US Economy’s Rebound on Track, but Inflation Takes a Pause

The US economy’s performance thus far in the second quarter looks on track to return to its pattern of moderate expansion, in our view, reversing the softness seen at the beginning of 2017. The robust foundations provided by labor, housing and financial market strength remain in place, supported by the post-election improvement in consumer and corporate confidence, even if this economic cycle is unfolding in a different way than previous ones. Up to now, and for reasons that are yet to be fully understood, the labor market has not produced any noticeable increase in wage inflation, though it appears close to full employment. Although we are cognizant this weaker correlation between employment and wages may persist for some time, if the labor market continues to tighten, then it seems likely to us the historic pattern of higher wages feeding into broader inflation seen in past economic cycles will eventually reassert itself, allowing the Fed to move closer to the normalization of monetary policy.

The second reading of first-quarter US gross domestic product (GPD) growth, which saw the initial annualized rate of 0.7% revised up to 1.2%, helped to ease concerns about the sluggish start to the year, as did ongoing questions about the impact of seasonality on growth statistics. But more compelling evidence that the US economy could be regaining its footing came with April’s consumption report, in which consumer spending posted a respectable gain of 0.4% month-on-month, while March’s figure was amended from unchanged to a rise of 0.3%. Reassured by such data, most estimates for second-quarter growth predicted a solid rebound back above the 2% trend rate that has been characteristic of the US economy in recent years, with some outliers projecting a sharper acceleration to over 3%.

The labor market report for May showed additional hiring of 138,000, around 50,000 below consensus expectations, and also included a sizable reduction in April’s strong jobs gain. Nevertheless, the unemployment rate continued to move lower, with the reading of 4.3% marking the lowest level since 2001, while measures of labor participation and underemployment declined as well. In keeping with the pattern that has generally prevailed as the labor market has tightened during the current economic cycle, there was little sign of a sustained build-up in wage pressures in May’s report, even though April’s personal income release had shown an outsized gain in wages and salaries. Average hourly earnings ticked up 0.2% month-on-month—with April’s reading revised down to the same level—to leave the annual rate unchanged at 2.5%.

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