Quarterly Market Update
U.S. GDP Growth Heavily Dependent upon Fourth Quarter Results
It appears that the service sector is supporting U.S. GDP growth while the manufacturing sector is acting as somewhat of a drag.
Business and Consumer Confidence Weaken GDP Growth Expectations
First-quarter real GDP growth is projected to be 0.7% but is subject to further deterioration in consumer spending and equipment investment after U.S. business and consumer confidence declined over the quarter, according to an EISI tracking study. The U.S. international trade gap also widened more than expected in February to -$47.1 billion, the largest deficit in six months. Note that over the past few years, despite seasonal adjustments, initial first-quarter GDP estimates have consistently understated actual growth in the quarter while initial second-quarter estimates have overstated actual second-quarter growth. Although the Bureau of Economic Analysis continues to work on the adjustment glitch, it may not matter much because first- and second-quarter GDP numbers tend to wash each other out anyway. Because third- quarter growth is typically quite weak, GDP growth for the full year is often determined by fourth-quarter results. The consensus outlook for real GDP growth in 2016 is 2.0%.
Jobs Growth Solid despite Economic Turmoil Abroad
Job growth continued to show steady improvement, reflecting continuing strength in the service sectors and weakness in the manufacturing sectors.
The March payroll number came in at 215,000, down slightly from the 242,000 jobs added in February, but up from the 151,000 added in January. The March report showed the strongest job growth in retail, construction, and health care. Close to 400,000 people joined the labor force in March which pushed the unemployment rate up to 5.0% from 4.9% in February. The labor force participation rate reached 63.0%, the highest level in two years. Declining labor force participation has been a structural concern, although the participation rate has been slowly reversing itself in the past few months. Consistent job growth above 200,000 per month falls in line with the Fed’s outlook for the labor market and helps support expectations for two rate hikes in 2016.
Inflation Continues to Elude Fed Target
Personal Consumption Expenditures (PCE), the Fed’s preferred measure of inflation, ticked up a bit to 1.7% in the first quarter, but overall the inflation needle appears to be stuck in a range of 1.5% to 2.0%. Despite aggressive action, the ability of the Fed and other global central banks to stimulate growth and inflation appears to be waning. Negative interest rate policies in countries like Japan have been ineffective, making it unlikely the Fed will follow similar tactics. However, at its last meeting, the European Central Bank (ECB) implemented a quantitative easing (QE) program which calls for not only the purchase of sovereign government debt but also the purchase of corporate debt in the open market. That policy does appear to have some efficacy in that it prompted credit spreads on corporate debt to tighten. Should U.S. growth and inflation targets continue to fall short, the Fed could follow the ECB’s path and introduce another QE program in the form of corporate debt purchases. However, because domestic growth appears to be in better shape than growth overseas, another QE program remains unlikely.
Manufacturing Results Trail Service Industry
The March ISM Manufacturing Production Index rose to 51.8 after falling to 48.0 in December. Fifty is the supposed line between expansion and contraction, indicating that U.S. manufacturing sector may be on the mend. The U.S. dollar has finally begun to weaken a bit lately which may be helping the manufacturing sector by way of increased exports. Also, increased disposable income from lower oil/gasoline prices may finally be contributing to consumption.
The ISM Non-Manufacturing Production Index, a measure of the services industry, rose to 54.8%, surpassing manufacturing and continuing a three-month expansion. The ISM manufacturing index’s March expansion on the other hand was the first since September 2015. It appears that the service sector is supporting U.S. GDP growth while the manufacturing sector is acting as somewhat of a drag.
Housing Starts Benefit from Hospitable Weather
The spending model that drives the U.S. economy has been described as a three-legged stool comprised of personal consumption, business spending, and government spending. Housing is a large and important component of personal consumption, and therefore the industry’s health is a closely followed indicator of economic well-being. The mild winter season that is just now ending in many parts of the U.S. contrasted sharply with last year’s malevolent weather which was blamed for the first quarter’s negative GDP number. And indeed, new starts of homes increased 5.2% in February to 1,178,000 units (the most recent data available), above the 1,150,000 expected by economists. Both single family (up 5.2% in Feb) and multifamily (up 0.8%) contributed to the overall gain in the housing starts number.
Oil Prices Make Round Trip
The decline in oil prices has not lifted U.S. domestic demand as much as hoped. Instead, the consumer savings rate has increased while consumption has largely failed to accelerate. Fed Chair Yellen indicated that should oil prices continue to decline, growth and inflation expectations are likely to decline, causing market volatility to increase and equity valuations to fall. After a dismal start to the year, energy prices began to improve during the last six weeks of the quarter, sparking a sharp rally in global stocks and bonds. However, the rally in crude futures weakened by the end of the quarter on renewed concerns about oversupply and diminishing hopes for a cap on production. On February 11, West Texas Intermediate fell to a low of $26 per barrel then rose up to $44 before ending the quarter at $38.34 per barrel.
A number of U.S. fracking companies have been shut down, unable to continue pumping in the face of falling oil prices. However, stockpiles are still near record levels as most U.S. and global producers have slowed production less than was expected. The U.S. is entering the summer driving season which may be supportive of oil prices given increased demand for gasoline.
U.S. Dollar Remains King of the Reserves
The U.S. dollar remained the world’s favorite reserve currency in 2015. The euro, which had been projected to challenge the dollar when it was first introduced in 1999, saw its share of reserves fall in 2015 to its lowest level since 2002. Regardless, the dollar began to lose some value versus the euro in the first quarter as tepid economic data, stubbornly low inflation, and dovish Fed commentary began to dampen expectations of higher interest rates in 2016. All other factors held equal, when U.S. interest rates go up, the greenback rallies and when U.S. interest rates go down, the dollar weakens. In addition, the Euro surprisingly rallied despite negative interest rates in several European countries. For the quarter, the dollar lost value versus the euro as the exchange rate went from 1.07 at the beginning of the quarter to 1.14 at the end of the quarter.
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