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The U.S. economy’s performance in the first quarter was disappointing on several fronts, partly due to one-off factors that mask the economy’s solid underpinnings. But the growth outlook for the rest of the year remains bright.
Winter cast a long shadow on the U.S. economy once again, albeit to a lesser degree compared with the situation of a year ago. The West Coast port strike led to temporary disruptions in economic activity through supply bottlenecks. Oil prices appear to be stabilizing but only after unsettling energy-related sectors. The dollar’s sharp advance is another factor in the mix of things that should be more than a temporary influence.
Taking into consideration both the transitory and fundamental factors, soft growth in the first quarter most likely will be followed by above-trend momentum in subsequent quarters.
Key Economic Indicators
Key Elements of Forecast:
- Consumer spending in the first quarter is predicted to have advanced at a slower pace compared with the 4.2% increase in the final three months of 2014. For now, consumers seem to be banking — not spending — their energy dividend; we expect this will change as the year progresses. The latest core retail sales numbers (which exclude autos, gasoline and building materials) showed a small pickup after a string of three weak monthly readings. Auto sales suffered under the snow but have since rebounded.
- Incoming data suggest a deceleration in business spending, partly reflecting the decline in equipment spending in oil-related industries. The dollar’s strength and associated weakness in exports are factors weighing on the outlook for business equipment spending.
- A rebound in housing-related activity is expected after inclement weather held back home sales in the first two months of the quarter. Mortgage interest rates remain attractive, and the supply of new homes for sale is very low. Progress may continue to be limited, however, by the finances of prospective first-time homeowners.
- Exports and imports of goods slipped in the January-February period. The dockworker’s strike contributed to some of this weakness. Exports showed a larger drop compared with imports, which translated into a wider trade gap in the first quarter.
- Payroll employment increased only 126,000 in March. Markets have recognized that one-off factors such as weather may have played a role and that the strengthening of the labor market has not come to a standstill. Initial jobless claims, the high-frequency labor market indicator, continue to trend down. Job openings are rising, as is the rate at which workers voluntarily quit their jobs to seek better ones.
In light of the recent jobless rate of 5.5%, the Federal Open Market Committee (FOMC) lowered its estimate of full employment to 5.0%-5.2%. Further improvements in hiring should result in the economy nearing this full employment mark by year-end. Wages should accelerate as labor market slack shrinks.
- The February all-items personal consumption expenditure (PCE) price index increased only 0.3% from a year ago. The core personal consumption expenditure (PCE) price index firmed a bit in February to 1.4% after posting slightly lower readings in the December–January period. Both measures of inflation remain far short of the Fed’s inflation target.
A strong dollar and lower energy prices have held down goods prices, while the cost of services maintains an upward trend. FOMC members lowered their prediction of inflation at the March meeting. They expect inflation to move up as oil prices stabilize.
- The 10-year Treasury note yield is marginally lower than quotes seen in early March. The whiff of weakness in economic data is driving bond yields; as winter blues are put behind, higher bond yields are likely to follow. The global search for yield should, however, limit the depreciation in bond prices.
- High-yield debt defaults in the U.S. energy sector could result in credit spreads widening and restraining growth in the United States. A significant weakening of economic conditions in China and a stagnant eurozone are other sources of potential risk. Oil prices and related geopolitical challenges remain areas of concern that we are closely monitoring.
- The FOMC dropped “patient” from its forward guidance and replaced it with “reasonable confidence” about inflation moving toward the 2.0% inflation target. As for the mechanics of the rate hike, the minutes of the March meeting noted that interest on excess reserves would serve as the upper limit of the policy rate, and the rate paid on the overnight repo facility would set the lower limit.
The Fed has conveyed an unambiguous message to markets about its plans to tighten monetary policy in 2015. Although all meetings after the April gathering are open for a tightening of monetary policy, we expect the FOMC to raise the policy rate at the September meeting.