Macro Factors and their impact on Monetary Policy, the Economy, and Financial Markets
GDP growth slowed in the fourth quarter to 1.9% down from 3.5% in the third quarter. Both numbers were skewed by trade data. Third quarter GDP was lifted by .7% from the export of soybeans to South America, while imports shaved -1.7% from fourth quarter GDP. Since GDP attempts to measure gross domestic production, the Bureau of Economic Analysis (BEA) subtracts imports since they were produced outside of the U.S. While the BEA’s methodology is understandable, it can be misleading. While imports are not produced in the U.S., they are a reflection of U.S. demand. Final demand, which excludes trade, grew by 2.5% in the fourth quarter compared to 2.1% in the third quarter. Business investment rose 2.4% versus 2.1% in the third quarter. This is an encouraging sign since business investment has consistently lagged during this recovery. For the year, GDP grew 1.6%, the slowest since 2011 and down from 2.6% in 2015. The good news is the economy was stronger in the second half of the year and in better shape than the fourth quarter GDP suggested.
Although 2016 finished on a firmer note, it is still reasonable to expect the economy to slow in the first quarter. Year over year income growth was 2.5% at the end of 2016. While up from the 2.3% increase in 2015, the gain was modest, and not likely to cover the higher expenses most consumers will be paying in coming months. Health care costs continue to rise faster than income growth, which was clear to everyone paying higher insurance premiums for the first quarter of 2017. Energy costs have risen significantly since the first quarter of 2016 and this winter has been moderately colder than last winter. Heating homes, apartments, and driving cars is consuming more of consumer’s income in the first quarter of 2017. Mortgage rates are up, housing activity has slowed, and adjustable rate mortgage rates are taking a bigger bite out of paychecks. Since the election consumer confidence has jumped and consumers spent 4% more celebrating Christmas. This is probably why final demand was stronger in the fourth quarter, but consumers will likely start paying down credit card balances in the first quarter.
While the prospect of lower taxes for consumers and corporations has cheered equity investors, tax rates have not been lowered yet, so consumers don’t have more net pay to spend. Even if the tax cuts are made retroactive to January 1, 2017, which is very likely, consumer spending will be constrained in 2 the first quarter by all the issues just discussed. Corporations are likely to spend a little less in coming months, until the details for the depreciation of equipment investments and corporate tax rates are clarified. Companies that may be affected by the potential border adjustment tax are likely to be cautious and spend less. This could include a large range of companies that incorporate a portion of their supply chain outside the U.S. for even a small part of the final product sold in the U.S. Changes in the value of the Dollar impact the domestic economy about 9 months after a significant change. Between May and the end of 2016, the Dollar rose by more than 12%, so the drag will begin to hit by the end of the first quarter and carry through the third quarter. The recent 3% decline in the Dollar won’t become a positive until the fourth quarter.