Orlando's Outlook: In search of a one-armed economist

03-13-2018

Bottom Line The U.S. economy and financial markets find themselves at something of a crossroads at present. On the one hand, the labor market, business and consumer confidence, corporate profits and both the ISM manufacturing and service indexes are all quite strong, perhaps fueled by President Trump’s tax cuts, repatriation, the immediate expensing of corporate capital spending on equipment and deregulation. But on the other hand, net trade is deteriorating to its worst level in a decade—with the potential for a damaging, self-inflicted trade war, the consumer appears to have hit the pause button after the best holiday shopping season in six years, autos and housing have softened during the winter months and manufacturing trends are spotty. So amid concerns inflation may be picking up, the markets appear to be hypersensitive to the Federal Reserve’s leadership transition under new Chairman Jay Powell, and are watching for signs of a possible monetary policy blunder.

There’s a lot to like Since the tax cuts were passed, nonfarm payrolls have risen from 175,000 jobs in December to 239,000 in January to a surprisingly strong 313,000 in February, the labor market’s strongest month since July 2016. Importantly, average hourly earnings growth in February moderated to a solid 2.6% year-over-year (y/y) growth rate versus a downwardly revised wage increase of 2.8% in January. This helped to calm inflation concerns, along with core PCE and CPI inflation prints that have been running at relatively benign levels of 1.5% and 1.8% y/y, respectively, over the past several months.

The Leading Economic Indicator (LEI) in January and the Conference Board’s consumer confidence index last month are both running at cycle highs, while the Michigan consumer sentiment index and the small-business optimism index are just off recent peak levels. Similarly, both ISM indices hit new cycle highs this year. All of this contributed to the strongest y/y corporate earnings growth in six years—about 13% in 2017—along with a return to trend-line economic growth of about 3%.

What’s not working The trade deficit in January expanded to its widest level in a decade at $56.6 billion, 28% higher than just last August due to a record surge in imports that chopped some two percentage points from fourth-quarter GDP. That prompted President Trump to threaten the imposition of tariffs on our global trading partners. After strong holiday shopping in November, consumers retrenched in December and January and spent less on autos and housing. Finally, durable and capital goods orders and shipments declined month-over-month across the board in January, during which time factory orders fell and industrial production and capacity utilization rates slipped.

Adjustments to our GDP forecasts The equity and fixed-income investment professionals who comprise Federated’s macroeconomic policy committee met last week to discuss the economy and how the Fed might respond.

  • The Commerce Department revised fourth-quarter GDP down a tick to 2.5%, although the full year was unchanged at 2.3%. The third and final revision comes March 28.
  • The growing trade deficit has become more structurally worrisome, in conjunction with what we believe will be a temporary slowdown in both consumer spending and manufacturing in the first quarter of 2018. So we are reducing our first quarter GDP estimate (which we had raised from 3% up to 4.5% after the fourth-quarter flash) back down to 3.2%, while the Blue Chip consensus has raised its estimate from 2.5% to 2.8% (within a range of 2.1% to 3.5%). The Atlanta Fed reduced its GDPNow model from 5.4% last month to 2.5% last week.
  • Residual concerns about trade in the second quarter of 2018 prompt us to reduce our GDP estimate from 3.5% to 3.3%, while the Blue Chip consensus is raising its estimate from 2.8% to 2.9% (within a range of 2.4% to 3.5%).
  • We are keeping our third quarter of 2018 GDP estimate unchanged at 3.1%, while the Blue Chip consensus is raising its estimate from 2.6% to 2.7% (within a range of 2.1% to 3.2%).
  • We are also keeping our fourth quarter of 2018 GDP estimate unchanged at 2.9%, while the Blue Chip consensus is raising its estimate from 2.5% to 2.6% (within a range of 2.1% to 3.1%).
  • So our full-year 2018 GDP estimate is reduced from 3.4% to 3.1%, while the Blue Chip consensus is increasing its estimate from 2.7% to 2.8% (within a range of 2.6% to 3.1%).
  • Our full-year 2019 GDP estimate remains unchanged at 3.0%, while the Blue Chip consensus remains unchanged at 2.4% (within a range of 1.9% to 2.8%).
  • Additionally, we are raising our core PCE inflation estimates from 1.8% y/y in 2018 to 2%, and we are similarly increasing our 2019 estimate from 2% to 2.2%.

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