Q1 Could Be Soft, But The Rest of 2018 Looks Solid

The economy looked stronger in Q4-17 than had been previously estimated, with GDP being revised up from 2.5% to 2.9%, and consumption being revised up from 3.8% to 4.0%. Good news.

But that was three months ago. Yesterday’s Personal Income and Outlays report gave a more current reading through February. It was pretty much as expected, and it was pretty much a mixed bag. After tax income, known as disposable personal income (DPI), gained +0.4% m/m and personal consumption expenditures (PCE) rose +0.2% m/m. Recent gains in income combined with muted spending have brought the personal savings rate back up from a perilously low 2.4% in December to 3.4% in February. This is unabashedly good news because it’s a more sustainable path than before, and it lays a foundation for consumption going forward.

However after inflation, the real income and spending data was somewhat less encouraging. Real DPI gained +0.2% m/m, resulting in a 2.1% y/y rate; that’s less than last month’s 2.3%, but it’s much better than the recent lows of 1.0% eight months ago and 0% fifteen months ago. This is the number that we hope to see accelerating through the year as wages rise. But it’s consumption, not income, which is counted in GDP, and real PCE was dead flat on the month. And on an annualized quarterly basis, PCE is now running at a tepid 2.2%, compared to the aforementioned strong 4% at the end of Q4, suggesting a limp Q1 GDP report. (We won’t actually see that report until April 27.)

Part of this slowdown is due to the fact that hurricanes brought auto and furnishing sales forward in Q3-17 and Q4-17, leaving those sales “artificially” depressed in Q1-18. In addition, ever since the end of the recession, GDP in Q1 of most years has underperformed, perhaps for improper seasonal adjustments, and that could be the case this year as well. Because hurricanes and seasonal adjustments cause temporary distortions, they do not affect our outlook for a solid remainder of the year and a forecast of 2.9% GDP growth.

The inflation side of the report showed the Fed’s favorite gauge, the PCE core (ex-food and energy), creeping up to +1.6% y/y from the +1.5% where it had been stuck for four consecutive months.

For consumers to spend, they need both the ability and the willingness to spend. The ability to spend, income, is developing slowly. But we have the willingness to spend in abundance. The U. Mich. Consumer Sentiment survey came out this morning at a 14 year high, with the current conditions component reaching a record (40 year) high.

I met with the Metals Service Center Institute a few weeks ago, which came at the height of the frenzy over the imposition of the 25% tariff on steel and 10% tariff on aluminum, and it was not a surprise that it was pretty much THE topic, almost to the exclusion of anything else. What was a surprise was that many of the attendees were doubtful about the supposed benefits of the tariffs, and viewed them with a significant degree of concern. Some fabricators had contracts to deliver their goods to customers in the future, set at a price before the tariffs were announced. If their input prices were to rise, their margins would be squeezed, or erased, or even made negative. Distributors were mostly ambivalent since they thought they could pass most of the costs through to their customers, but nonetheless the distributors’ sentiment towards the tariffs seemed leery. And there were reports that some firms were desperately trying to buy up as much metal as possible in anticipation of further prices increases, with the result that there are now shortages of certain products in the marketplace. Potential beneficiaries of the tariffs such as metals producers were in the minority of attendees and those who were there were quiet. Sometimes economists and real-world businessmen actually do agree, and in this case, they both disagree with the administration’s actions.

Separately, I heard the same report that is now sounding like a poorly-pirated recording of a song which has lost its novelty: a shortage of skilled labor. As a result, the business people are really embracing the ideas of promoting more vocational/technical education, and more skilled legal immigration. Unfortunately the former will take some time to become effective, and the latter may take much, much more time to even be considered.

All in all though, it’s a decent picture, with plenty of reasons for optimism, despite ever-present concerns.