It was a tough week for the markets, as worries about first-quarter economic growth, especially in the U.S., began to set in. Over the past week or so, economic growth expectations have dropped from 2% to well under 1%. As one might expect, that helped make U.S. equities one of the worst performers this week and decreased bond rates. The U.S. 10-year Treasury rate has dropped from 1.79% last week to 1.7%.
However, the weaker economic expectations did not take their usual toll on oil, with signs that U.S. producers are finally taking product cuts more seriously. Commodities in general were up about 1.5% for the week. Europe and developed markets outside the U.S. were little changed for the week, which was better than U.S. market performance, as a lot of the poor economic news this week was from the U.S. However, emerging markets took it on the chin again, down 2.3% as investors generally moved to risk-off positions as economic prospects dimmed in the U.S., especially in the first quarter.
A combination of surprisingly low auto sales in March, announced late on Friday, an increased deficit for February announced on Tuesday, along with revised data in the factory order report (inventories and shipments) sent economists back to their drawing boards. That was before this morning's wholesale trade report that inventories were declining again and likely to further depress GDP growth rates. As recently as two weeks ago, average forecasts were for 2% growth. As late as Tuesday, a Wall Street Journal poll showed consensus growth of 1.3%. That survey was conducted Friday of a week ago through Tuesday, and we witnessed a lot of reports late this week suggesting growth of well under 1%. The Atlanta Fed's GDPNow forecast is down to just 0.1%. A negative GDP print is indeed a possibility, though not quite the likeliest case.
The first quarter has a track record of being flukey and has produced poor reports, so we are not particularly concerned. GDP growth was negative in the first quarter of 2014 and just 0.7% in the first quarter of 2015. Statisticians haven't caught up with changing spending patterns, and weird weather hasn't helped matters, either. Even if the first quarter shows no sequential growth, the year-over-year growth rate in GDP will likely approach 2%, hardly worrisome.
Trade data give another kick in the pants to the Q1 GDP calculation
The trade report for February showed a modest increase from US$45.9 billion to US$47.1 billion, with exports growing about 1% in nominal terms and imports growing by a faster 1.3%, causing the deficit to increase. When adjusted for inflation, goods exports were up 2.2%, imports were up 2.3%, and the deterioration in the trade balance looked modestly worse. There was some sense of relief that both exports and imports managed to increase after two consecutive months of decline in both categories. There were some real worries that the wheels were coming off the track for total world trade, a key driver of world growth over the last decade.
However, the number isn't great news for the U.S. GDP calculation. The inflation-adjusted trade data for February was one of the worst showings of this recovery. Without a lot of improvement in March, it appears that net trade is likely to subtract in the March quarter more than double the 0.14% subtraction in the December quarter. With inventories and consumers both looking at least temporarily soft, this latest hit from trade could easily drive first-quarter GDP below 1%.
The category data wasn't terribly useful, though the increase in exports was primarily related to consumer goods and autos. Consumer goods, particularly pharmaceuticals and toys, and capital goods, namely aircraft and computers, helped finally move imports back up. Import growth would have looked stronger if not for a relatively large decline in auto imports.
Year to date by region, falling exports to South America and Canada continue to show the biggest dollar declines. Exports to China, which held up relatively well in 2015, are down about 11% for the first two months of 2016. Imports from China are down a smaller 5%, likely because of the depreciation of the currency and not the quantity of goods coming into the U.S.
At the halfway point, federal budget deficit holding its own
The federal budget deficit for the first half of fiscal 2016 (October through March) increased slightly to US$457 billion from US$439 billion the prior year, or just US$18 billion. The increase in the deficit would have been even smaller if not for a quirk in the payroll calendar (one less Monday in March, a key payroll deposit date) and an abnormally large jump in inflation-adjusted interest payments, which is likely to be reversed with the April report. Without those two special factors, the deficit would have been less than US$10 billion higher than a year ago.
If past patterns hold, the deficit for the full fiscal year will be just slightly higher than the six-month deficit, as receipts in the second half (that includes the April 18 tax deadline) are much higher than in the first half and spending is relatively more balanced throughout the year. Adjusted for timing issues, it appears that the deficit for the full year will be about US$500 billion, or about 15% higher than a year ago and about 2.7% of GDP. But most of the deficit increase we anticipate for this year is due to the fact we are not expecting a repeat of the sale of frequencies to the telecom industry, which aided the deficit calculation by around US$30 billion in fiscal 2015, most of that in the back half of the year.
The year-to-date data on the deficit shows that receipts and expenditures are growing about 4%, but the total deficit is still up as expenditures are larger than receipts. If receipts and expenditures grow at the same rate, unfortunately the deficit decreases. Both revenue and expenditure growth was slower than a year ago. Those higher growth rates for the year-to-date 2015 data are shown in the far right column below.
A combination of new taxes and new spending, many related to the Affordable Care Act, caused large one-time spikes in both revenue and spending growth in fiscal 2015 (along with inflation adjustments to Social Security taxes and payments in calendar 2015, and zero inflation adjustments in calendar 2016). We are a bit surprised that Medicare and Medicaid payment growth has dropped so sharply given expanded coverage levels. We suspect that some true-up factor will show up later this year (as it did last year) that might boost these growth rates.
There is also reason to believe that the relatively low growth rates in these two categories may be what is holding back medical spending in the consumption reports and the GDP calculations. As usual, there has been no growth in defense spending (though it's not going down any more, either, at least in nominal dollars). The discretionary portion of the budget (nondefense, non-social-spending programs) also continued their modest growth at just 2.2%. Both of those low growth rates are almost unprecedented.
Longer-term deficits still an issue
The deficit situation looks benign for now, likely remaining below 3% of GDP through 2018. However, the good news is not expected to last, according to the most recent estimates from the Congressional Budget Office. The deficit is expected to expand from 2.7% in 2016 to 4.9% by 2026. The crux of the problem is a slow-growth economy, and a political climate that makes it very difficult to raise taxes will limit the growth of revenue, while an aging population will continue to dramatically increase spending. Continued expectations of higher interest rates and expanding debt will also drive spending higher.
Source: Congressional Budget Office
The mismatch in spending and revenue growth, without further legislation to raise taxes and cut spending, results in almost unprecedented peacetime, non-recession deficit levels. Though low inflation, better healthcare cost containment and potentially later retirements could improve these levels, it appears that legislative action to address the issues is needed sooner than later.
Source: Congressional Budget Office
Job openings report showing hopeful signs that labour mismatches are diminishing
In February, job openings decreased modestly as open positions at the end of January were filled by an increase in the number of new hires during the month of Feburary. While economists like to see an increase in openings as a precursor to better hiring, the recent growth in openings was unprecedented and perhaps even unhealthy. For almost 15 years' worth of data, hires always exceeded openings, since many openings were very quickly filled from a relatively large pool of workers that generally had the skills that businesses wanted. However, from the beginning of 2015, the number of openings ran higher than the number of hires, indicating significant mismatches. Those mismatches could be related to skills, low pay, or geographic location of the employment opportunities versus worker locations.
Those mismatches appeared to ease some as statistically, hires were up in February and now almost equaled opportunities. We caution that this is just a month's worth of data, and that this is just the start to a return to normal where hires exceed openings by a meaningful amount.
Source: Bureau of Labour Statistics
Also, the number of people quitting their jobs also remains near recovery highs. This is an exceptionally positive sign, indicating consumer confidence in the labour market. It is also consistent with the large increase in the labour pool in the March employment report, which was another sign of worker confidence that good jobs at a favorable wage were more readily available.
The pool of available workers compared with openings continues to shrink
As pleased as we are to see the gap between hires and openings, labour markets are continuing to tighten as the number of openings per unemployed person continues to contract. Overall, the ratio has declined from 1.8% to 1.5% over the past year. More notable is that industries appear to have severe issues with ratios below 1. In other words, if everyone in that industry who was currently unemployed was hired, there would still be more openings to fill. While worker churn accounts for some of this, it is still not a tenable position longer term. In addition, most industries are showing a decline in worker availability, with pressures easing only in the government sector and durable goods. The improvement in the construction industry is also notable in that the market appears to have tightened by more than a third, with a healthy decline in unemployed workers and an even bigger increase in openings.
ISM nonmanufacturing data the week's real bright spot
We don't usually spend a lot of time on the ISM services report, but in a slow week of soft data, we couldn't resist. Recall that last week, the ISM manufacturing index finally pushed back up above the critical 50 mark and registered its third monthly improvement. Alas, manufacturing isn't a huge part of the economy anymore. However, the services index for this week provides some basis for optimism. The overall services index jumped from 53.4 in February to 54.5 in March. Previously, the index had declined from 58.3 in October to 53.4 in February, though the rate of decline had slowed dramatically over the past couple of months. The ISM believes that the current reading is consistent with GDP growth of about 2.2%, which would be a nice improvement from what we are now anticipating for the first quarter.
New orders, one of the more forward-looking components of the index, showed an impressive increase, from 55.5 to 56.7. Export orders were up impressively from 53.5 to 58.5. Every major index component showed improvement with the exception of imports. Our only concern was the employment index at just 50.3, which is only slightly better than February's 49.7. Both of those readings would seem to suggest softer hiring conditions in the months ahead. Recall that the employment portion of the ISM was even weaker at 48.1. We have undergone a period where employment growth has run above GDP reports and this piece of data suggests that imbalance may begin to reverse.
Home price growth continues to accelerate
CoreLogic data provides us with an early look at home price increases every month. This week, we received the data for February, which showed continued above-expectation growth in home prices. Both monthly and year-over-year data are showing an acceleration even as most experts forecast a healthy decrease in home prices for all of 2016.
While higher home prices have the potential to slow the market, we believe that lower mortgage rates and higher employment levels are likely to offset that effect. Our guess is that as long as home price appreciation remains below 8%, homes will continue to improve with slightly slower growth in existing-home sales in 2016 and better sales of new homes. On a side note, prices are now just 6.5% below the previous peak in 2006.
Key data next week includes CPI, retail sales and industrial production
Lousy auto sales in March combined with limited growth in retail sales in January to punch a giant hole in everyone's consumption and GDP forecasts for the first quarter. The last thing we need now is another poor retail sales report for March. Unfortunately, we already know that auto sales will look terrible from the manufacturers' reports, so headline retail sales growth is expected to be a very modest 0.1% in March. Excluding autos, retail sales should be a much better 0.4%, though that also includes a healthy boost from higher gasoline prices (this report is not inflation-adjusted). We will continue to focus on the year-over-year, averaged data, excluding autos and gasoline, which we expect to be up its usual boring 3.8% or so.
We have had some fear about inflation, especially in services, for the past several months. Expectations are for both core inflation and headline inflation to be up about 0.2% after a 0.2 decline last month on headline and a surprisingly strong 0.3% on core. We will be watching the core number and suspect that both estimates might be just a little low. We suspect that gasoline will contribute 0.1% to 0.2% to the CPI calculation all by itself. We will also be watching healthcare inflation, which we hope cannot keep up its torrid pace of the first two months of the year. There have also been some recent articles about more balanced supply and demand for new apartments, which hopefully begins to soften rental price increases that have weighed so hard on the index, with annual increases approaching 4%.
Renewed declines in the oil sector are likely to push headline industrial production into negative territory again in March, with headline forecasts clustered around negative 0.1%. Utility growth will probably keep the number from being even worse. The manufacturing-only segment is expected to increase a very modest 0.1%, though even that may be a bit high given the decrease in manufacturing employment in March. The PMI data suggest that at least some improvement may be just around the corner, though probably not soon enough to help the March report.
