"Modest-to-moderate" was the Federal Reserve's
unvarying verdict of the economy all through last year and even in the
last Beige Book posted earlier this month. But don't be too surprised
if FOMC policy makers begin to upgrade their assessment given the
building strength of incoming data centered in the consumer. In this
week's report we'll breakdown fourth-quarter GDP, take a look at the
housing sector, and even offer updates on the dollar and the lift
underway for oil.
The economy
GDP
came in at 2.6 percent annualized growth in the fourth quarter which
is solidly above the FOMC's long-range median of 1.8 percent and also
well above the long-range 2.2 percent high estimate. GDP has been
gradually trending upward over the course of the expansion including
the last 3 years and especially during 2017, a year that included the
3.1 percent and 3.2 percent results of the second and third quarters.
But
the hidden highlight of 2017 may very well be the fourth quarter's
results. Consumer spending, which makes up more than 2/3 of GDP, rose at
a very strong 3.8 percent rate. This is among the very strongest
results of the expansion and, importantly, is centered in durable goods
which surged at a 14.2 percent rate. Buying a new car or a new
appliance speaks to the confidence and strength of the consumer and
stands in contrast perhaps to less discretionary spending on essential
services like medical care or electric bills or spending on nondurable
goods such as groceries or household supplies. The 14.2 percent showing
for durables is the strongest in more than 9 years, a time when results
were being lifted by easy comparisons coming out of the Great
Recession.
What
really limited the fourth quarter were net exports, at an annualized
deficit of $652.6 billion. This comes out to more than 54 billion
inflation-adjusted dollars leaving this country each month! Imports of
oil are always an issue for the deficit but less so in recent years
given increases in the output of domestic oil. What is a persistent
sore point is the import of consumer goods, and looking at the details
(here in nominal dollars) shows an average monthly deficit of nearly
$53 billion. Imports of capital goods are even slightly higher but
these goods help improve business output and worker productivity.
Consumer goods, whether discretionary or non-discretionary, don't
provide the same benefits. These increasing levels of consumer imports
are masking what is in fact a healthy rate of export growth led
especially by foreign demand for capital goods which is one of this
nation's greatest strengths, such as aircraft and machinery.
Cross-border trade is in fact very active though the U.S. consumer's
preference for foreign consumer products continues to inflate the
deficit and in turn hold down U.S. GDP.
Inventories
also held down fourth-quarter GDP, rising $9.2 billion in the quarter
vs the prior quarter's $38.5 billion increase which is a negative in
the GDP calculation. But here, like the rising totals for exports which
are being masked by the greater totals for imports, the slowing
inventory build is coming at a time of strengthening demand which is
actually very positive for the economy. The lack of fourth-quarter
build points to the need for a greater first-quarter build and that
means rising production and rising employment. When excluding the
effects of net exports and inventories, GDP actually rose 4.3 percent
in the fourth quarter which is the best showing in 3-1/2 years and the
second best in nearly 9 years.
A
major plus for the economy over the past year has been solid rates of
business expansion which is measured in the GDP report by nonresidential
fixed investment. This rose at a 6.8 percent rate in the fourth
quarter and follows similar rates in the prior 3 quarters. Strength
here is no surprise given the exceptional rise in business confidence
and flow of investment funds into the stock market. But there is a note
of caution in the week's data and that comes from the core capital
goods component of the durable goods report. This reading, which
excludes defense products and also aircraft, shows a 0.3 percent
December decline in orders. The monthly weakness in core orders, which
includes a second straight sharp decline for communications equipment,
points to a future slump in capital goods shipments and poses an
obstacle to first-quarter growth in business investment.
We
close fourth-quarter GDP with a look at residential investment, which
is another consumer-related component and which rose at a very
impressive 11.6 percent rate. This is the best showing in nearly 2
years and reflects the rising strength of the new home market and
rising demand for home improvements. And similar to the strength in
nonresidential investment, it reflects the general strength of
confidence in the economy and especially the fundamental strength of
the labor market.
Residential investment makes up a deceptively
small percentage of GDP, less than 5 percent, yet the effect of housing
on the economy as a whole can be very significant. Home sales were
another feature of the week's news and the results were mostly solid.
Month-to-month sales data can be extremely volatile which makes 3-month
averages a necessity. Sales of new single-family homes (blue line of
graph) have been very strong, up 12 percent for the 3-month average
over the past year and up 9 percent during the fourth quarter to a
638,000 annualized rate. But sales of existing single-family homes
(green line) are another story, up only 1 percent during 2017 though
they did show life at year-end with a 4 percent quarterly gain to a
4.973 million rate. Yet with employment as strong as it is and with the
stock market taking off, why haven't more Americans been moving up to
better homes?
The
Federal Reserve's explanation is lack of housing inventory which
limits buyer choices. On the new home side, completions have been rising
with 6 percent more homes, at 295,000 in December, on the market than
in September. But existing homes are going the other way, at only 1.480
million for a quarterly decline of 20 percent. Why aren't more
homeowners putting their homes on the market? It's not because prices
are low. They've been rising at an annual 6 percent pace by the various
measures which, outside the stock market right now, is a strong rate
of return in a low interest rate economy. Perhaps part of the answer
lies in the labor market, specifically the JOLTS report where the
monthly separation rate has been subdued at just under 4 percent. With
people staying put, that is employers holding onto their employees very
closely and vice versa, there may be less relocation going on and with
this less need to swap homes. Whatever the factors, lack of supply in
the resale market looks to be one of the few early obstacles for the
2018 economy.
Markets: The dollar and worn out jawbones
The
dollar fell sharply at midweek after Treasury Secretary Mnuchin cited
the positive effects of its decline on "trade and opportunities",
comments that ECB President Draghi the next day warned are the language
of a currency war. The dollar index fell 1-1/2 percent in reaction to
Mnuchin to hit a 3-year low below 89 before President Trump voiced his
support for a strong dollar which sent the greenback higher. This is a
back-and-forth replay of the dollar-yen strategy early in the Clinton
administration when some advisors, seeking to reduce the nation's trade
imbalance with Japan, were calling for a stronger yen while others were
warning against it, most memorably Larry Summers who, as then Treasury
Undersecretary, spoke his famous line "you cannot devalue yourself
into prosperity." But devaluation was definitely the outcome back then
as the dollar fell 1/3 against the yen during the first 3 years of
Clinton's first term. And what did this mean for the deficit?
Devaluation certainly didn't reduce it as the goods deficit with Japan
widened from $49.6 billion in 1992 to $59.1 billion in 1995. Note that
the dollar index is down 3.4 percent so far this year following last
year's very sizable decline of 9.7 percent.
One
effect of a weaker currency, if not improvement in the deficit, is a
higher cost for imported foreign goods and services. This means getting
less for more which is the definition of inflation and which actually
would be welcome by Fed policy makers who have been trying hard to
reflate the economy. Another source of inflation is also now coming
from oil. Here supply is the key as OPEC is talking about sustained
production cuts at the same time that U.S. inventories, as tracked in
the columns of the graph, continue to fall. Dollar weakness and oil
strength, not to mention a very low 4.1 percent unemployment rate and
the risk of wage inflation, could fire up inflation quickly -- and, in
what would be an irony, perhaps more quickly than the Fed could contain.
Markets at a Glance | Year-End | Week Ended | Week Ended | Year-To-Date | Weekly |
2017 | 19-Jan-18 | 26-Jan-18 | Change | Change | |
DJIA | 24,719.22 | 26,071.72 | 26,616.71 | 7.7% | 2.1% |
S&P 500 | 2,673.61 | 2,810.30 | 2,872.87 | 7.5% | 2.2% |
Nasdaq Composite | 6,903.39 | 7,336.38 | 7,505.77 | 8.7% | 2.3% |
Crude Oil, WTI ($/barrel) | $60.15 | $63.50 | $66.14 | 10.0% | 4.2% |
Gold (COMEX) ($/ounce) | $1,305.50 | $1,334.40 | $1,354.20 | 3.7% | 1.5% |
Fed Funds Target | 1.25 to 1.50% | 1.25 to 1.50% | 1.25 to 1.50% | 0 bp | 0 bp |
2-Year Treasury Yield | 1.89% | 2.06% | 2.11% | 22 bp | 5 bp |
10-Year Treasury Yield | 2.41% | 2.66% | 2.66% | 25 bp | 0 bp |
Dollar Index | 92.29 | 90.64 | 89.12 | -3.4% | -1.7% |
The bottom line
There's a lot of activity in the U.S. economy
right now and FOMC policy makers may not have the luxury of downplaying
the strength. Yes, inflation has been very limited but there are many
advanced indications of greater pressure ahead: strong consumer demand,
strong business demand, a falling dollar, rising oil prices -- not to
mention a tax cut and full employment.
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