Orlando's Outlook: Fiscal policy matters
Bottom line The U.S. economy grew at a much faster sequential pace during the just-completed first quarter, largely due to stronger-than-expected consumer spending and inventory restocking. But the results were nevertheless well below consensus expectations, as government spending fell sharply and as weaker-than-expected trends in net trade, housing, and business capital expenditures were unable to fully compensate.
GDP disappoints In its flash report for the first-quarter of 2013, the Commerce Department this morning announced the U.S. economy grew by 2.5%, substantially better than the 0.4% sequential growth rate achieved in last year’s fourth quarter. But the bad news is that this represents a sizable miss compared with consensus estimates for real Gross Domestic Product (GDP) growth of 3.0% for the first quarter, although it was a tick better than our own more conservative estimate here at Federated for 2.4% growth.
To be sure, this morning’s initial GDP report will be revised twice over the next two months, and the flash report is largely based upon data from the first two months of the measurement period (in this case January and February). But we also know that the U.S. economy has begun to decelerate into a typical “Spring Swoon” over the past two months. So when the first revision for today’s GDP report comes out on Thursday, May 30, our best guess is that the initial 2.5% growth estimate will be revised somewhat lower, due to the slower pace of economic growth during March, which will be worked into the government’s revised data at that time.
Moreover, we’re expecting that the fiscal-policy headwinds associated with the tax hikes that kicked in at the beginning of the year and the automatic spending sequester that kicked into gear on March 1 will combine to pressure second-quarter GDP, which we’re estimating at only 1.7%, with the consensus only a tick higher than us at 1.8%. We expect second-half economic growth to begin to improve from these tepid second-quarter levels.
The silver lining, then, to this downbeat picture of near-term economic-growth prospects is that Fed policymakers likely will remains fully engaged with both ZIRP (zero interest-rate policy) and “QE to Infinity” until at least the fourth quarter of this year.
Here are the details from this morning’s first-quarter GDP report:
- Consumer spending strong Personal consumption expenditures, which account for 70% of GDP, enjoyed their largest gain in more than two years, rising by a much stronger-than-expected 3.2% in the first quarter. This added 2.24 percentage points to first-quarter GDP, and compares with only 1.8% growth in the fourth quarter and first-quarter estimates for 2.8% growth. Much of the first-quarter gain in consumption probably occurred during January and February, in the aftermath of early dividend and bonus payments at the end of last year, to beat the expected increase in tax rates. To that end, retail sales in March declined sharply from robust February gains. In addition, the savings rate plummeted to 2.6% in the first quarter—the lowest in more than five years—from 4.7% in 2012’s fourth quarter, which also helped to boost spending. Finally, high-end consumers also benefitted from a rising wealth effect, due to higher stock and real estate prices.
- Inventories rise The pace of inventory restocking soared to $50.3 billion in the first quarter, up from $13.3 billion in the fourth, which added a full percentage point to quarterly GDP growth. This bounce was largely due to the rebound from Hurricane Sandy and the end of the farm drought in the Midwest. In addition, businesses had kept their inventories very lean heading into an uncertain Christmas season, given the economic chilling effect from fiscal-cliff discussions in Washington.
- Defense cuts drive government spending lower again Total government spending fell for the 10th time over the past 11 quarters, declining at a 4.1% annual pace in the first quarter, versus a 7.0% fourth-quarter drop, which subtracted eight-tenths of a point from first-quarter GDP. Although nondefense federal, state, and local government spending was down also, the decline was largely driven by an 11.5% drop in military spending, following a 22.1% plunge during the fourth quarter, due to President Obama’s planned cuts in defense. So real defense spending has now plummeted an annualized 16.9% over the past two quarters, which represents the largest back-to-back quarterly declines in defense since the military demobilization in the Korean War in 1954.
- Housing still healthy Marking its eighth consecutive quarterly gain, residential investment rose by 12.6% in the first quarter, which is certainly a slower pace than the blistering 17.6% gain in the fourth quarter and added three-tenths of a percentage point to first-quarter GDP. However, we believe that this sequential slowdown was due to seasonality and weather issues more than anything else, as we fully expect housing to reaccelerate strongly into the spring and summer months.
- Net trade slower While the stronger U.S. economy and the stronger dollar versus both the yen and the euro boosted imports and exports, the mix of imports outstripped solid export growth, resulting in a negative net trade balance that shaved half a percentage point from first-quarter GDP. Exports enjoyed a 2.9% gain in the first quarter, versus a 2.8% decline in the fourth quarter, but imports soared by 5.4% in the first quarter, versus a 4.2% fourth-quarter decline.
- Capex slows, too Legitimate concern among consumers and businesses regarding the government’s plans for tax hikes and spending cuts likely kept most on the sidelines and transformed potential spenders into “alligator arms,” with deep pockets and short arms. Real business fixed investment rose by a muted 2.1% in the first quarter, compared with a more robust 13.2% in the fourth quarter, which still added half a point to first-quarter GDP. Business equipment and software spending rose by 3.0% in the first quarter, compared with a much stronger gain of 11.8% in the fourth quarter. Business structure investment, such as factories and office buildings, slipped by 0.3% in the first quarter, versus a powerful gain of 16.7% in the fourth quarter.
Conclusion Poor fiscal-policy decisions in Washington have deleterious economic consequences, as it appears that the real and perceived concerns among both businesses and consumers about higher taxes and ill-targeted spending cuts have come home to roost—GDP in the fourth quarter of 2012 was barely positive, the just-completed first quarter was a disappointment, and we’re expecting the current quarter to experience a sequential decline in growth. We deserve—and need—better pro-growth fiscal policies.