Uncertainty

We live in an uncertain world. Policymakers have to sift through a wide range of data, much of which is subject to statistical error and measurement difficulties. Financial market participants deal with much of the same data, but also have to account for the uncertainty in how policymakers will interpret the data and respond. There are longer-term questions, which won’t be resolved anytime soon. So where do we stand now?

On April 29, Federal Reserve officials will meet again to set monetary policy. That morning, the Bureau of Economic Analysis will release its initial estimate of 1Q15 GDP growth. There’s always a lot of uncertainty in the advance GDP estimate. The BEA does not have a complete picture of the component data – and as we’ve seen over the last several quarters, subsequent revisions can be very large. Rather than focus on the headline GDP figure, investors would do better to consider the key details. Consumer spending accounts for 70% of GDP. Job growth has been supportive, but wage growth has been relatively lackluster over the last several quarters. The drop in gasoline prices has pushed consumer price inflation close to zero (the CPI fell 0.1% over the 12 months ending in March), resulting in a sharp rise in real wages. That should help drive consumer spending in the near term. Spending was soft in December, January, and February. Inflation-adjusted spending appears to be on track for about a 2.0% annual rate in 1Q15, down from a 4.4% pace in 4Q14 (reflecting unusual strength in October and November). Spending in 2Q15 should pick up.

The sharp drop in energy prices has led to a significant contraction in oil and gas exploration. While locally severe, the loss of jobs should be small on a national level. The bigger impact on GDP will come through the drop in business structures. That decline will be magnified in the GDP calculation. Growth is reported at an annual rate. So a sharp decline in a single quarter will appear much larger. It’s hard to put a precise number on it, but the decline in business structures is likely to help push the headline GDP figure close to zero (or a bit negative) in the first quarter. Note that while energy exploration has contracted, energy extraction is still going strong, helping to keep energy prices low.

The negative impact of lower energy prices should be more front-loaded, while the benefits (to the consumer) are likely to build over time. In the advance GDP estimate, there is also the usual uncertainty surrounding inventories and net exports.

The Fed generated some confusion by saying it would begin debating rate increases in June. That doesn’t mean that the Fed will begin to raise rates at that time. Rather, it’s simply a return to business as usual for the Fed (less reliance on the forward guidance). While officials have continued to indicate that conditions are likely to warrant a rate hike by the end of the year, they have also suggested that the pace of increases (after the first) will be much more important, and likely very gradual.

U.S. investors are not the only ones interested in the Fed policy outlook. We saw significant global reactions in the “taper tantrum” of 2013. The reaction in emerging market economies to the initial Fed rate hike could be just as severe or greater.

Greece has been a reoccurring worry for investors here and abroad. We’ve been through this a number of times, and it usually ends with the can kicked down the road. However, the length of these “kicks” has gotten shorter and the calls for a Greek exit from the euro have grown louder. Both sides have been reported to be preparing plans for a Grexit, but there will be enormous challenges for policymakers if that happens.

The financial markets appear to be searching for a direction. Stocks often climb a wall of worry, but a lot of good news (a 2Q15 rebound in GDP growth, a Federal Reserve not in any hurry to tighten policy) is already factored in.

© Raymond James


© Raymond James

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