1st Quarter GDP Disappoints…Again.

by Zach Bethune, Thomas Cooley and Peter Rupert

Today’s release of first quarter real GDP by the Bureau of Economic Analysis saw another weak 1st quarter, gaining only 0.2% at an annual rate.  It was expected that first quarter growth would be weak but this was below most analysts estimates. They were off by about a full percentage point as the median forecast was around 1%. The first quarter of last year was forecast to be around 1.1% and the eventual revisions left it at -2.1%!  It may well be that the first quarter numbers for 2015 will eventually come in negative.

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While there is much discussion of the impact of a severe winter on GDP…that is only a small part of the story. The bigger issues facing the economy are declining commodity prices – particularly oil prices and the much stronger U.S. dollar as other countries try to stimulate their domestic economies. The U.S. is a big oil producing economy so the impact of lower oil prices, while helping consumers, hurts producers and has a decidedly chilling impact on investment. In the first quarter alone, twenty five central banks around the world eased their monetary policies in an attempt to stimulate their economies. The effects of these could be long lasting. The decline in investment is likely to be a long lasting drag on growth. The decline in exports is only the first wave of the impact of a strengthening dollar.

oil

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The biggest detractors from GDP growth in the first quarter were non-residential fixed investment and exports.

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Nevertheless, the U.S. has an interest in other countries stimulating their economies. The U.S. is still the strongest game in town. Europe and Japan have continued to lag far behind in the recovery from the financial crisis – a fact the following graph makes very clear. But this tolerant stance will become more difficult to maintain when the Fed begins the cycle of raising interest rates later this year. That will undoubtedly strengthen the dollar further and raise questions about the unsynchronized nature of monetary stimulus among developed economies. So what does all this mean for the Fed and the future of policy? With such a weak reading for GDP and with the Atlanta Fed’s GDPNow forecast of just 0.9% growth for the second quarter likely means liftoff is likely not in the cards for the next couple of meetings at least.

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The Labor Market Falters

by: Zach Bethune, Thomas Cooley, Peter Rupert

Today’s Employment Situation  revealed a gloomy picture of the labor market for the first quarter of 2015. Non-farm employment increased by 126,000 in March, well below expectations. Job growth in January and February was revised down by 13%. Ovearall the picture is one of a stagnant labor market in the first quarter.  The unemployment rate remained unchanged, wages increased slightly and hours worked declined slightly.  The transition rate from unemployment to employment remained unchanged.

What are the implications of these developments for the future?  Some of the decline in job growth is due to declining oil and commodity prices.  Employment in the mining sector and construction fell as drilling declined sharply. Some of it was due to particularly severe winter which slowed economic activity.  These are both short term effects. Oil prices will not likely fall much more and the positive effects of consumers having more disposable income will show up gradually over time. If that is all we are dealing with we might expect the damping effect on labor markets to be short-lived.  More troubling for the longer term outlook is the dramatic rise in the value of the dollar.  Since the beginning of 2015 25 central banks have eased monetary policy. The list includes China, the ECB, and Canada, major trading partners of the U.S.  This has pushed up the value of the dollar precipitously and the effects of that on our export industries are only beginning to be felt. Exports declined in the most recent trade report and the effects on employment will, most likely, be increasing and ongoing.

A sluggish labor market and sluggish GDP growth all suggest that Fed will have plenty of reason to be patient at its June meeting and has plenty of breathing room for deciding on the timing of liftoff.

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Unemployment

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Part time for economic reasons

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Final Estimate of 4th Quarter GDP

by: Zach Bethune, Thomas Cooley, Peter Rupert

The third and final estimate of GDP released today by the Bureau of Economic Analysis provides no substantial new information on the growth of the economy…and therefore little to guide us to the future of interest rate changes by the FOMC. The final number for real GDP growth for Q4 is 2.2%, seasonally adjusted at an annual rate.

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Since the negative growth rates in 2008 and 2009, real GDP growth has been weak, but fairly steady year to year, 2010: 2.5%, 2011: 1.6%, 2012: 2.3%, 2013: 2.2%, and 2014: 2.4%; but, as noted here and elsewhere, quite slow relative to previous expansions.

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Consumption growth received a small boost, as did net exports, but inventories took a hit.

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Real investment took about 25 quarters to get back to it 2007 peak, typically taking only about 10 quarters. Residential fixed investment has yet to get back to its peak in 2007, it is still about 14% below that level.

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There is still real debate within the FOMC, however. From KC President George’s remarks: “While the FOMC has made no decisions about the timing of this action, I continue to support liftoff towards the middle of this year due to improvement in the labor market, expectations of firmer inflation, and the balance of risks over the medium and longer run. Liftoff in the middle of this year, in my view, would be fully consistent with the FOMC’s Statement on Goals and Monetary Policy Strategy, which reminds the public that monetary policy actions tend to influence economic activity and prices with a lag.” But, Chicago President Evans from a speech in London: “What is my personal view of the appropriate path for Fed policy? I think economic conditions are likely to evolve in a way such that it will be appropriate to hold off on raising short-term rates until 2016.”

In their own words, the future of lift-off will be “data-driven.” When isn’t it?

February Employment Stays Strong

by: Zach Bethune, Thomas Cooley, Peter Rupert

According to the Bureau of Labor Statistics establishment survey, employment increased 295,000 from January to February and has increased by about 3.3 million since February 2014. January employment was revised down slightly by 18,000 and December had no revision.  This continues the trend of strong employment growth consistent with an an ongoing robust recovery.  The unemployment rate fell further to 5.5% average weekly hours were flat and average hourly earnings rose only slightly. 

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Job gains were robust, only mining and logging, non-durable goods, and temporary help services saw small declines. Is the decline in temporary help services, for the second month in a row,  a signal of underlying strength in that firms are relying more on full-time workers rather than temps?  Maybe, but, as the chart below shows, as a fraction of total employment, firms use temp help much less during downturns.  Moreover, the use of temp services has doubled relative to total employment since the early 1990’s.

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Average weekly hours have remained fixed at 34.6 for the past 5 months after being stuck at 34.5 for the previous 7 months. Average hourly earnings rose only slightly from $24.75 to $24.78.

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While the establishment survey provided solid numbers, the household survey provided some mixed messages. True, the unemployment rate fell from 5.7% to 5.5%.

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But the labor force fell by 178,000 leading to a decline in labor force participation from 62.9 to 62.8 and no change in the employment to population ratio at 59.3.

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The number of persons working part time for economic reasons fell by 175,000, with 165,000 fewer reporting slack work reasons. The number of persons reporting part time for non-economic reasons increased by 15,000.

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All of this seems to provide further support for the view that the Fed should begin normalizing monetary policy sooner rather than later. Although recent communications have emphasized the view that they could be “patient,” we expect that language to disappear. The graphs below show the continued strength in the labor market, albeit slower than coming out of previous recessions.

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4th Quarter GDP….Downward Revision….Keeps Us Guessing

by Zach Bethune, Thomas Cooley and Peter Rupert

GDP Report
The BEA’s second estimate of 4th quarter GDP trimmed the growth rate to 2.2% from 2.6%. The downward revision will certainly give those more “patient” policy makers additional ammo to sit back and let the dust settle further before making any moves.

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Since the recovery began, real GDP has continued a long, slow climb out of the depths. As is evident in the graph below, the growth has been weaker than the typical recovery. Said differently, almost 30 quarters since the previous peak real GDP is less then 10% higher now; however, in the past real GDP was 20-30% higher after 30 quarters from the previous peak.

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Meanwhile, a version of the Taylor Rule with unemployment targeted at 6% and inflation at 2% calls out for an increase…and has been for more than 4 years.

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However, average hourly earnings growth has been anemic, stuck around 2% since 2010, meaning any changes in real earnings came from changes in inflation. The latest drop in inflation has meant an increase in real hourly earnings of about 2%. As can be seen in the graph below real hourly earnings growth since 2010 spent lots of time in negative territory, rarely hit even 1% and has averaged about zero.

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Moreover, five year out inflation expectations are also low.

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With no inflation pressures now or later, many on the FOMC likely feel little reason to begin liftoff. Indeed, from Chair Yellen’s remarks to Congress,

In sum, since the July 2014 Monetary Policy Report, there has been important progress toward the FOMC’s objective of maximum employment. However, despite this improvement, too many Americans remain unemployed or underemployed, wage growth is still sluggish, and inflation remains well below our longer-run objective.

While many were thinking that liftoff might begin in the middle of this year, but these words from her testimony imply later rather than sooner,

The FOMC’s assessment that it can be patient in beginning to normalize policy means that the Committee considers it unlikely that economic conditions will warrant an increase in the target range for the federal funds rate for at least the next couple of FOMC meetings. If economic conditions continue to improve, as the Committee anticipates, the Committee will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis.

But recent data have confirmed that falling oil and commodity prices may be masking movements in prices. Core inflation – excluding food and energy – jumped at the last reading and markets reacted.  The FOMC seems to be leery of acting too soon on liftoff but the bigger worry is that the costs of acting too late might be higher.

Finally, from the end of the testimony,

As always, the Federal Reserve remains committed to employing its tools to best promote the attainment of its objectives of maximum employment and price stability.

Good to know, thanks.

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