Coming Into View

by Scott Brown of Raymond James, 3/29/17

Upcoming data reports will help to fill in the near-term picture of the economy, while developments in Washington will lead to a reassessment of the intermediate outlook.

As the first quarter of 2017 comes to a close, we have an incomplete picture of the economy. However, we’ll get some fresh information in the next two weeks that will allow us to get a more accurate reading. Note that the advance estimate of 1Q17 GDP growth isn’t due until April 28.

Consumer spending accounts for nearly 70% of GDP. February figures will arrive on Friday. Retail sales were reported to have risen modestly in February. However, the 1Q17 spending total is likely to be moderately strong, but slower than in 4Q16. Job and wage growth has been supportive, but gasoline prices have risen over the last year. While nominal average hourly earnings rose 2.8% year-over-year, but 0.0% after adjusting for inflation. In addition to reduced purchasing power, the household sector has also experienced delayed tax refunds, higher rents, and a reset of health insurance deductibles. As it is, February is a transitional month for the household sector. Many will pay down debt incurred during the holiday shopping season. Weather and seasonal adjustment can also distort the picture. Still, the fundamentals remain sound. Job data over the next few months will be an important gauge.

Business fixed investment appears to be trending at a moderately strong level. Orders and shipments of capital goods are trending higher, although orders may not be as robust as was hoped for earlier. Last year’s bottoming in energy exploration has had a positive impact. Job losses from the energy contraction were severe in some areas of the country, but small on a national level. The bigger impact was on business investment. There’s a lot of capital equipment in energy exploration. The contraction had a big impact on business fixed investment and, in turn, GDP growth. There is an interesting aspect to the energy recovery. Technology changes have led to fewer jobs being added. One technician can monitor and adjust multiple rigs. This is expected to be a theme in much of the goods-producing sector. Those hoping that manufacturing jobs will return are almost certain to be disappointed.

Foreign trade has been an important component of U.S. growth and a possible misstep remains one of the biggest risks going forward. At the recent meeting of G-20 central bankers and finance ministers, the U.S. pressured to remove language from the communiqué indicating that countries would resist protectionist efforts. Needless to say, this is not encouraging. Trump administration officials are reported to be divided sharply on foreign trade policy. The Wall Street types understand the importance of global trade and finance. The populists buy into the anti-trade rhetoric. Peter Navarro, who (despite having a Harvard Ph.D.) has been widely criticized for not understanding the elementary basics of foreign trade, is reported to have the president’s ear. Disagreements are not unusual in the early months of a new administration, but the trade policy outlook remains very uncertain and that uncertainty could end up being a negative for the economy.

The stock market rallied following the election, presumably on the belief that a rollback in regulations, a large infrastructure program, and tax cuts would propel the economy forward. The relatively few naysayers were more cautious on two fronts. One was that economic growth would likely be restrained due to labor market constraints – a simple story of the demographics. Indeed, this appears to be the view of the Fed, where the median forecast for GDP growth is 2.1% for 2017 and 2018.

The other reason to be cautious on the Trump rally is that his agenda will be difficult to achieve. A rollback in regulation is easy enough. Congress doesn’t need to rewrite regulations. The administration can simply put less effort into enforcing them. The $1 trillion infrastructure spending program seemed far-fetched, largely because, while needed, legislation will be difficult to get through the House (Democrats might go along if it were funded through tax increases, but that’s unlikely). Tax reform is more problematic. A tax reform bill would require 60 votes in the Senate, which would mean getting at least eight Democrats on board. That’s possible, but the end result would surely be watered down. Republicans could try to achieve tax reform through budget reconciliation (where only 51 votes are needed in the Senate), but they only get one extra item per year through budget reconciliation and they’re using that for the ACA repeal. Moreover, there are a number of tax issues embedded in the ACA, which means that Republicans will have to get the repeal done before work can begin on tax reform. Lowering business taxes will reduce revenues. A Border Tax Adjustment would offset about half of that, but the idea has received a lot of pushback, first from the European Union, which has indicated that it would file a complaint before the World Trade Organization, and second, from U.S. businesses that import supplies and materials from the rest of the world (the Senate has gotten an earful on this and it hasn’t been pretty).

If the post-election rally has been based on the full Trump agenda eventually coming to pass, there will be disappointment. The failure of the ACA repeal casts even more doubt about the ability to get things done in Washington. If the stock market rally is based on other factors, we may not see much of an unwinding. Still, there is a lot of uncertainty in the outlook as one gazes ahead to the next several months.

Coming Into View

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