Last week, statistical agencies in both countries released preliminary figures for first-quarter growth that were weaker than market expectations.
However, because growth numbers are backward-looking, they do not tell us much about where the economy is heading, making them less useful for markets. Investors should focus instead on whether this first-quarter dip will lead to a bigger stumble, or whether a larger rebound can be expected over the rest of the year.
The fact that both the US and UK’s economic growth slowed in the first quarter did not really come as a big surprise. Official data such as industrial production and durable goods had signalled that growth would be low over the first three months of the year. It is also worth remembering these initial estimates are based on limited data and are subject to heavy revisions. In the case of the UK, less than half of the data that goes into the final GDP calculation is available as the time of the first release and means that the ONS is relying heavily on estimates for the rest.
Digging down into the data, it is clear that US growth was affected by some one-off factors such as the poor weather and the port strike. However, the real surprise came in the size of the decline in investment infrastructure, which includes oil and fracking. But even then, given that energy companies have been signalling declining capital investment, even this should not have been a huge surprise.
The real question is how much of the loss will be recovered in the coming quarters. Survey data, such as the Purchasing Managers’ Index for manufacturing, remain above that key level of 50, which indicates expansion and is an encouraging sign for growth ahead. For the UK, the figure has actually been rising for the last three months. The strength in the labour market provides further evidence of robust underlying growth, fuelling the consumer’s status as the bedrock of the economy, with both retail sales and consumer confidence remaining elevated.
The consumer will play a greater role in the US growth story from here. The drop in the oil price has yet to lead to the anticipated oil windfall of an increase in consumer spending, and households have chosen to save the extra cash rather than spend it.
The softness in economic data is not helping to make the case for a mid-year rate hike by the US Federal Reserve or a 2015 move by the Bank of England. Both central banks remain in a “data dependent” phase of policy making. However, with the market pushing out estimates for the timing of the first rate hike in either country, there is a risk that markets could move too far. Markets are not pricing in a full 25-basis-point move in the UK policy rate until September 2016. One of the biggest risks to US assets is that markets are underestimating the strength of the labour market and the move towards full employment in the economy.
In the UK, the dip in first-quarter economic growth may not bode well for the current government just days before a general election, but it should not be taken as a signal of an economy beginning to stumble. Furthermore, economic activity should increase over the latter half of the year as the global economy gains momentum. History shows that political uncertainty has had little bearing on longer-term economic growth, and the UK economy was quick to recover from the 2010 election and the 2014 Scottish referendum.
For the US, the miss on economic growth was bigger than expected, but better weather in the second quarter, the resolution of the dock-workers’ strike, and a pick-up in retail spending should allow economic activity to accelerate over the rest of the year.
Investors should focus on the knowns: the economic outlook in the US and the UK is improving, and higher rates are on the cards. However, the big unknown is how we get there, and investors should prepare themselves for a rough ride ahead.
Kerry Craig is global market strategist of JP Morgan Asset Management
