If the US economy had a report card for the first part of this year, the verdict would have a lot in common with my own school reports: disappointing, could try harder.
With each passing data release, the forecast for economic growth is getting a little lower. At the start of the year, the expectation was for economic growth of 3.1 per cent for 2015, according to FactSet estimates, but that has now come down to 2.6 per cent. There is also a strong case that the first-quarter figure will actually be revised into negative territory once all the data is in. The question for investors is whether this soft patch will develop into something more serious.
The underwhelming first-quarter growth number was driven by two big shocks: a plunge in the oil price and the strong appreciation in the US dollar. However, with the oil price moving a little higher and the dollar’s rise slowing, the expectation is for a bounce back in the economy in the second quarter of the year. Sadly, this bounce is not shaping up to be as high as hoped based on economic data for April.
The underwhelming first-quarter growth was driven by a plunge in the oil price and the strong appreciation in the US dollarThe fall in the price of oil led to declining investment in the energy sector and this drag will likely remain as long as the oil price remains low and oil companies cut back on capital expenditure spending. Meanwhile, the all-important US consumers have yet to crack open their wallets and flex their spending muscle. The fall in the oil price was supposed to have created an economic tailwind, as it is effectively a tax cut. When combined with a tighter labour market, rising wages and rising levels of consumer sentiment, the consumption boosters were ready to fire. Instead, they just fizzled.
American households chose to save their oil windfall instead of spending it, suggesting a much more cautious attitude to household finances than in the past. The retail sales numbers for April confirmed this trend in saving rather than spending, and the monthly time series has now fallen for four out of the past five months. Industrial production has also failed to deliver, with output declining for five months on the trot.
I would not give up on the consumer just yet, though. Wage data continues to improve, and the employment cost index rose by 2.8 per cent year-on-year in the first quarter for private sector workers, and given that inflation is zero, real wages are firmly in positive territory. It may take a little longer for that connection between cheap fuel and the increase in spending to materialise this time around. The tricky thing about the retail sales figures is that they include the very thing that should make them higher – fuel. When we strip out fuel sales from the headline retail sales numbers, things do not look quite so bad, but they are still not great.
The US, and the global economy in general should see faster growth over the second half of the year alleviating some of the current concerns. Certainly, this has been the case in the eurozone as inflation expectations have risen along with growth estimates. The growth outlook naturally leads to a conversation on rates and whether the pace of growth is enough to see inflation move higher and the unemployment rate lower and achieve the US Federal Reserve’s dual mandate of full employment and inflation of close to 2 per cent. I think there is, and that the Fed will continue to make noises on higher rates this year. And as the data turns, this rhetoric will increase. June may now be too soon, but, waiting too long to set off on the path to normalisation could be just as detrimental if it casts doubt on the financial stability of markets.
Finally, this could all come down to inaccurate measurement. Most economic data is seasonally adjusted to give a better reflection of underlying trends and account for factors that can distort data. Some economists are beginning to question how seasonality is affecting the gross domestic product figures, on the suspicion that the decline in first-quarter economic growth for the US in the past few years may be more than just a coincidence. Most recently, the Federal Reserve Bank of San Francisco published a paper discounting the official growth statistics and argued that the “real” number may have been closer to 1.8 per cent. The US economy may be on softer ground, but it is not yet stuck in the mud.
Kerry Craig is global market strategist of JP Morgan Asset Management
