United States Forecast Summary
Three months ago we began this commentary with: “The U.S. economy took a half step backwards in the fourth quarter.” Sadly, with basically zero growth, the same can be said of the first quarter. Although some of this was due to one-time factors, the two quarter swoon has forced us to rethink our expectation about the economic recovery. The result is a significantly less optimistic forecast, especially in the near term.
The advance report on economic activity during the first quarter was totally different from what we expected three months ago. Total output grew at just a 0.2% rate (compared with our forecast of 3.0%). Worse, the report included a significant amount of growth from inventory growth. Final sales fell at a 0.5% rate, almost 4% below our forecast. Worse still, when the NIPA data are updated toward the end of this month, the revisions are likely to be negative.
Unfortunately, the details were equally discouraging. The growth deficit was pretty much across-the-board. Consumption growth was put at 1.9%, well below our forecast of 3.4%, and this was the most positive part of the story. Growth in business investment was negative 3.0%, even though intellectual property investment was very strong. Spending on equipment was flat and investment in structures fell like a rock, as did exports. Residential investment recorded another weak quarter, and government spending (specifically state and local) shifted back into reverse after three positive quarters.
Some of this was due to a pair of unexpected temporary factors that should partially correct in the current quarter. The first was the weather, which for the second straight year was worse than normal in the northeast and Midwest. This probably weakened housing and business spending on structures. It may also have been a factor in weak spending on goods by households. The second was a port strike on the west coast that left goods headed for export backed up and imports waiting to be unloaded. The net effect was a very large jump in the trade deficit. Overall we think that collectively these effects may have reduced first quarter growth by up to one percent.
Also at work, however, were expected transitory effects that proved to be either less positive or more negative than we anticipated. To be specific, the impacts of the crash in oil prices that began in mid-2014. This was certainly partly responsible for the surge in consumption in the second half of last year (up at a 3.8% rate). Even so, this was below our expectation, causing us to anticipate further elevated spending in the first half of this year. Even factoring in the weather, the data suggest this is not occurring. On the other side of the ledger the price collapse was bound to drastically reduce investment for exploration and development. This has definitely occurred, and is a big part of the bad first quarter investment numbers. At the same time we had hoped that this would be partially offset by stronger investment from energy using sectors. There is little evidence for this. Overall, the net effect is that (so far at least) the oil price drop has been at best a wash, rather than the mild positive we had expected.
From a longer-term perspective our model continues to perform well. Our forecast a year ago looking out through the year ending in the first quarter estimated that output growth would be 3.2%. The actual data say 3.0%. Our expectations for components were also generally quite close. The largest miss was for international trade where we did not factor in the dollar appreciation of the past six months (or the effects of the port strike).
We find little in the first quarter data that is positive regarding the prospects for the rest of this year. There should be some bounce back from the effects of the weather and the strike, but beyond that we do not see any obvious impetus that could produce a significant acceleration in the economic recovery.
Recent Monthly Data
Monthly data are consistent with these conclusions. Data from March were on the soft side, perhaps with lingering weather influences. Data for April show improvement, but nothing to get excited about.
Consumption, for example showed some life in March, but not real strength after weak numbers in the two previous months. Consumer sentiment bounced higher in March, but then receded in April. Housing starts were very weak in February and then again in March. There is no sign that the sector is moving above the relatively low plateau it reached two years ago.
The business sector also remains in neutral. Industrial production has been flat over the past six month and is down over the past four. Similarly, the ISM manufacturing index declined from December through March and then was flat in April.
Friday’s release of labor market data for April was greeted with a huge sigh of relief and a 1.5% jump in the Dow Jones Industrial Average. Payroll employment rose 223 thousand. This was much better than the dismal 85 thousand in March, but less encouraging relative to the 269 thousand average of the year ending in February. Unemployment was down a tick to 5.4%, its lowest level since May 2008. Through 2013 and 2014 the rate fell just short of one tick per month, but so far in 2015 it is coming down at just half that rate. The participation rate was basically flat in April, indicating that the declining unemployment rate is due to rising employment rather than people leaving the labor force. This has ben the case since mid-2013.
We have become significantly less optimistic about the next year compared to our outlook three months ago. For the next four quarters (through 2016:1) we now expect growth to average 2.4%, down from 3.2% in our February forecast. For the current quarter our growth estimate is just 1.8%, compared with 3.3% in February.
At a disaggregate level the forecast has changed in a way that reflects our earlier discussion of the data. Consumption is somewhat weaker in our current outlook, as is housing. There is little change in our outlook for business investment, but its 0.6% contribution to GDP growth is down substantially from its level during the height of the energy boom. Over the five quarters ending in 2014:3 investment added 0.9% to GDP growth. We also have a continuing weakening in the trade balance.
In the labor market we now see employment growth averaging above 211 thousand per month over the next year, about 45 thousand below our February forecast and about 35 thousand below the actual increase during 2014. The deceleration in job creation is accompanied by further deceleration in the decline in unemployment. Unemployment falls to about 5.1% by year-end, down just 3 ticks below the current 5.4%.
Since the middle of last year our working hypothesis has been that the U.S. economic recovery from the Great Recession had been a two-phase experience, with a step up to a third phase in the offing.
The first phase, beginning in 2009 and lasting about four years, was the disappointing “new normal” with output growth of about 2%, and job creation well below 200 thousand per month. Unemployment declined, but in significant part because of a decline in labor force participation.
But after mid-2013 things began to look up. Phase two had growth slightly below 3%, with job creation at or above 250 thousand per month on average. Labor force participation stabilized, but unemployment continued to decline. The improvement was broadly based, with stronger spending by both consumers and business. Government spending shifted from decline to flat. There was even improvement in the trade deficit largely due to energy.
Our forecasts showed this second phase providing the basis for a further improvement this year and into 2016, with growth rising above 3%. Consumption was seen strengthening further, as was business investment. We thought the housing sector would re-accelerate. Government spending was expected to go from flat to slow growth.
Our current forecast abandons that optimistic phase three scenario. Rather than a basis for further progress it is consistent with the view that phase two was largely the result of the energy sector boom (bubble?). With the boom ended (at least for now), the economy is sinking back part way toward the new normal. Not all the way, since a lot of the damage done to household balance sheets has been repaired, and government sector finances are in better shape.