Looking Back, Looking Ahead

The advance GDP report was a mixed bag. The headline figure was stronger than expected, but boosted by faster inventory growth and a narrower trade deficit, both of which are likely to reverse in the second quarter. Consumer spending and business fixed investment slowed, while residential fixed investment fell for the fifth consecutive quarter. The first quarter’s softness in underlying domestic demand likely reflected an impact from the partial government shutdown, and these key components of the economy are expected to rebound in 2Q19. Still, we’ll need to see proof of that in upcoming economic data reports.

Investors place far too much weight on the headline GDP figure. First quarter growth figures will be revised, and revised, and revised again over the next few months. The 2nd estimate is due May 30, the 3rd estimate arrives on June 27, and annual benchmark revisions are set to be released on July 26 (along with the advance estimate of 2Q19). However, the underlying story ought not to change much.

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Private Domestic Final Purchases, consumer spending plus business fixed investment plus residential fixed investment (or equivalently, GDP less net exports, the change in inventories, and government) rose at a 1.3% annual rate in 1Q19 (vs. +2.6% in 4Q18), up 2.8% year-over-year. Growth in underlying domestic demand was almost certainly restrained by the partial government shutdown (December 22 to January 35, the longest on record). However, it’s hard to say exactly how much. March figures on retail sales and capital goods orders point to a rebound, but the underlying trends appear to be lackluster to moderate.

We’ll get personal income data for March on Monday (April 29) and the Friday’s employment report (May 3) will give us a good idea of wage and salary income for April. Monday’s report will also include spending figures for February and March (the February figures were delayed due to the government shutdown). We’ll also get some clues in the details of the employment report. Retail, manufacturing, and temp-help payrolls each fell in March, not a good sign – and a further drop in April would be a red flag.

The PCE Price Index rose at a 0.6% annual rate in 1Q19 (+1.4% y/y), restrained by lower energy prices, which had begun to turn higher in March. Ex-food & energy, the PCE Price Index rose at a 1.3% pace (+1.7% y/y), below the Fed’s 2% goal. Low inflation allows the Fed the luxury of waiting to decide its next move. The odds of a Fed rate cut by the end of the year, as reflected in the federal funds futures market, have varied widely in recent weeks – from nearly 75% in late March, to about 28% on April 16, and back up to about 65% more recently.

The Federal Open Market Committee is widely expected to leave short-term interest rate unchanged following the two-day policy meeting (announcement due at 2:00 p.m. on May 1). There will be no revised Fed forecasts this time – no new dot plot. Inventors will focus on Chairman Powell’s press conference, where he is almost certain to be asked about the low inflation trend and about the specific conditions that would prompt the Fed to cut rates in the months ahead. Powell should add further color to this year’s ongoing discussion of the Fed’s monetary policy framework – its strategies, tools, and communication policies. The first quarter’s low inflation figures should further fuel the discussion on whether the Fed should shift to a price level-targeting system (where periods of low inflation would prompt a push for higher inflation to make up the shortfall for the current 2% goal).