Paul Single
Managing Director
Paul.Single@cnr.com
(415) 576-2531

Steven Denike
Portfolio Strategy Analyst
Steven.Denike@cnr.com
(212) 702-3500

Here we go again. After several weeks of generally positive economic news that helped calm markets and seemly put recession talk to rest, a recent string of weaker-than-expected data releases is once again raising anxiety over the outlook. Following disappointing results in consumer spending, durable goods orders, home sales, and exports, the Atlanta Federal Reserve’s GDPNow forecast model for first-quarter U.S. growth has plunged to 0.6% from a high of 2.3% in Mid-march (Figure 1). That is still well below current consensus forecasts of 1.5% growth but it appears the all-too-familiar pattern of slow starts to the year, which we have seen over this economic cycle, will not be avoided in 2016.

The current softness in activity remains at odds with the many tailwinds the domestic economy continues to enjoy, including healthy consumer income growth, low gas prices, and declining mortgage rates. Some of the reasons behind this are that consumers are not immune to nervous financial market headlines, and appear to have recently turned cautious in the face of stock market turbulence and increasing downside risks from the world economy. Last month’s terrorist attacks in Europe, as well as the progressively negative tone of the U.S. presidential election, have not helped.

Similarly, the more downbeat sentiment expressed by small businesses in the past couple of months, is likely related to recent economic unease and political uncertainty. Stronger confidence is necessary for businesses to begin to feel comfortable in making long-term capital commitments and for the U.S. economy to start seeing a more meaningful acceleration in growth. Unfortunately, too many businesses appear to be taking a “wait and see” approach for now.

Still, if we step back and look at the big picture, the underlying trend in U.S. economic activity remains healthy and we continue to be optimistic that improved growth will materialize in the quarters ahead. Despite the slowdown in January and February, household spending is still growing at a relatively solid three-month average annual rate of 2.0%. Moreover, the adverse impact to consumer sentiment has been minimal thus far, and the accumulated savings households have pocketed over the last several months should give Americans better confidence to shop down the road.

Likewise, while capital spending has been decidedly lackluster, businesses have remained confident enough in the demand outlook to keep up a strong pace of hiring. In fact, with the recent uptick in the employment participation rate, a historically high job openings rate and the sharp decline in forward-looking initial claims, the labor market continues to be the star of the economic show. This ongoing improvement in labor conditions should further lift domestic demand and shore up business confidence in the months to come.

Indeed, in our minds, with domestic fundamentals reasonably solid, the most pressing concern for the U.S. economy continues to emanate from overseas as export-oriented U.S. manufacturing struggles with weak global demand and the stronger dollar. Yet, we believe there are reasons for optimism here as well. Despite the many headwinds confronting the factory sector, output continues to expand, and recent survey data points to improvement ahead. While it is unlikely that manufacturing will swing back to a position of strength anytime soon, a bottoming in the production slump (which we have seen over the past year and a half) would reduce a significant drag on the overall economy.

Adding all these factors together, we believe the case for better, though still modest, economic growth over the remainder of 2016 remains strong. Although ongoing global economic and financial uncertainty recently led the Fed to state that a slower path to rate increases is warranted, the impact on the relatively closed U.S. economy from negative events overseas should be modest. Indeed, if all policymakers are waiting for is calm on the international stage, they may be waiting for quite some time.

THE FED

There was a sharp and unexpected dovish turn by the Fed following the recent Federal Open Market Committee (FOMC) meeting in mid-March. The Fed established a more gradual path for its expected increases in short-term interest rates in 2016. In December 2015, when the Fed last met to publish its outlook, it planned on a 100 basis point increase in the federal funds rate (four increases of 25 basis points each). Due to the Fed’s concerns about the global economic and financial markets, this increase has since been reduced to a total of just 50 basis points over the remainder of the year. The Fed has been pushing down its outlook since August 2014, when economic growth was a strong 4.3% (Figure 2).

The Fed most likely feels confident with the lower level of interest rate increases, due to the low level of inflation. Since inflation is not expected to surpass the Fed’s target of 2.0% until after 2018, the Fed seems to be slowing the pace of the rate reduction to help further stimulate the labor market. The lower level of interest rates should also help to better govern the pace of the appreciation of the dollar, which has reduced the amount of exports and is, in turn, hurting the domestic industrial sector.

LABOR

The brisk pace in hiring continues to show that labor demand is rock solid. The unemployment rate remains at just 4.9% (Figure 3). This is an expansion low, and the rate has remained at this level for the past two months. The recent monthly gain in total non-farm payrolls was 242,000. Total non-farm payrolls have exceeded 240,000 in four of the past five months and are ahead of the 2015 average pace of 229,000. This is especially good news given the financial volatility in the first two months of this year.

The unfortunate part for workers has been the slow pace in wage increases, with average hourly earnings increasing just 2.4% in the past year. This is a key proxy for the Fed, which indicates some amount of slack in the labor market. This might be one of the reasons why the Fed reduced the number of future interest rate increases - specifically, so that the labor market can continue to grow and, it is hoped, lift wages.

INFLATION

Price pressures are continuing their upward ascent as the large price declines of commodities (especially energy) are falling off the year-over-year calculations. The Consumer Price Index (CPI) is at 1.0%. The Core Personal Consumption Expenditure Index (Core-PCE), which is the Fed’s preferred inflation gauge, is at 1.7%, the highest increase since July 2014. Gasoline prices ($2.06 per gallon as of March 31) are near their lowest level since 2008. The yearly change is down 15.7%. However, price declines are not as extreme as they were last year, when the average annual percentage decline was 27.3% (Figure 4). The same story is holding true for other commodities, as well. The commodities component of CPI (which represents 38% of the total index) is down 1.7% in the past year. That is approximately half the average annual decline of 2015 (-3.3%).

CONSUMPTION

The rate of growth in consumer spending since the recession ended has been averaging 2.0%, which is a pace below that seen in past economic expansions (Figure 5). This is due in part both to the anemic pace of the expansion, and to those households that have been paying down debt to reduce the amount of leverage on their personal balance sheet(s). The important issue is that this expansion is more likely to be sustainable for a longer period of time because households are spending within their means. 

A major tailwind driving consumption has been the accelerating rate of growth in the amount of income that households have for spending, investing, and saving. Economists look at a monthly report called Real Disposable Personal Income. The “real” in the Real Disposable Personal Income report indicates it is adjusted for inflation, which is needed in a time series. This metric has been on a sharp upward trend since January 2013, and has benefited greatly from solid employment gains, slightly stronger wage growth, and low inflation.

 

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Index Definitions

The Atlanta GDPNow model forecasts GDP growth by aggregating 13 subcomponents that make up GDP with chain-weighting methodology used by the U.S. Bureau of Economic Analysis.

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living.

The Core Personal Consumption Expenditures Price Index (Core PCE) measures the prices paid by consumers for goods and services without the volatility caused by movements in food and energy prices to reveal underlying inflation trends.

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