Predicting The Past With Greater And Greater Accuracy

The advance estimate of 1Q19 GDP growth will arrive on Friday (April 26). There’s always a lot of uncertainty in the advance figure (we’re missing a number of components) and that is especially so this time. The partial government shutdown and poor weather had an adverse impact. A narrower trade deficit should add to the growth estimate, but underlying domestic demand was likely moderate. The details of the report, and subsequent revisions, will help to gauge the underlying strength of the economy in 2Q19 and the rest of the year.

“If we could first know where we are, and whither we are tending, we could then better judge what to do, and how to do it.” -- Abraham Lincoln

The partial government shutdown led to the delay of a number of economic data releases. At this point, we only have January consumer spending data, which is subject to revision (consumer spending accounts for 68% of Gross Domestic Product). Retail sales results, which make up about a quarter of overall consumer spending, may give us a good idea about spending in February and March, but are an imperfect indicator. The March retail sales figures surprised to the upside, but still haven’t made up for the unexpected weakness in December. These data are adjusted for floating holidays, such as Easter, but it’s difficult to get that right. Looking through the noise, the weather, and the government shutdown, the underlying trend appears moderate – not particularly strong, but not terribly weak either.

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A strong job market is expected to support consumer spending growth in the near term. Weekly jobless claims have fallen to nearly a 50-year low. That could reflect seasonal adjustment issues (the late Easter) or eligibility issues (which vary by state). Corporate layoff announcements have been trending somewhat higher. However, those totals do not measure actual layoffs. Moreover, in a strong labor market, someone newly laid off is more likely to find another job more quickly – and therefore, is less likely to file a claim for unemployment insurance. Job growth should remain strong in the near term. However, the Fed’s most recent Beige Book, the anecdotal summary of economic conditions from around the country, showed that the tight job market was restraining the rate of growth” in some areas. Wage growth has picked up, but it remains relatively moderate compared to past periods of low unemployment. Firms continue to pull out all the stops to attract new workers, including offering signing bonuses, increased vacation, and other perks – but generally remain reluctant to lift wages for their existing employees. Gasoline prices have risen (much more than usual for this time of year), reducing consumer purchasing power in the near term.

Meanwhile, factory output has been soft in recent months. Some of that likely reflects a pullback from strength in manufacturing activity in previous months. However, the slowdown is also consistent with a softer global economy, a lackluster trend in capital goods orders, and trade policy disruptions. Weakness in manufacturing production has traditionally been an indicator of recession, but an imperfect one, often giving false signals in the past. The factory sector has accounted for a decreasing share of the U.S. economy – a trend that goes back decades. The recent soft patch is nothing to worry about, but is consistent with a slower trend rate of growth in the overall economy in the near term.

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One of the big surprises in last week’s economic data releases was the unexpected narrowing in the trade deficit. Trade policy has been disruptive. Imports of supplies and materials picked up in the second half of 2018 ahead of expected increases in tariffs. In turn, imports softened in 1Q19. We only have figures for January and February, so there is some uncertainty. Imports have a negative sign in the GDP calculation. When the U.S. economy is strong, we consume more domestic goods and we consume more imported goods. The increase in imports subtracts from headline GDP growth. Exports increased in January and February. Adjusted for inflation, net exports ought to make a sizable contribution to 1Q19 GDP growth, perhaps a full percentage point or more (note that net exports added 2.0 percentage points to 3Q18 GDP growth).

Foreign trade and the change in inventories are relatively small components of GDP, but they account for more than their fair share of volatility in the quarterly figures. Swings in defense spending can also add volatility. Financial market participants typically concentrate on the headline GDP figure, but if we are interested in the economy’s underlying strength, we should focus on Private Domestic Final Purchases (PDFP). PDFP can be thought of as GDP less government, the change in inventories, and foreign trade. It’s also consumer spending, business fixed investment, and residential fixed investment (mostly homebuilding) – the real meat and potatoes of the economy and is much less volatile from quarter to quarter. PDFP is likely to have risen at a lackluster-to-moderate pace in 1Q19, but should pick up in the second quarter.