2009. However, there is an enormous source of untapped capacity in the labor market.
The percentage of part-timers who would prefer full-time employment is close to 3 percentage points higher than the historical average, and the share of long-term unemployed is elevated. While there has been slight progress on both fronts recently, these aspects of the labor market restrain the growth of wages and hold back spending in the economy.
- Inventory accumulation is predicted to stabilize in the coming quarters after a significant correction in the first quarter. Also, government spending is expected to return to growth and add to GDP in the balance of the year. A part of the weakness in exports seen in the first quarter should be reversed as well.
- Inflation in the United States is subdued for the most part. There is a small bit of acceleration visible in the personal consumption expenditure price index (both overall and core), but both measures are below the Feds 2% inflation target. Inflation expectations are also contained, for now.
- We have adjusted our forecast of long-term interest rate downward to reflect the somewhat unexpected bond market rally for the year to date. With growth accelerating and the Federal Reserve nearing the transition from tapering to tightening, we continue to think that 10-year rates will gradually move upward from here.
- Market expectations of economic growth will be tested when the Federal Open Market Committee publishes its Summary of Economic Projections following the June 17-18 meeting. A downward revision of the growth forecast is nearly certain, given the weakness in the first quarter, but the magnitude of the revision and the estimates of inflation and unemployment will be closely watched.
Given the nature of incoming economic reports, another $10 billion reduction of asset purchases to $35 billion is almost certain. Discussions of the Feds likely actions to normalize monetary policy are evolving.