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Weekly Economic and Financial Commentary: What Lies Beyond the Soft First Quarter?

U.S. Review

Resiliency in the Face of Uncertainty

  • The U.S. economy continues to show a great deal of resiliency in the face of slowing global economic growth and a whole host of geopolitical uncertainty.
  • Falling long-term interest rates have raised fears about a recession but have also halted the slide in home sales.
  • Consumer confidence fell in March, as consumers expressed less optimism about employment conditions. Plans to purchase cars and homes both rose notably.
  • Regional production indices weakened in March but remain at levels consistent with modest economic growth.

What Lies Beyond the Soft First Quarter?

Today marks the last business day of an exceptionally soft first quarter. We estimate that real GDP grew at a 1.4% annual rate during the quarter, largely due to the weakness in consumer spending and housing at the end of 2018 and at the start of this year. The federal government shutdown also negatively impacted Q1 growth, as did weaker global economic growth and lingering uncertainty surrounding geopolitical events, such as Brexit and ongoing trade negotiations with China.

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Through all of this uncertainty, the U.S. economy has continued to show a great deal of resiliency. The downward revision to Q4 GDP growth to a 2.2% annual rate effectively lowered the bar for the current quarter, which should make it easier to meet our modest growth expectations. The trade deficit also shrank sharply in January, which should boost Q1 growth.

Most data through February show the economy losing momentum. Income growth has been surprisingly weak, with personal income rising just 0.2% in February after declining 0.1% the prior month. Most of the weakness was in farm income and income from interest and dividends. Wages and salaries rose 0.3% in both January and February. Tax payments also apparently jumped in January, resulting in a 0.2% drop in real after-tax income. The softer income data may explain the recent dip in consumer confidence, which fell 7.3 points in March but remains at a fairly lofty level.

The hangover from the government shutdown has the statistical agencies playing catch-up. Only nominal income data are available through February. The latest real personal consumption data are for January and they rose just 0.1%, following a 0.6% drop in December. Much of January’s weakness in January was in durable goods, which plunged 1.6%. With incomes growing slowly, tax refunds running late and Easter falling late this year, the risks to Q1 spending are stacked to the downside for our 1.7% forecast. Any shortfall would at least partially result in higher inventories, mitigating some of the damage to Q1 growth.

Inflation continues to run slightly below the Fed’s objective. The overall PCE deflator fell 0.1% in January, and prices excluding food and energy rose just 0.1%. On a year-over-year basis, the core PCE deflator—the Fed’s preferred price gauge—is up just 1.8%. The lack of inflationary pressure gives the Fed plenty of latitude in holding off on any additional rate hikes.

Softer economic news combined with the drop in long-term interest rates has produced an inverted yield curve, with the yield on the 10-year Treasury note falling below the three-month T-bill. On an ominous note, every recession for the past 60 years has been preceded by an inverted yield curve. Every inverted yield curve, however, has not been followed by a recession.

Fortunately, the U.S. economy is slowing from a fairly strong position. Employment growth has been fairly strong, unemployment is low and household balance sheets are relatively healthy. The key areas to watch are the more cyclical areas of the economy—most notably motor vehicle sales, home sales and factory orders, all of which are losing steam.

U.S. Outlook

Retail Sales • Monday

After the largest monthly decline since the Great Recession, retail sales rose a modest 0.2% in January. Excluding volatile components, the control group rebounded 1.1% in January, but that wasn’t enough to make up for the cratering in this measure at the end of last year.

Consumer fundamentals have shown some signs of weakness. This morning we learned that income growth has been surprisingly weak, with personal income rising just 0.2% in February. Consum