U.S. Economic Growth Appears to be Self-Sustaining
BBVA Research calls for annualized GDP to reach 2.3% this year. Optimism surrounding Mr. Trump’s goals of reducing regulation, reforming the corporate tax code, and implementing a major infrastructure package has generally boosted 2017 estimates. GDP growth fell to 1.60% in 2016, its lowest level in five years, primarily influenced by cheap oil and a strong U.S. dollar which hurt exports and business investment
“Seasonal idiosyncrasies,” associated with first-quarter results for a number of years, and incoming data suggest moderate economic growth in the first quarter, primarily due to declines in net exports and change in inventory investments, according to BBVA. However, first-quarter results are expected to surpass the anemic under one-percent increase for the same period last year. First-quarter estimates will be released on April 28.
Fourth-quarter GDP increased at an annualized rate of 2.10%, following a 3.5% increase in the third quarter, according to the third estimate released by the Bureau of Economic Analysis, after personal consumption expenditures rose more than previous estimates.
After a solid start to the quarter, the labor market again indicated that the road to full employment holds a few surprises. Employers added 227,000 jobs in January and 235,000 jobs in February, but the pace slowed sharply to an unusually low 98,000 in March, partially due to seasonal conditions as a balmy winter likely pulled forward hiring in some sectors. Job growth averaged 187,000 for the quarter, not materially different from last year. The construction industry added only 6,000 jobs in March after adding 59,000 in unseasonably warm February. Manufacturers added 11,000 jobs, the fifth consecutive month of gains. Health care added 16,700 jobs while retail shed 29,700 jobs in March.
The unemployment rate dropped more than expected to 4.5% in March, its lowest level in almost a decade, indicating that the economy is at or near full employment. The labor-force participation rate was steady at 63%. The U6, a measure of unemployment that includes those who have stopped looking and those in part-time jobs who want full-time employment, fell to 8.9% in March, its lowest level since December 2007.
Domestic inflation as measured by the PCE index (Personal Consumption Expenditures), the Fed’s preferred price gauge, exceeded the 2.00% target in February for the first time since March 2012. Energy prices, which rose monthly from September through January, were the primary driver despite pulling back in February. Inflation has trended higher since 2016, but February’s 2.1% level indicates that the high unemployment and excess capacity which have dogged the U.S. economy since the financial crisis began in 2008 may be abating.
The economic improvement paves the way for additional Fed rate increases in the months ahead. Although the Fed has tightened three times off the zero level, an easy money environment continues and the Fed funds rate remains under 1.00%, technically an emergency mode level. The Fed is targeting a yearend rate of 1.5%, and the Fed dot plot (indicates the interest rate projections of the 16 FOMC members and is published after each meeting) calls for three more rate hikes this year.
On average, housing construction makes up 13.00% to 18.00% of GDP, a not insignificant contribution. In February, construction was the leading job sector, growing by 58,000, the most in almost a decade, due partially to a balmy winter. Home sales have recently taken off in line with expectations for higher mortgage rates as the Fed eases off monetary stimulus.
Although the anticipation of higher mortgage costs appears to be driving home sales, other factors are simultaneously putting upward pressure on housing prices, making affordability less attractive than it was a year ago. Home prices rose in January (the most recent data available) at their fastest pace since mid-2014. The S&P CoreLogic Case-Shiller Indices (U.S. single-family home price indices) rose 5.9% in the twelve months ended in January, the strongest increase in almost three years.
Limited supply is a concern as housing levels are at a low not seen since pre-2008 and 2009. And, while more housing starts will increase supply, there is a shortage of workers in the industry. Housing price increases benefit sellers, but create a hurdle for first-time buyers and discourage buyers looking to trade up into a larger home. Such factors could impact near-term growth rates, and in the long run, lead to a slowdown in the overall housing market.
Although the pace of the expansion slowed in March, factory activity continued to expand. The ISM Manufacturing Production Index fell to 57.2 from 57.7 in February which had been the strongest reading in six months. All 18 industries reported growth in new orders for the month. According to the ISM, inventories of raw materials fell while prices for raw materials increased for the 13th consecutive month, in line with the February PCE inflation gauge. On the manufacturing side, inventory levels, along with the trade deficit, are swing numbers in that sharp moves in either direction can destabilize the economy.
While the pace of U.S. nonmanufacturing activity (services), including health care, finance, agriculture, and construction also slowed, activity continued to expand for the 92nd consecutive month. The index fell to 55.2 from 57.6 in February. Although “the majority of respondents’ comments indicated a positive outlook on business conditions and the overall economy, there were several comments about the uncertainty of future government policies on health care, trade and immigration, and the potential impact on business,” according to the ISM.
The improvements in manufacturing and services appear to be global. Indeed, the breadth of economic growth right now is the greatest that it has been in a number of years. The final Markit Eurozone Manufacturing PMI rose to 56.2 in March, the highest reading since April 2011. Manufacturing growth accelerated in Germany, Italy and France, but slowed in Spain and Ireland. Manufacturers’ purchasing costs also rose, as in the U.S.
Oil prices dipped below $50 a barrel to end the quarter at $47.34, largely due to supply side factors. Although Mr. Trump has approved two oil pipelines since taking office, mostly composed of “dirty oil,” product from the oil sands in Canada that is not easily refined, the pipeline product is not considered to be a significant driver of domestic supply. But fracking in the U.S. is profitable within the current price band of $40 to $60, and domestic output continues despite ample supply.
Members of OPEC and other producers including Russia are working to reduce global inventories by cutting output for the first half of the year, but rising U.S. output reduces the possibility of any price rally. Indeed, U.S. oil-production companies benefit from OPEC restriction because it supports prices. In our opinion, it would take a much higher level of GDP growth to push the demand for oil above the $60 a barrel band in the foreseeable future, which has implications for the pace of inflation over the balance of the year.
Continued healthy consumer confidence, as measured by the University of Michigan’s consumer sentiment index, is strongly related to optimistic views surrounding higher incomes and wealth, more favorable job prospects, and low inflation expectations. But after the November elections, views have taken a more partisan tone. According to the most recent University of Michigan study, Democrats anticipate recession, higher unemployment, lower income gains, and higher rates of inflation, while Republicans anticipate that the Trump stimulus programs will grow incomes and jobs, and push inflation lower. The strength in consumer confidence is forecast to propel retail sales growth this year to 4.2%, up from 3.6% last year.
Beginning April 1, online giant Amazon will begin collecting individual states sales tax across 45 states, the exceptions being those states which do not impose a sales tax – Alaska, Delaware, Montana, New Hampshire, and Oregon. Amazon began leveling the tax on customer purchases in 2012 in states where the online giant had a physical presence. The company slowly expanded that list as it strived to widely establish warehouses and distribution centers to enhance one-day deliveries. The move is anticipated to level the retail playing field for big- box retailers, and to shore up individual state coffers.
Irrespective of election results, it appears that after years of muddling along, the domestic economy is poised to become self-supporting, eliminating the need for continued monetary easing. Some pundits contend that the economy is finally running on all cylinders – housing and autos are strong, inflation and interest rates are below average, and wage growth has picked up. The labor market continues to be a bright spot, and the unemployment rate indicates that the economy may be near full employment.
This best of all worlds, seen not only in the U.S. but around the world, goes a long way toward explaining the behavior of the markets in general – including bonds and stocks. The good news has leeched into the stock market, helping the equity market to advance despite disappointment in initial efforts to advance the Trump stimulus packages.
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